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GCC enter the JP MORGAN EMBI index

June 2019

GCC enter the EM club

China Turkey and Argentina  dominated the headlines in recent months but one emerging market story has been neglected. That of the oil-rich Gulf Co-operation Council (GCC) nations entering the leading external EM sovereign bond index.

Entry window...

On 31 January, five countries of the GCC (Saudi Arabia, UAE, Qatar, Kuwait and Bahrain) began their phased nine month entry into the JP Morgan EMBI Global Diversified index. This represents the largest ever one-time adjustment to the leading dollar EM debt index. Oman, the other GCC member, already joined in 2018. 

The new GCC nations will account for 11.4% of the benchmark, a big change in one year. We highlight what bond investors need to know.

Concentrate now

Saudi Arabia dominates the GCC economically with 44% share of overall GDP.  The UAE accounts for 25%, Qatar 14%, Kuwait 9%, Oman 5% and Bahrain 2%. As Figure 1 shows, what unites all the GCC economies is their concentration: they account for five of the top six most concentrated economies, according to the UN*.
Fig. 1
UN product concentration index by country: 2017
UN product concentration index by country: 2017

Source: Pictet Asset Management, CEIC, Datastream, UNCTAD, 31.12.2017

*The index ranges from 0 to 1 where a number close to 1 indicates a highly concentrated economy

The reason for this high concentration is these nations remain heavily reliant on the oil sector as shown below.
FIg. 2
GDP breakdown by economic sector & country: 2018
GDP breakdown by economic sector & country: 2018

Source: Pictet Asset Management, CEIC, Datastream

As a result, GCC economies are very vulnerable to oil price fluctuations which makes GDP growth more volatile - see below.
FIG. 3
GDP growth volatility vs concentration index
GDP growth volatility vs concentration index

Source: Pictet Asset Management, CEIC, Datastream, UNCTAD. *Degree of concentration of goods exported excluding services

 

Diversify...

With low oil prices becoming a persistent rather than temporary factor, it is imperative for GCC nations to diversify their economies. They have made significant strides towards this objective, as we can see in the concentration index in Figure 4a. The UAE clearly stands out, despite containing oil-rich Abu Dhabi.

Looking at the World Bank “Ease of doing business” survey, the UAE is again the front runner with a very credible 11th place out of 190 as Figure 4b shows. However, other GCC nations have some way to go. For example Saudi Arabia has made numerous reforms since 2005 but is still more poorly ranked. 

FIG. 4
Fig 4a: Concentration index by country: evolution / Fig 4b: Performance in World Bank "Ease of doing business" survey*
Fig 4a: Concentration index by country: evolution / Fig 4b: Performance in World Bank "Ease of doing business" survey*

Source: Pictet Asset Management, CEIC, Datastream, UNCTAD /  Pictet Asset Management, CEIC, Datastream, Bloomberg, World Bank. *Countries ranked from 1-190  with low numerical value indicating favorable (easing) business conditions

Going forward, all GCC economies are targeting economic diversification under their respective Vision 2030 goals. But delivery is now required: investors will have to watch out for VAT implementation, reforms to business environment and labour markets, and the rolling back of subsidies, to name a few.
Pictet

Why was the GCC added to the index?

GCC nations had previously been deemed “too rich” to meet normal emerging market index eligibility. However, JP Morgan introduced the purchasing power parity ratio as new parameter, making them eligible for inclusion. 

The inclusion also reflects the fact that GCC governments have become some of the biggest debt issuers globally, as the plunge in oil prices has forced them to turn to debt markets for funding. Issuance by GCC nations has risen to reach 4-5% of the block’s GDP. 

What is the impact?

Beyond adding an element of oil price beta to the JP Morgan EMBI index, roughly USD120 billion of bonds will be added to the index by end of this September. The number of countries in the index rises to 72, the highest ever. The number of issuers and instruments increases as well (by 52 to 731 and 14 to 168 respectively).

With Kuwait, Qatar and UAE in the double A rating range, the weighted average credit rating of the benchmark will rise to investment grade (BBB- from BB+). This will offset the ratings hit the index took on the back of significant downgrades of Brazil, Russia and Turkey.

FIg. 5
USD denominated 10 year bonds vs credit rating
USD denominated 10 year bonds vs credit rating

Source: Pictet Asset Management, CEIC, Datastream, Bloomberg

As Figure 5 shows credit quality and yield diverge among the GCC. Kuwait, Qatar, Saudi Arabia and the UAE exhibit higher credit quality and low yields, which is the opposite for Bahrain and Oman.

It is too early to see what the wider impact of inclusion will be in terms of investor returns. However, as our Market Watch table shows below, YTD the JP Morgan EMBI Global Diversified is the leading bond index with a return of 7.65% – almost double the return of the local currency JP Morgan GBI-EM Global Diversified.

Overall, we think the GCC nations are relatively attractive compared to the wider EM sovereign universe given their high credit ratings, lower risk and generally stronger financial buffers, as well as the fact they are pegged to the US dollar.