Saudi Aramco IPO: Loss for Equities, Gain for Fixed Income?

News that Saudi Aramco is unlikely to list its shares in the foreseeable future may be a loss for equity investors, but could expand the global fixed income universe.

The Saudi Arabian government has a number of other ways of monetizing its assets, including loans, in order to fund its development plan for the Kingdom, known as Vision 2030. One option would be to sell its stake in the petrochemical company Saudi Arabia Basic Industries Corporation (SABIC), held via the Public Investment Fund and valued at US $70bn, to Aramco. Aramco could issue debt to fund the purchase, which in turn would catapult Saudi Arabia into the top five biggest issuers in emerging markets. This could have significant implications for holders of emerging market bonds via major indices.

If Aramco were to issue the debt, it would likely enter the widely followed JPM EMBI Global Diversified Index (EM USD Sovereigns). Saudi Arabia is not currently part of this index yet but its inclusion, alongside other Gulf states, is under consideration (as discussed in our previous blog). Debt issuance of US $70bn would put Aramco, and thereby Saudi Arabia, among the top five biggest issuers of emerging market government bonds. Given the current index constituents, it would have a weight of around 4% (Figure 1), just below the current weighting of Indonesia. If all investors were to be neutral versus the index weight, it would result in total purchases of about US $15bn or about 20% of the deal size.

If Aramco were to issue debt indirectly via SABIC, the bonds would undoubtedly be added to the widely followed JPM CEMBI Broad Diversified Index (EM USD Corporate Bonds) (Figure 2). Saudi Arabia would jump from being the 21st biggest weight in the index to the third biggest with a likely weight of 5.4%. This would result in index-related flows of about US $5.5bn, a lot lower than if Aramco were to issue the debt.

Aramco or SABIC both would be the highest rated bonds to be added to the two EM Indices, but still offer a higher yield than many lower-rated issuers like Panama Government bonds on the sovereign side or Polish PKO Bank (B rated) bonds on the corporate side (Figures 3 and 4).

If Aramco were to issue US $70bn of debt, directly or indirectly, it would almost certainly be the biggest debt issuance by any EM issuer ever. It is also highly likely that the new debt would be added to the Bloomberg Barclays Global Aggregate Index which has about US $2 trillion to US $3 trillion managed against it. Saudi Arabia would have a weight similar to that of Russia in this index at about 0.3%, leading to potential index flows of US $4bn.

Saudi debt maturing in five years trades at a spread of about 100 bps over US Treasury benchmark. Issuers similar to SABIC with similar ratings and maturity (like chemicals giant BASF) trade at just at a 4 bps spread. So there should be good demand from investors seeking to pick up the additional yield, as well as broader interest from both EM and developed market investors. This is turn should boost Saudi’s capital markets and bring spillover benefits for other Saudi issuers further down the line, as it would enable them to tap international bond markets in size and at lower costs.

Whether or not Saudi Arabia goes down this debt route in order to fund its Vision 2030 remains to be seen. But investors should be aware of the potential ramifications for their portfolios if and when the Kingdom decides to issue bonds, potentially at considerable scale and possibly both in hard and local currency denominations.

 Abhishek Kumar – Sector Head, Emerging Markets Debt – State Street Global Advisors