Bahrain faces a dilemma in coming days as it decides whether to issue a sovereign bond at a time of extreme volatility in global markets. It is a dilemma which issuers confront around the world - but in Bahrain's case it looks particularly acute.
The island kingdom, which is alone among the six oil exporters of the Gulf Cooperation Council in running a sizeable budget deficit relative to its economy, this week completed investor roadshows in the United States, Middle East and Europe for a potential bond issue of at least $500 million.
Since then, the rout in global debt markets has worsened, after U.S. Federal Reserve Chairman Ben Bernanke said on Wednesday that the U.S. economy was strong enough for the Fed to begin slowing the pace of its bond-buying stimulus this year. He signalled an end to the programme by the middle of 2014.
If Bahrain puts its issue on hold, as most borrowers around the world are doing, it will risk having to pay much more when budget pressures eventually force it to come to market; it has no certainty the market turmoil will ease in coming months.
The 10-year U.S. Treasury yield is at 2.38 per cent after Bernanke's statement; in the long term it may be heading to around 4.0 per cent, which some consider a "normal" level historically.
But if Bahrain goes ahead and issues its bond now, it will leave itself open to investor speculation that it is simply unable to wait as it needs the money urgently. Because of its weak state finances, that speculation could be damaging.
"Looking to issue in such conditions will raise questions about how desperately Bahrain needs to raise funds from bond markets right now," said Chavan Bhogaita, head of markets strategy at National Bank of Abu Dhabi.
He added that Bahrain would still be able to get a deal away in current market conditions, if the pricing met investor expectations.
The acuteness of Bahrain's dilemma is at least partly responsible for the underperformance of its debt since the bout of market instability began.
Its $1.5 billion, 6.125 per cent sovereign bond maturing in 2022, rated BBB by Standard & Poor's and Fitch Ratings, is bid at a yield of 5.80 per cent, its highest level since last August and up 133 basis points since the end of May.
By contrast, yields on Middle East sovereign bonds have risen 28 bps on average since the start of this month, according to the HSBC NASDAQ Dubai Middle East Conventional Sovereign U.S. Dollar Bond Index.
Bahrain has underperformed countries such as Turkey, which is in the middle of its biggest political crisis in a decade. The yield on Turkey's $1 billion sovereign bond maturing in 2022 is up 107 bps since end-May.
Behind the concern about Bahrain is its rising state budget deficit; in May the International Monetary Fund forecast a fiscal shortfall of 4.2 per cent of gross domestic product or roughly $1.2 billion this year, up from the 2.6 per cent deficit reported by the Bahraini government for 2012.
The country has succeeded in keeping its economy growing during political unrest and street protests by its Shi'ite majority that have continued since 2011.
But while many investors were willing to ignore the political risk just a few months ago as they searched for yield in a global environment of loose liquidity and falling interest rates, they may become less willing against a background of rising rates.
The long-term economic outlook may be more of a concern than the political outlook, because trends in oil prices and government spending appear to be moving the wrong way for Bahrain. It needs to spend heavily to support the economy during the unrest, but its small oil reserves are expensive to exploit.
Moody's Investors Service cited these trends last Thursday when it put its Baa1 rating of Bahrain on review for a possible downgrade, with the result to be announced in three months. Moody's now rates Bahrain one notch above the other two agencies; Moody's analyst Steffen Dyck told IFR, a Thomson Reuters service, that any downgrade could be by one notch or two.
"The IMF estimates Bahrain's fiscal break-even oil price close to $120 per barrel. Under the current forecasts for global oil prices of just over $100, Bahrain will continue to run a fiscal deficit for the foreseeable future," he said.
Key to Bahrain's finances is support from Saudi Arabia, which is politically and economically close to the tiny state. Bahrain relies on an oil field it shares with Saudi Arabia for some 70 per cent of its budget revenue, and investors expect Riyadh to extend more financial aid if necessary.
However, the extent of Bahrain bonds' slide this month suggests investors do not attach a 100 per cent probability to unlimited Saudi financial support.
"For Bahrain to successfully issue bonds, the key debate is how much a $120 fiscal break-even oil price and unresolved domestic political divisions are offset by support from Saudi, and the desire among international investors to regain lost ground and hunt for yield," said Dubai-based Hasnain Malik at Frontier Alpha, an independent research provider.
Raza Agha, chief economist for Middle East and Africa at VTB Capital in London, said that if Bahrain did go ahead and issue in coming days, it would be reasonable to expect a new 10-year issue to price at a spread of at least 350 bps over benchmarks, considering where the 2022 bond was now trading.
He noted that with such pricing, Bahrain would still pay less than it did to issue its 2022 bond in July last year.
Other options could be considered. Islamic bonds are generally less volatile because of the buy-to-hold nature of their traditional investor base, and would appeal to regional, and especially Saudi, investors.
"Some could also argue that instead of a regular dollar-denominated issue, a sukuk or a euro-denominated issue may help improve pricing even further," Agha said.
Saudi markets are closed for the weekend on Thursday and Friday, so a Bahraini sovereign deal looks unlikely to print on those days. Market sources said Bahrain might proceed next week, once markets had fully digested Bernanke's statement.
Even a smooth issue could prove expensive for both Bahrain's finances and its profile among investors, however.
"If they go ahead, it will be out of necessity. Primary markets will struggle, especially a Bahrain bond," a regional fixed income trader said.
Bahrain has mandated BNP Paribas, Citigroup, JPMorgan Chase & Co and GIB Capital, the investment banking arm of Gulf International Bank, to arrange any bond sale.