Financial Markets and Instruments in Saudi Arabia - Assignment Example

?FINANCIAL MARKETS AND INSTRUMENTS In the Kingdom Saudi Arabia, the use of money market is very active as a means of provision of liquidity funding for most transactions that take place on short term basis with asset maturity period of less than a year (Hargroves, and Smith, 2005). In most of these cases therefore, there is over the counter payment using various instruments. A typical of these instruments is the use commercial paper. In the Kingdom of Saudi Arabia, the use of commercial paper is governed by a Royal Decree No 37 of 10.11.1383 AH (Drucker, 2011). Under the regulatory instrument, emphasis is on the use f commercial paper by larger corporations or companies who have had the backing of an issuing bank, promising to make settlement for the quotation on the face of the commercial before or on the date specified. Like in most other financial jurisdictions, the issuance of commercial paper is not guaranteed by a collateral and so the need for strict regulations that ensure that such instruments on the money market are used only by corporations that have been rated with excellent credit rating status (Fombrun, 2012). 2. At different times in the economic management of the country, the government of the Kingdom has had the need to generate both long term and short term financing. As far as short term financing is concerned, emphasis has always been on the use of short term financing to take care of short term debt financing. One of the commonest instruments used in this case is overdraft, whereby it transmits cash that are beyond available funds (Greenley and Foxall, 2011). On the long term also, the use of equity investment ranks as the commonest form of financing that the government undertakes. Often, this is done by targeting local industries and buying and holding shares of the stocks of such businesses for projected capital gains and dividend growth. Commonly, equity investment has been selected in cases where investments have been proven to have high information asymmetries and moral hazard (Drumwright and Murphy, 2001). 3. With a global rank of 40, the Macro Economy Meter (2013) rates the total outstanding debt of the Kingdom of Saudi Arabia as $134 billion. Of this total outstanding debt, the share of public debt has been calculated to be 12.9% of the gross domestic product of the country, coming up to $6.6 billion. According to the CIA World Factbook, the Kingdom of Saudi Arabia as of 31 December 2012 had a total outstanding external debt of $127.4 billion. By this, it means the government of the Kingdom owed this amount to public and private entities that were nonresident of the country and thus repayment had to be done in either foreign currency, goods or services (Fombrun, 2005). Because these external debts are paid through foreign currency, they are calculated based on exchange rate base rather than the use of purchasing power parity terms. 4. Since 2001, the annual total value of new borrowing by the Kingdom of Saudi Arabia has generally been experiencing and upward rise trend. This means that the rate of borrowing done by the government has been increasing consistently by the year. In the graph below, it would be noted that but for the periods from 2003 to 2005, and 2008 to 2009, the annual total value of debt has been increasing, indicating a rise in new borrowing. Source: Marco Economy Meter (2013) Based on readings from the graph, McAlister and Ferrell (2012) have argued that the new borrowing that is done by the Saudi government on a monthly basis is US $1.2 billion, coming up to an annual total of $14.4 billion. With this value, the debt-to-income ratio of Saudi Arabia has been estimated to be very high, leading to annual per capita income of $25,000. 5. The use of stripped coupons is not illegitimate in the Kingdom of Saudi Arabia but not a commonly preferred form of debt financing or financial capital generator. This is because in the use of stripped coupons, there are often two stripped parties, one of which receives the principle as zero-coupon bond when the bond is mature, and the other receiving the fixed interest that is done during the life time of the bond as stream of coupons (Neville and Bulent, 2005). Among other factors, this form of capital generation is not preferred because of the risks of guaranteed profitability and the number of processes involved in generating profits. For example it takes much accounting to peg a price at which to sell the face value of the bond after the total bond has been stripped and if this calculation is not done right in relation to prevailing interest rates at the time of sale, could bring about under subscription of the bond (Pachauri, 2004). 6. There exists an active market in corporate bond financing in Saudi Arabia, which is not actively engaged by only private corporate institutions but also state and public corporations (McAlister and Ferrell, 2012). Due to the government’s activeness in bond financing, it has received various ratings AA- from Standard & Poor, Aa3 from Moody’s rating and STA from Moody’s outlook (Global Finance, 2013). Corporate bond financing serves as both short term and long term financing instrument for most local and foreign corporations who engage in bonds for periods of such as 1-Month, 2-Months, 3-Months, 6-Months, 9-Months and 1-Year. 7. In principle, it can be said that there is a foreign bond market in the Kingdom of Saudi Arabia. This is because there are several corporations which offer bond financing, being local companies, but with huge foreign share or ownership. What is more, almost all the bond financing that is done in the country are international bonds. Examples of companies offering bond financing in the domestic market are Islamic Development Bank, which has binds issued till 2016, Saudi Electricity Company, which has bond issued till 2022, Banque Saudi Fransi, which has bond issued till 2017, and SABIC, which has bond issued till 2018 (C Bonds, 2013). Of these companies, who may be relatively local, there are international or foreign investments from Deutsche Bank, HSBC, Standard Chartered Bank, CitiGroup, Credit Agricole CIB, Mizuho Financial Group and RBS (C Bonds, 2013). 8. All latest outstanding bonds issued in the Kingdom of Saudi Arabia are coupon bonds (C Bonds, 2013). This means that among other provisions, the issuers do not redeem the bond prior to its maturity as takes place with callable bonds and do not sell bonds at prices lower than the their face value as prevails with zero-coupon bonds (Greenley and Foxall, 2011). Rather there are coupons paid in ranges of six months. The quoted coupon rates are however annualized for even transposition of the bonds. In a typical example, the Islamic Development Bank has issued a coupon bond till 2016 at norminal minimum settlement amount of $1,000 and Par at $1,000 with outstanding face value of 75,000,000 at a coupon rate of 2.350% in a coupon frequency of 6 months (C Bonds, 2013). The situation is similar for other issuers with the only forms of differences coming in with the coupon rates, some of which are 2.947% for Banque Saudi Fransi and 2.625% for SABIC. 9. It would be noted that the use of high risk or junk bonds are generally associated with high yields to bondholders when borrowers do not have much option of selective criteria (Greenley and Foxall, 2011). What is more, junk bonds or high risk bonds are common among bond markets that are usually rated in the BB or Ba categories or even less. To this end, the existence of high risk or junk bonds do not abound on the bond market of Saudi Arabia as majority to all issuers are rates above BB and hold credibility as low- to medium-risk lenders. Instead of high risk or junk bonds therefore, there is the issuance of investment grades (Fombrun, 2012). 10. The use of ratings is very common in the host country of Saudi Arabia. Generally, the rationale for the presence of a number of rating agencies who focus on the money market and medium to long term markets alike is because of the presence of competitive agencies issuing out these money market and medium to long term market transactions. The two commonest international rating agencies are Standard & Poor and Moody’s. 11. Due to the history associated with debt defaults in the Kingdom of Saudi Arabia, with the Sukuk default as a major reference point, corporate entities that default on debts are not made to enjoy extra protection as it exists in the United States and other parts of the world. It would be noted that the Sukuk, which represents that type of bond that exists as Islamic Bond had a major payment default in 2009, two years after it was instituted (Neville and Bulent, 2005). This default affected credibility in the region and led to withdrawal of most forms of financing till recent years when government take over in most forms of financing brought back credibility (Drucker, 2011). Due to these situations and history, trading in debt has been regarded as an immoral offence in Saudi Arabia that would not come with any protections. 12. There are very reputable non-bank financial companies that act as shadow bankers, giving out financial support to companies in the forms of loans and other private equity (Neville and Bulent, 2005). The term reputable is used with caution and much meaning to depict the nature of service that these shadow bankers provide. This is because the operations of all these banks regulated and monitored by the Arab Banking Corporation, giving so much legal and ethical guidance to the companies as to how they should operate. References C Bonds (2013). Saudi Arabia: bonds. Accessed November 1, 2013 from http://cbonds.com/countries/Saudi-Arabia-bond Drucker P. F, 2001,Social impacts and social Problems, The Essential Drucker, Butterworth Heinemann Publication: Oxford Drumwright, M.E., Murphy, P.E. (2001), "Corporate societal marketing", in Bloom, P.N., Gundlach, G.T (Eds),Handbook of Marketing and Society, Sage, Thousand Oaks, CA, pp.162-83. Fombrun C. J. (2005 ) , RI Insights A World of Reputation Research, Analysis and Thinking Building Corporate Reputation Through CSR Initiatives: Evolving Standards, Corporate Reputation Review , Vol. 8, No. 1, 2005, pp. 7–11 Fombrun, C. (2012), Reputation: Realizing the Value from the Corporate Image, Harvard Business School Press: Boston, MA. Global Finance (2013). Saudi Arabia Country Report. Accessed Novermber 1, 2013 http://www.gfmag.com/gdp-data-country-reports/186-saudi-arabia-gdp-country-report.html#axzz2jRwJsUuB Greenley, G. and Foxall, G. (2011), "Consumer and non-consumer stakeholder orientation in UK companies", Journal of Business Research , Vol. 35 No.2, pp.105-16. Hargroves, K. C. and; Smith, M. H, eds (2005) Natural advantage of nations: business opportunities, innovation and governance in the 21st Century, Earth scan :London Macro Economy Meter (2013). External Debt (Total) Saudi Arabia. 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