SAUDI Arabia’s ambition to tap global bond markets in 2016 has international banks lobbying hard to convince Riyadh they can secure the best borrowing rate for what is expected to become a benchmark in Middle Eastern debt.

But amid competition for market share between oil producers, pushing oil prices to multiyear lows, and with fellow exporters Nigeria and Azerbaijan looking to emergency bailouts, the kingdom is being advised to tread carefully.

Credit investors say the size and rate of Saudi Arabia’s first sale of international bonds will depend on three things: the price of oil, the kingdom’s financial reserves and market volatility.

Oil price and wider volatility threaten the success of the kingdom’s international debut

If pressure on all three eases, it could be one of the most successful debuts on bond markets. If they collide, the sale may be limited to an unremarkable few billion dollars borrowed at a higher rate.

The world’s largest producer of oil has always managed to fund public spending, incurring little external debt and amassing reserves.

But with oil prices close to $30/barrel, down from more than $100 in 2014, and with military spending increasing thanks to its involvement in Syria and Yemen, the kingdom has been burning through its money.

Foreign reserves fell to $640bn last year from $737bn in 2014, leading some Saudi experts to question whether the riyal’s peg to the dollar is in jeopardy.

Saudi Arabia has announced a budget deficit of $87bn for this year. Plugging that gap without depleting foreign reserves requires drastic action.

King Salman, who took the throne last year, and his son, deputy crown prince Mohammed bin Salman, have cut price subsidies and mooted a public offering of shares in Saudi Aramco, the state-owned energy group, which is the world’s largest oil-producing company.

Andrew MacFarlane of BNP Paribas says the company could be worth $2-3tn. So if Riyadh sold 5pc, the receipts could fund the deficit for a year.

However, the float has no deadline and plans are vague. Making use of capital markets to borrow funds has been suggested as a more immediate plan.

Officials have said public debt, which reached SR44bn at the end of 2014 — 1.6pc of gross domestic product — could hit 50pc by 2020.

Local markets have been fired up. Last year Saudi Arabia sold its first domestic-currency bonds since 2007, selling SR15bn ($4bn) to local banks. Issuing local debt is cheap, but to expand the pool of creditors and avoid overwhelming local investors dollar- denominated debt is also being planned.

Credit strategists at two banks say the first dollar-denominated bond could be about $5bn, possibly split into tranches, with the first issuance unlikely to have a long maturity.

While this will make only a tiny dent in the deficit, the bankers say it is wise to start small when investors may be wary about the kingdom’s ability to service its obligations. Last month Standard & Poor’s, the credit rating agency, cut Saudi Arabia one notch from double A minus to single A plus. The cost of insuring existing local-currency debt against default has doubled in the past year.

According to one person at a large European bank, a Saudi bond issued tomorrow would incur a 200 basis point premium above equivalent US bonds, giving a five-year borrowing rate of 3.34pc.

Oxford Economics expects new Saudi bonds to be issued at a yield 100bp over equivalent US Treasuries, for a five-year rate of 2.34pc, while analysts at Bank of America Merrill Lynch say the bonds would probably trade a little wider than those of Qatar, which has a dollar-denominated 2022 bond yielding 3.05pc.

State-owned Saudi Elec­tricity has a dollar bond due in early 2023 that yields 3.82pc. One banker at a large European institution said Saudi Arabia’s five-year borrowing rate could be close to 3pc.

“I don’t expect them to issue euro­bonds in the first quarter while markets are so volatile,” says Steven Hess at Moody’s, which recently opted not to cut the kingdom’s credit rating. “Then again, if oil prices stay where they are then the need to finance the deficit plans could be accelerated.”

Published in Dawn, Business & Finance weekly, February 8th, 2016