One of the more interesting but esoteric financial news stories in recent days came from the Middle East. Kuwait has hired a handful of investment banks to help it issue international bonds on the open market. National governments issue debt all the time, so the news is nothing new, but Kuwait has never issued debt before and is famous for having a strong revenue stream from oil exports that makes international debt unnecessary.

The fall in oil prices in recent years has been big news and had a major impact on economies everywhere. Inflation ground to a halt in 2014, 2015, and early 2016 as a result of the crash in commodities. It was also broadly seen as a serious challenge for oil producing countries such as Kuwait. Saudi Arabia publicly said this was an opportunity to diversify away from energy; those diversification plans remain unclear. More recently, OPEC has worked to fight the fall in prices with an agreement to cut oil production. Many analysts believe countries that agreed to cut will not abide by their promises, so the impact on oil prices will be minimal.

Nonetheless, we’re far from the lowest point on oil futures and prices have shown greater stability in recent months than we’ve seen since the crash began in 2014. This is the context which Kuwait finds itself in as it hires banks to sell debt.

So the question now becomes: why are they selling the debt and what does this mean for the future of oil and the Middle East?

Firstly, the debt sale will help the country cover its budget deficit, which could fall by 50% if oil rises to $55 per barrel on average (not far from its current level). That would bring the deficit down to about $15.5 billion. The bond sale is expected to bring in another $10 billion, leading to a deficit of about $5 billion.

The bonds are clearly a way of repairing public spending in a country not used to running budget deficits. There are various other problems with Kuwait: an unskilled domestic labor force, very low productivity, high incomes, no domestic tax revenue, and of course all the geopolitical problems the region offers.

In such an environment, the sovereign bonds Kuwait offers will have risk attached to them. S&P rates the country at AA, meaning the yield investors will get may fall short of the real risks involved.

However, the upside is that the country’s financial situation will improve rapidly as oil prices recover. With this in mind the bonds could be an unconventional income-yielding proxy for the oil markets without the volatility of energy futures themselves and the capital loss potential of buying stock in energy companies.

With that in mind, the bonds are an interesting financial instrument and there’s obvious reason why institutional investors could have high demand for them. The actual pricing on the bonds and their subsequent repricing in the secondary market will be complex and very hard to predict. This is partly what makes them so interesting, and also of tremendous potential value for the right analyst who can understand these new assets.

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