Deepening the GCC debt markets: The Saudi Arabian experience

Abstract

Financial markets are a vital and integral part of the modern economic system. The financial system essentially provides the grease upon which the wheels of commerce and industry operate efficiently. A well-functioning financial market is therefore critical to the health and well-being of the economy. Disruptions in these markets can have dire consequences for the real sectors of the economy, as was vividly evidenced during the financial meltdown of 2008, triggering global recessionary trends, the effects of which are still being painfully felt. While financial markets can be classified in numerous ways, one useful way to view the overall market is in terms of equity versus debt markets. The global fixed income or debt market is a vibrant and vital part of the overall financial system, accounting for over two thirds of the total value of outstanding securities. Much of the financial engineering and innovations in recent years have taken place in this segment of the market. Floating rate bonds, inverse floaters, inflation-indexed bonds, multicurrency bonds, pay-in-kind bonds, catastrophe bonds, Islamic bonds, etc., are just a few examples of innovations that have caught the interest of investors. Entities that issue debt securities essentially are economic units that are deficient in funds and enter the markets to obtain funding at terms that suit their current and future needs. An exception to this is Central Banks that issue debt securities in their role as regulators of money supply and liquidity. While private corporations can raise funds through the issue of equity (shares), governments, municipalities, and semigovernment agencies may have no other recourse but to issue debt. Nevertheless, there are compelling reasons why corporate entities may wish to issue debt. These include tax management strategies, market signaling of their future prospects, and altering management incentives. Buyers of debt securities are either institutional or individual investors whose objectives include receipt of periodic income, lower risk exposure, and the diversification of their investment portfolios. In addition to buyers and sellers, the efficient working of the market requires an institutional infrastructure within which the system can operate. This is provided by financial intermediaries and institutional arrangements, which include primary and secondary dealers, exchanges, investment banks, credit-enhancing agencies, and credit rating agencies. Figure 2.1 shows a schematic representation of the structure of debt markets. The market consisting of the institutions and players is governed by the economic, business, legal, and regulatory structure of the economy.