* Gulf bonds rally on global "risk on" mode
* Bond pipeline strong, borrowers eye window to issue
* Islamic bonds may appeal after outperformance
By Rachna Uppal
DUBAI, Oct 13 (Reuters) - After two months of inactivity due to the euro zone debt crisis and turmoil in global financial markets, high-grade borrowers from the Gulf Arab region may be close to resuming issuance.
There is a substantial number of bonds in the pipeline, and a partial improvement of sentiment in global markets in the past week -- although the euro zone crisis remains fundamentally unresolved -- has helped Gulf spreads tighten dramatically.
The average yield on the HSBC Nasdaq Dubai GCC conventional dollar bond index fell to 5.039 percent on Wednesday from 5.245 percent at the end of last week. Average spreads, calculated over Libor, narrowed to 305.6 basis points from 345.6 bps. In the week to Oct. 5, net outflows from emerging market bond funds slowed to $1.4 billion from the previous week's $3.2 billion, according to IFR Markets.
Abu Dhabi's Union National Bank held roadshows for a potential bond in September but has so far refrained from issuing. Dolphin Energy, Dubai-based mall developer Majid Al Futtaim (MAF) Holding, and Tourism Development and Investment Co (TDIC) met investors earlier this year but did not issue, citing "market conditions".
"Clearly it is not the market where low-quality issuers can get anything done," but the situation is different for some higher-quality issuers, said a London-based Middle East fixed income investor.
High-quality names still face higher spreads compared to several months ago but this is partly due to a collapse of U.S. Treasury yields , he noted. "In spread terms, they get frustrated because it is not as tight as it was, but in absolute yield terms people are still looking at levels that are very attractive."
Several Gulf names have rallied to trade at near-par levels during this week.
"If Europe remains quiet on the bad news front, we should see this rally continue in the short term," said a regional fixed income trader.
The Dubai government's 7.75 percent 2020 bond was bid at 99.831 on Thursday morning to yield about 7.776 percent, down from 8.468 percent on Oct. 5.
Abu Dhabi investment fund Mubadala Development Co's 5.75 percent 2014 maturity was bid at around 107.549 on Thursday afternoon to yield about 2.667 percent, from 2.953 percent on Oct. 10.
"You can price credit risk but not event risk, and that is the main reason why the volume of new issues is low," said an Abu Dhabi-based trader.
"If the stability that we saw this week continues, then the climate will be better for new issues, and then we can talk of spreads and how much premium issuers need to pay to raise money."
If issuance does resume, however, it is likely to be gradual because high-grade credits do not appear desperate for money, analysts said.
"At the end of the day, the most highly rated credits are the ones that tend to have the least need for finance," said Nicholas Stadtmiller, fixed income analyst at Emirates NBD. "Entities that can raise funds easily either don't need or don't want them, and those would like to raise money have a harder time getting it."
Some traders speculate that Islamic bonds, or sukuk, could be among the first bonds issued after the drought. Sukuk held up relatively well in the secondary market during the recent volatility, partly because investors tend to buy them to hold for maturity rather than for trading. This could prompt both borrowers and investors to see the sukuk market as a relatively low-risk place for issuance.
"The sukuk markets are new and not nearly as liquid as developed debt markets. That creates opportunity," said Akram Annous, MENA strategist at Al Mal Capital in Dubai.
Government-owned Abu Dhabi National Energy Co (TAQA) is seeking regulatory approval for a ringgit-denominated benchmark sukuk, while Kuwait Finance House's Turkish unit Kuveyt Turk Participation Bank is on the road this week in Asia, the Middle East and Europe for a potential Islamic issue.
Average spreads for GCC sukuk on the Nasdaq Dubai dollar sukuk index have narrowed to about 295 bps from over 320 bps at the beginning of this month. (Additional reporting by Martin Dokoupil and Mala Pancholia; Editing by Andrew Torchia)