* GCC's international bond issuance set for record in 2017
* Bonds replacing syndicated loans as primary debt instrument
* This eases liquidity pressure on regional banks
* Institutional investors drawn by higher bond market liquidity
* Loans to remain first option for many corporates
By Davide Barbuscia and Saeed Azhar
DUBAI, April 26 (Reuters) - The volume of international bond issues from the Gulf may hit a record high for a second straight year in 2017 as lower oil prices crimp the capacity of banks to finance billions of dollars of investments and state budget deficits.
Issuance data shows the six-nation Gulf Cooperation Council's bond market is on track to become more important than its syndicated loan market in a region traditionally dominated by relationship-driven bank lending.
This historic shift is positive for economies because it eases risks and liquidity pressures for the region's banking system, which has been hurt by smaller flows of petrodollars, bankers and economists say.
It is also changing the behaviour of investors in the bond market, which has long been led by local banks that buy the bonds to hold them until maturity rather than trading them.
Jumbo bond issues by governments – such as Saudi Arabia's $17.5 billion debut sale last October, the largest ever in emerging markets - have deepened the market and created new pricing benchmarks. This has stimulated trading activity, attracting more institutional and foreign investors.
Monthly Reuters polls of Middle East fund managers in the last few months have shown their interest in bonds at or near record levels, to a large extent because of the bond market's increasing liquidity.
The trend looks set to continue. Last year Standard & Poor's estimated the funding needs of GCC countries - Saudi Arabia, the United Arab Emirates, Kuwait, Qatar, Oman and Bahrain - at $560 billion between 2015 and 2019. This will push regional governments to rely heavily on bonds.
"The financing requirements are significantly larger than they have been historically," said Jonathan Segal, head of capital markets for the Middle East and Africa at Mitsubishi UFJ Financial Group.
"Given that the region's financing requirements have risen very sharply, absolutely there is a need for the region to be looking at other sources of financing and doing more to attract those sources."
The GCC's international bond issuance was around $30 billion each year from the mid-2000s until it suddenly spiked to a record of $69 billion in 2016, Thomson Reuters data shows.
Meanwhile, syndicated loan volumes totalled about $60 billion annually in 2013 and 2014, $70 billion in 2015 and $78 billion last year. If the current trends continue, bonds could overtake loans this year.
"Syndicated loans will continue to be important, for instance in the project finance space, but debt capital markets will remain in focus going forward," said Monica Malik, chief economist at Abu Dhabi Commercial Bank.
Segal said: "In this region, in the past if you had $1 dollar of DCM (debt capital markets) for financing, roughly $3 came from loans. Now I would not be surprised if there is parity."
Some borrowers are expected to continue to fuel demand for bank loans, however.
"The absence of local currency bond markets leaves regional corporates with little choice but to resort in the first instance to traditional bank loans," said Dima Jardaneh, head of regional economic research at Standard Chartered.
"Also, transparency requirements for tapping international capital markets could still be a deterrent for a large segment of corporates in the region."
Bank lending on a project finance basis will remain key for many of the Gulf's multi-billion dollar infrastructure requirements. But tight liquidity and regulatory burdens on banks will limit their lending capacity in this area.
"The project financing gap which the region is expected to experience for the coming few years will require tapping a wider array of financing modalities, including structured finance and project bonds," Jardaneh said.
Editing by Andrew Torchia and Toby Chopra