This May, in what would turn out to be one of its last actions, the Egyptian government under Mohamed Morsi approved a law allowing the state to issue Islamic bonds. A central part of the Muslim Brotherhood’s economic programme, Islamic bonds (or sukuk) were to be issued in order to ease pressure on government finances and narrow the fiscal gap. Optimistically, the Finance Minister predicted that the state could raise as much as $10 billion annually through these Sharia-compliant measures.
Egypt’s government debt is currently at about 80% of GDP and policymakers are trying to reduce the country’s dependency on local banks by increasingly turning to foreign lenders. “The North African country has already secured a large number of concessional loans from Arab governments,” says Jacques Verreynne, economist at the research organisation NKC Independent Economists, “and issuing international bonds could be another way of securing foreign exchange”.
Sukuk are a fairly niche product but are open to all types of investors. They are a type of financial certificates, commonly referred to as bonds, that comply with Islamic law which prohibits the charging or paying of interests. One of their benefits is that they are based on the ownership of real assets rather than other debts. Moreover, investors share in the profits as well as in the losses and risks of the underlying asset. “The government cannot simply use it to repay other debts,” says Verreynne. “They must by law be backed by, or used for, the production of real assets.”
Other advantages Islamic bonds offer to investors are the opportunities for relatively high returns. As Sandisile Dlamini, investment analyst at Momentum Asset Management, notes, “Sukuk also offer more liquidity than some other Sharia-compliant securities”.
“The specific goal of issuing sukuk is to broaden the range of potential investors”, Verreynne explains. And fortunately for Egypt, she says, “Thanks in large part to oil and gas exports Arab countries are awash with liquidity. They are therefore in a relatively good financial position to buy Egyptian debt securities”.
Indeed, according to some observers, there has been an increasing overall demand for sukuk not only from Sharia-conscious investors, but also from investors looking for a good return and exposure to quality issuers. “There is less uncertainty, the issuers are well-known, the structures are better understood, and there is more clarity about sukuk,” says Michael Grifferty, president of the Gulf Bond and Sukuk Association. “You can say they have gone mainstream and are now widely accepted capital market instruments, which more and more global investors are familiar with and comfortable investing in.
“I think Gulf investors will take a serious look at Egypt,” he continues. “They invest in other sectors in the real economy and I have reason to believe that they would also be interested in these Sharia-compliant instruments from Egypt. GCC [Gulf Cooperation Council] investors are familiar with Egypt and understand the dynamics.”
However, some are less optimistic. Perhaps unsurprisingly, investment sentiment towards Egypt is relatively weak at the moment, due to the political instability, rising poverty and economic crises facing the country.
Furthermore, downgrades to Egypt’s credit rating make it more difficult to attract investors in the short term. The country has been assigned a CCC+ or equivalent rating by both Moody’s and S&P, and a B- rating by Fitch. And as Sherif Metwally, senior investment analyst at the National Bank of Abu Dhabi, points out, most international investment managers are prohibited from investing in countries with insufficiently high credit ratings.
There is thus disagreement over how attractive Islamic bonds will prove to potential investors. But one thing experts seem to agree on is that regardless of whether they work or not, sukuk are no simple panacea for Egypt’s deep economic ills.
“We do not expect flows from sukuk issues to be significant enough in the short-term to improve the country’s economic position”, says Dlamini. “But even if the sukuk were successfully subscribed, this funding is unlikely to make a significant dent in the budget deficit in the short term.”
Verreynne meanwhile suggests, “By providing much-needed foreign currency, the issuance of sukuk would temporarily improve the economic situation in Egypt, but it will not lead to a sustained improvement. For that, structural issues such as political stability, the business environment, corruption, the large fiscal deficit, and high inflation all need to be addressed.”
Indeed, the issuing of sukuk on its own can do little to solve Egypt’s deep structural problems, which will have to be addressed before the Egyptian economy can really improve in a sustainable way. According to Verreynne, political stability has to be the first step in this. “As political risk continues to trend upwards, investment – and the economy in general – cannot flourish,” she says.
Griffety agrees, adding, “Everyone is hoping that the situation will settle and in that case there could be demand for Egyptian sukuk. But for now access to credit is going to be really challenging, not only for sukuk but for any kind of issuance".
“It is not in a realm of economics, it is more a matter of politics," Griffety concludes. "Economics will follow the politics, but the politics have to be settled before we can make much of a prediction regarding Egypt’s economic future.”
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