Euromoney: Egypt sukuk law an odd priority

Euromoney, February 2013

Egypt has plenty else to worry about besides gaining traction in its Islamic finance industry. But the passing of a new sukuk law last month could provide a vital source of funds as the country’s reserves and credit rating continue to decline.

On January 16, Egypt’s government approved a new sukuk bill after several previous attempts to agree on one had failed. The draft law has proven controversial in the volatile post-revolutionary country, for several reasons.

One is a fear that it represents a growing level of Islamic influence in Egypt, partly because the Muslim Brotherhood, from which President Mohamed Morsi hails, has stated partly religious reasons for promoting sukuk. (In fact sukuk laws exist all other the world and in many non-Islamic nations, among them the UK.) Another is the fact that sukuk must be underpinned by physical assets: a rumour began to circulate that the Suez Canal or other state assets would be used. Prime minister Hisham Qandil denied this in January – on Facebook.

Other objections were more technical. The first draft of the bill allowed the government to lease out assets for up to 60 years in order to underpin sukuk, but the Islamic Research Academy, a powerful Shariah body linked to Egypt’s Al-Azhar University, voiced concerns that this would allow authorities to abuse their control of public assets. The academy also rejected one version of the bill on the grounds that it was not Shariah-compliant.

There is also a feeling that Islamic finance is a curious priority in a country with so much else to deal with. Even some of the most revered Islamic scholars feel this way. “I would have thought the first priority is to feed hungry mouths,” says Mohamed Ali Elgari, the leading Saudi Arabian Shariah scholar. “And to make sure unemployed people have the opportunity to have a job. People only appreciate the fact that they have a new constitution or parliament if they have something to eat.”

Nevertheless, there has been a growing sense that Egypt needs the bill in order to increase its available avenues for funding. Egypt has a widening budget deficit, declining foreign exchange reserves ($15 billion in January compared to $36 billion pre-uprising), a deteriorating currency and falling credit ratings from a pre-revolution BB.

In January Moody’s placed Egypt government bonds on review for possible downgrade from its B2 rating, citing the re-emergence of unsettled political conditions, uncertainty around a planned $4.8 billion loan from the IMF, capital controls imposed by the Central Bank of Egypt on foreign currency cash withdrawals from the country’s banks, and climbing fiscal financing costs.

To the Muslim Brotherhood government, Islamic finance represents a happy coincidence of interests: it furthers its own ideas about how Egypt should run its finances, while also providing a new source of funds. While its initial plans to launch a global sukuk by the end of 2012 clearly did not succeed, the idea is not so outlandish: the sukuk market has shown itself open to debut sovereign borrowers recently, notably Turkey (see Islamic deals of the year).

That said, any issue is going to have to pay heavily to get away. Yields on Egypt’s 364-day Treasury Bills hit 14.4% in mid-January. And even wide pricing doesn’t guarantee that a deal could succeed. “Egypt needs to show some kind of inflexion point in its direction,” says one investment banker in the region. “Investors like to invest in growth and turnaround stories, and there are many examples of countries which have had extraordinary success in doing so – Romania, Hungary, Iceland – not because they have necessarily turned everything around, but because they have a credible plan in place to do just that.”

And investors, by and large, do not yet sound ready to bite. “It’s too early for Egypt,” says the Middle East head of an international fund manager. “There’s probably another revolution to come. Let’s not get stuck in the middle of it.”

Are we anywhere near that elusive inflexion point? “Not yet – technically,” says Angus Blair, president of Signet Institute, a regional think tank specializing in the region. “There is still too much current, and expected, political noise for non-hydrocarbon FDI to rise sharply.”

“With no clear, creative, or brave economic plan from the government, which has a fear of rising prices, the economic and political risk has risen,” Blair says. “We still like Egypt longer term very much, but we are recommending that investors wait until some tough decisions are made first and the legal environment clearer before entering the market.”

Nevertheless, the passing of the bill was a big moment for Egypt’s new finance minister, El-Morsi Hegazy. Hegazy’s appointment raised eyebrows, as he is an Islamic finance expert and an economics teacher from Alexandria University rather than a politician.

Resolving the IMF loan will be Hegazy’s next big challenge. It remains stalled despite the fact that what the IMF calls a “preliminary, staff-level agreement” was reached on November 20. As Moody’s notes: “This credit-negative delay jeopardizes the fragile stability that the country has slowly rebuilt in recent months, because an IMF program would have directly provided $4.8 billion in financial support and, more importantly, helped to shore up investor confidence through a monitored program of economic reform.”

In the meantime the country has been receiving aid and investment from elsewhere. Turkey has so far lent $1 billion, the last $500 million of it in January, while Qatar has put $2.5 billion into Egypt’s central bank, part of what the Qatari Minister of Finance has described as a total US$5 billion aid package. There are early signs of private sector interest too, with Qatar National Bank buying SG’s Egyptian operation and Emirates NDB buying the Egyptian unit of BNP Paribas, and news coming in January that Bill Gates would join a group of US investors putting US$1 billion into the construction and fertilizer group OCI NV. That, though, comes as part of OCI’s move from Cairo to Amsterdam: “Another negative,” says Blair, “as it will cut trading on the market.” OCI accounts for over 20% of the Egyptian stock market index.

Last year the government said it intended to boost the Shariah-compliant share of total banking assets from 5 to 35% within five years. As a market, it has considerable potential: a population of 80 million, mainly Islamic, of whom only 10% have a bank account. But that really is a big ambition. Malaysia is considered the gold standard for the prudent and successful adoption of a new Islamic finance industry, yet after a decade of hard work Islamic finance accounts for 22% of banking deposits there.