In this issue…
- Retail sukuk can be an important tool for boosting domestic savings rates
- GCC Islamic banks should prepare for international acquisitions in 2016 and beyond
Divisions at the G-20 came through loud and clear in their most recent communique with some calling for all options to be on the table (fiscal and monetary stimulus) while others were reticent about the prospects for stimulus to be an effective tool for raising global growth rates. These divisions mean little likelihood of coordinated action, particularly on the fiscal policy side in developed markets, which could spur global demand and help curb recent volatility. China’s Finance Minister aptly summarized the situation: “Monetary policy will probably have to be kept appropriately loose, even though people have realized that its role cannot replace fiscal policy”.
Indonesia’s retail sukuk have grown significantly in popularity since the first issuance in February 2009. The early offerings, coming out of the financial crisis, were relatively small but have grown dramatically since; from a $400 million worth of Rupiah-denominated sukuk in 2009 to about $1.5 billion in the retail sukuk issued in 2012 and thereafter. The dynamics of the pricing of the sukuk over time is interesting to consider for other countries looking to build a savings culture domestically to reduce reliance on foreign (particularly hard-currency) investors.
As discussed in Finance Forward recently, many foreign investors in a country evaluate the resiliency of an economy to future shocks based, in part, on the level of domestic savings in country. A higher savings rate in a fast-growing economy provides a more stable source of funding for the necessary investment and can help reduce interest rate volatility. Lower volatility, in turn, allows for greater predictability for business investors (both domestic and foreign) to support the long-term investment that is needed to support growth.
The savings rate in Indonesia, at 31%, is on par with Malaysia and significantly higher than the other emerging markets (including Turkey which was the focus of the previous article). Another way to compare the two is to look at the trajectory of the financial accounts over time. This measures the net amount of financing to or by nonresidents in a country and provides a measure of the dependence on foreign investors.
By this measure, Turkey and South Africa—both countries known for a high reliance on foreign capital—are significantly different than Malaysia and Indonesia. In the latter countries, a higher savings rate indicates more domestic sources of capital and, consequently, lower reliance on foreign borrowing. The difference shows up, in turn, in the value of their currencies against the dollar where Turkey and South Africa have seen declines since the end of 2010 of 48% and 59%, respectively, while Malaysia and Indonesia’s currencies have dropped 27% and 32%, respectively, during the same period. Stronger domestic savings can help support a country in challenging times but, clearly, cannot make it immune to foreign exchange depreciation.
This returns us to Indonesia’s retail sukuk which have been issued consistently (in increasing amounts) over the 2009 – 2016 period. The yields on these sukuk has generally been higher than, but still close to the benchmark rates from Bank Indonesia. One interesting feature of this spread (which should be interpreted with caution since it is based on relatively few data points) is that after narrowed in the immediate aftermath of the financial crisis but has widened (albeit not as far) since 2012.
When spreads for the retail sukuk were the tightest compared to the Bank Indonesia policy rate (against which many deposit rates are prices), the value of the Rupiah was relatively stable. By contrast, both during the financial crisis and from 2012-2014 around the Taper Tantrum (when volatility picked up based on expectations of US interest rate normalization), the spread on the retail sukuk was higher.
This makes intuitive sense in an economy with free capital flows because even retail investors are going to be sensitive to the changing purchasing power of local currency investments and deposits. For governments and central banks approaching ways to manage foreign exchange volatility, local currency financing can be effective. However, when tapping investors, whether local institutions or retail investors, there must be a sufficient diversity of products offered to help attract savings. In countries with significant Muslim populations, retail sukuk can help ensure the maximum number of people are willing to participate.
The sixth largest Islamic bank is also the 14th fastest growing Islamic bank (measured by asset growth). It is difficult to sustain this rapid growth as an institution grows. However, Qatar Islamic Bank is attempting to ensure that slower growth doesn’t become a long-term trend by exploring M&A financed with a future sukuk issuance, according to the bank’s Chairman Sheikh Jassim bin Hamad al-Thani who said: “We want to have it approved so at a later stage when we need it, probably for an acquisition, it is available and can be used.”
Qatar Islamic Bank benefits from its position in Qatar where rapid GDP growth from oil and gas, and infrastructure projects to accompany the rapid growth and prepare the country to host the World Cup 2022. Although overall economic growth is projected by the IMF to remain robust—falling to 4.0% in 2014 and projected to be 4.7% and 4.9% in 2015 and 2016, respectively—the fall in oil prices (to which Qatar’s natural gas production prices are linked—significantly affect government revenues and the government will have to both raise revenue from other sources and curtail its spending.
The decline in government revenues, on its own, does not affect the ability to fund the infrastructure and government spending, but it does put a cap on the rate at which new spending decisions are likely to be announced. As we discussed in an earlier Finance Forward, the slowing growth of government spending has a particularly pronounced effect on conventional banks (based on having more direct sovereign exposure in its loan book) but will also impact Islamic banks as Sheikh Jassim conceded, saying “market condition is not the same as we had last year and the year before”.
A reduction in the overall market growth in total assets, banks like Qatar Islamic Bank, one of 18 serving the 2 million people living in Qatar will have to look elsewhere as their asset growth falls from the 24% that QIB recorded year-on-year during 2014. In November 2015 when Finance Forward surveyed bankers, we found that international expansion one of many ways they saw to expand growth. When we asked for the primary area of focus for 2016 growth, new markets came in fourth (tied with digital channel expansion) and behind more traditional efforts for banks to grow within their existing footprint.
However, when we asked a longer-term question about what activities the bank expected to focus on developing and expanding during 2016, new markets was cited by 40% as a priority, on part with risk controls which bankers said elsewhere was one of the most important strategic goals for 2016.
What is the key takeaway for the banking market in the GCC overall? First, the most likely acquirers are to come from markets where recent growth has been most robust but which are comparatively overbanked which exasperates slowing asset growth. Second, banks are preparing now for acquisitions that may not happen during 2016.
Most of the bankers we surveyed planned to spend 2016 focusing on wringing the most growth in assets out of their home market while working on geographical spending to fill the long-term growth. As domestic asset growth slows, the pressure from shareholders to make acquisitions will only grow and the best positioned banks will be the ones that have already lined up financing from their own resources, those like Qatar Islamic Bank.