In this issue:

• Impact on the MENASEA region from Thomson Reuters’ Breaking Views 2016 Predictions – Funding deficits, better financial reporting and too much debt & financial engineering
• Islamic finance powering Nigeria’s future economic growth

January 18 2016

FAST FINANCE

Iran’s re-entry into the global economy is moving ahead as the sanctions that restricted its oil exports and trade are lifted. The deal is being viewed by suspicion by some nations in the region but represents an opportunity for others whose trade links were disrupted by the sanctions. Financial institutions in the Middle East and globally are likely to still hesitate in entering Iran directly for fear of being on the wrong side of U.S. sanctions enforcement. As we wrote when the deal was struck, financing exports to Iran could be a lower-risk way for banks to generate business on the back of sanctions relief.

Looking forward to the year ahead with Reuters’ Breakingviews

Every year, Reuters Breakingviews develops a set of financial market predictions for the year ahead that outline important and sometime unexpected trends for the year to come. With their permission, we have selected some of the most relevant to the MENASEA region which will be spread across this week and next week’s Finance Forward.

While most of the emerging markets are managing issues related to capital outflows as a result of market volatility, the GCC has a different problem of managing its deficits either by repatriating foreign investments or issuing debt into more skittish international markets as local liquidity tighten.

“During the most recent energy boom, the six members of the Gulf Cooperation Council (GCC) – including Saudi Arabia, Qatar and Kuwait – amassed sovereign funds worth more than $2.3 trillion. […] Large chunks of this cash are now being repatriated back to the region to finance widening budget deficits, which this year are expected to be in the region of 13 percent of GDP in the GCC.

“Should oil prices average $56 per barrel next year, then GCC states would need to liquidate some $208 billion of their overseas assets, or just below 10 percent of their sovereign fund holdings, based on a Breakingviews analysis of their fiscal break-even costs. But if oil prices fall to $20 a barrel, as Goldman Sachs has warned, the GCC states may have to sell $494 billion worth of booty to make up the budgetary shortfalls based on forecast fiscal costs for their oil production in 2016.

As emerging markets increasingly try to attract foreign capital to their markets by promoting more transparency for their listed companies, they should consider where the focus should be. Should companies report more often, or report more useful information to investors such as through integrated reporting which adds non-financial information to financial reports?

Quarterly capitalism has become a four-letter word. From BlackRock boss Larry Fink to American Democratic presidential contender Hillary Clinton, critics of the overweening desire to hit the numbers every three months, common among both investors and managers of publicly traded companies, see a fundamental flaw in today’s system. But words are cheap. For the system to change, significant players have to make the first move. That may happen in the year ahead.

Corporate executives have long railed against the treadmill of reporting their guts out every three months. They say it’s a waste of time, costs money, and is a distraction from the more important tasks of setting strategy and running a business. […] Stock-market investors who have regular glimpses into corporate finances [say they] are better placed to judge the progress of strategy, assess the efficacy of management and gauge product cycles. The ultimate investors – widows, retirees, teachers and billionaires – gain from the knowledge.

The more things change, the more they stay the same. Even though we are less than a decade on from a financial crisis driven by excessive debt and financial engineering, many large corporates have looked heavily to growing debt piles and financial engineering to fund M&A and stock buybacks. With market volatility rising around the world it may not just be highly leveraged emerging market-based companies that have to deal with the consequence of overleverage.

At a time of ultra-low debt costs, announced global M&A activity in 2015 has reached a record $3.9 trillion, according to Thomson Reuters. Global non-financial investment-grade debt issuance has climbed to $1.3 trillion so far this year. Acquisition-related debt reached a record $365 billion, says Thomson Reuters.

Even more debt has been issued by U.S. corporations for share buybacks. Over the past five years, the top 100 share repurchasers have grown their EPS by 93 percent. Their return on equity has climbed to 19 percent from 13 percent during this period, according to Thomson Reuters Worldscope, and their shares have handily outperformed the broader market.

This may look impressive. But the buyback leaders have also seen their sales growth slip and leverage rise. Their median capital spending (relative to cash flow) is below the S&P 500 average. To deliver EPS growth, these companies have been leveraging up and eating their seed corn.

Valeant’s fall from grace is just another example of how debt-fuelled growth creates only an illusion of value. Real worth comes from companies investing wisely for the future and acquiring shares – whether their own or in other companies – at low valuations. While corporate revenue is declining and debt is cheap, financial engineering is an easy way out – until it all falls apart.

Filling the infrastructure funding and unbanked population in Nigeria – Opportunities for Islamic finance?

The issues facing Nigeria’s economy are well known but quantifying the size of the problem has not led to its solution, and as the effects of lower oil constrain government resources, identifying ways to increase financial inclusion and reduce the energy infrastructure gap will become more important. They are also potentially complementary because the lack of a quality electricity grid constrains businesses which constrains jobs which is one factor that leads to financial exclusion. Addressing the energy constraint can help raise incomes which supports the financial sector. Including non-interest finance (banking and capital markets) into the equation can also support finding new sources of funding for infrastructure.

Funding the infrastructure deficit

After the Central Bank of Nigeria rebased its GDP for the first time in two decades, it became the biggest economy in Africa. As of 2014, Nigeria’s economy stood at around $560bn, making it almost 50% bigger than South Africa’s $350 bn economy. However, the value of a country’s infrastructure stock is estimated at only 15% of the GDP, compared to roughly 70% for other middle income economies of comparable size (and 21% that South Africa for its infrastructure).

The national planning commission of Nigeria has recognized the need to address this challenge and estimates that $3 trillion will be required in the next 30 years to build and maintain adequate infrastructure supplies. The underdeveloped sectors include and are not limited to energy; transport; agriculture, water and mining; housing and regional development; information and communication technology; social infrastructure and security. However, with oil prices—a significant source of the government’s revenues—falling dramatically, the issue of how to pay for it remains challenging.

Here within lies a very good opportunity for Islamic finance to make inroads into the Nigerian economic and financial system to finance and contribute towards bridging the infrastructure deficit. With the exception of a single small sukuk (issue size: $ 62 million yielding 14.75%) that was issued by the cocoa producing state of Osun, the Nigerian corporates and government have not actively used sukuk to raise capital.

This comes despite the Securities and Exchange Commission of Nigeria launched a major initiative last October to expand the scope of the issuance of sukuk in the Nigerian capital market. Initiative like these will help the government in addressing this infrastructure deficit gap. One of the major and critical area that needs funding is the power sector. Nigeria is currently facing acute electricity shortages.

According to the World Bank, an estimated 41% of Nigerian businesses generate their own power supply. The national electricity sector generates just 4,000 megawatts for a population of over 170 million, (which translates to about 22.8 watts per capita) compared to South Africa that has about 1,000 watts per capita. In order to support future growth, the power sector has a huge need for funding. Initiatives by the government as well as the corporates to use sukuk to raise financing for this sector can be mutually beneficial for the growth of non-interest finance as well as the power sector.

Banking the unbanked – increasing financial inclusion through Islamic finance

Another way in which Islamic finance can make imprints in the Nigerian economy is by targeting the Muslim as well as non-Muslim unbanked population. The demographic breakup and the number of people who are financially served in the Nigerian economy depict an interesting picture. The total adult population of Nigeria is 93.5% of which 60.5 % are financially served and 39% remain excluded out of the financial system.

Targeting a part of this 39% populace can increase the financial inclusiveness in Nigeria. A survey conducted by EFinA shows that 30% of Muslims desire Sharia compliant financial products and another 50-60% will use them if they are price competitive (representing around 21-60 million). Today, there is only one full-fledged Islamic bank in Nigeria and just 400,000 (0.4% of the adult population) have a non-interest banking product. The scope of developing the Islamic banking sector in this country is huge given the size of the Muslim population.