Kazakhstan Turns to Sukuk as Eurobond Dropped: Islamic Finance

Kazakhstan, the former Soviet republic that last sold international debt in 2000, is planning a debut Islamic bond sale to broaden its investor base after canceling a Eurobond offering last week.

The government will sell securities that comply with Islam’s ban on interest payments in the second half of the year and is pressing for legislative changes that would enable companies beyond state holdings and Islamic banks to sell sukuk, said Aibek Bekzhanov, head of Islamic instruments at the Regional Financial Center of Almaty, a government agency set up to develop the country’s capital markets.

“Our goal is to orient this market toward domestic demand, to help develop the market,” Bekzhanov said in a July 27 interview from Almaty. “There are also plans to raise funds abroad via Islamic finance as a way to develop international relations with Asia and the Middle East.”

The Finance Ministry said July 20 it canceled plans to sell $750 million of global bonds this year, citing a $1 billion loan agreement signed in May with a World Bank unit following defaults last year by four local banks and the government’s takeover of one, Almaty-based BTA Bank.

The financial crisis sent credit-default swaps linked to Kazakhstan debt to a peak of 1,650 basis points in February 2009, according to data compiled by CMA DataVision. The contracts, which pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements, have since dropped to 200, or 2 percentage points.

‘Difficult’ Sell

“It might make sense for Kazakhstan to start building their liability structure with a different investor base,” Richard Segal, director of emerging markets fixed-income in London at Knight Libertas Ltd., said in an interview yesterday. “If they were to target traditional European investors it might be difficult because many traditional investors had quite a difficult time over the past few years having invested in corporate debt.”

Kazakhstan, where the U.S. State Department says 47 percent of the 15.6 million population was Sunni Muslim at the start of 2008, last sold international bonds in April 2000. It issued $350 million of 11.125 percent notes that matured in 2007, according to data compiled by Bloomberg. The country has about $37 billion of bonds and loans outstanding, according to data compiled by Bloomberg.

Sales of Islamic bonds will see “sustained” growth in the second half of the year, led by Asia and first-time issuers, Standard & Poor’s said in a statement yesterday.

Global sales of Islamic bonds, or sukuk, fell 29 percent to $6.7 billion so far this year, according to data compiled by Bloomberg. Issuance totaled $20.2 billion last year, up from $14.1 billion in 2008 and reached a record $31 billion in 2007.

Al-Amanah Islamic

The debt is typically backed by assets or cash flow because Islamic law bars payment of interest. Investors earn any profit from the assets in place of interest.

The Philippines’ state-owned Al-Amanah Islamic Bank is seeking to sell the nation’s first Islamic bonds, the lender’s President Armando Samia said July 26. The state-run Islamic Bank of Thailand plans to sell sukuk to expand financial services for minority Muslims, while Tokyo-based Nomura Holdings Inc. is raising $100 million in its first sale in Malaysia as it develops a Shariah-compliant business.

The spread between the average yield for emerging market sukuk and the London interbank offered rate narrowed 63 basis points, or 0.63 percentage point, to 404 basis points so far this year, according to HSBC/NASDAQ Dubai US Dollar Sukuk Index. It widened three basis points yesterday.

Market Rally

Shariah-compliant bonds returned 8 percent this year, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index, while debt in developing markets gained 9.5 percent, JPMorgan Chase & Co.’s EMBI Global Diversified Index shows.

The yield on Malaysia’s 3.928 percent Islamic note due June 2015 fell one basis point to 3.04 percent today. It has dropped 48 basis points this month, according to RBS prices.

Kazakhstan’s $102 billion gross domestic product will expand 4 percent this year, Finance Minister Bolat Zhamishev said June 22, according to the Financial Center’s website, from 1.2 percent last year. The country’s debt is rated Baa2 by Moody’s Investors Service, its second-lowest investment grade, and one step lower at BBB- by S&P.

The government will apply guidelines for its new bonds from the international standard-setting Islamic Financial Services Board, said Bekzhanov. The Kuala Lumpur-based authority includes central banks from Saudi Arabia and Qatar as members. Global standards are still developing in the Islamic finance industry, whose assets may almost triple to $2.8 trillion by 2015, according to the IFSB.

Middle East

The sukuk’s structure will be important for Middle Eastern investors, who have a stricter interpretation of Islamic law, Scott Lim, chief executive officer of Kuala Lumpur-based MIDF Amanah Asset Management Bhd., which manages the equivalent of $670 million including Shariah-compliant funds, said yesterday.

“Demand for this product comes from Middle East investors,” said Lim. “If they are targeting the Middle East, they should structure the product accordingly.”

The government approved setting up Islamic investment funds and banks last year, attracting lenders such as Al Hilal Bank, owned by the Abu Dhabi government, to offer Shariah-compliant products in the country.

In addition to the Ministry of Finance, Development Bank of Kazakhstan may issue Islamic bonds, Bekzhanov said. Legislative changes are needed to expand the list of potential issuers, he said.

“There is clearly interest from companies to sell sukuk, but one of the major constraints is legislative limitations,” he said. “We are working on widening the list of companies that can issue those and hope that this market will be developing actively.”

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