Dubai's debt woes are bringing the world's attention to the Islamic finance, particularly the Islamic bonds known as sukuk. Sukuk are Sharia-compliant bonds that do not pay interest. Instead, the sukuk sellers pay the debt holders a share of the rent or capital gains from non-cash physical assets or share of the profits earned from businesses purchased with the money raised. Unfortunately for the Nakheel sukuk holders, the real estate bubble in Dubai that promised big gains from rents and sales has collapsed. And the Islamic bond holders are facing the possibility of a major default, resulting in a dramatic sell-off of sukuk in the last few weeks. According to Data Explorers, a company that tracks how much of a company's stock or bonds are out on loan, about 75% of institutions holding the sukuk sold their position between the end of August and the end of November. "It's an extraordinary sell-off in a bond so close to maturity, when there was no indication of a problem refinancing. The data suggests they had some information that it was a good time to sell," said Data Explorers managing director Julian Pittam.
Dubai's recent request for a debt standstill for Nakheel, one of its biggest state-owned companies, has raised the possibility of the largest Islamic bond or "sukuk" default on record, raising alarms in the global Islamic debt markets.
Nakheel, the Dubai developer behind many of the Emirate's high-profile projects, has to find $4bn to repay sukuk by the middle of this month, according to a report in Financial Times.
If Nakheel doesn't get creditors to agree to a stay on their claims, the Dubai company could be declared in default after Dec. 14, 2009. A group of the sukuk holders, including New York-based hedge-fund firm QVT Financial LP, have appointed London-based law firm Ashurst to represent them in the matter, says the Wall Street Journal.
A December 2006 report on the Nakheel sukuk sale in Euroweek, a trade publication for capital markets, said about 100 accounts bought the notes. Of those, more than half were banks. By geography, about 40% of the issue was placed in the Middle East and 40% in Europe. 
Beginning modestly in 2000 with three sukuk issuers collectively worth US$336 million, the Sukuk bonds exceeded $75 billion last year. Issuance of sukuk - both in domestic and foreign currencies - has been quite common in some countries. The most active issuers of sukuk in the past year include Malaysia, the UAE, Saudi Arabia, Pakistan, Kuwait and Bahrain.
The potential Dubai default is likely to negatively affect nations in Asia and the Pacific region planning to raise money by offering sukuk. Indonesia, Pakistan and South Korea are planning to sell Islamic bonds offshore in separate offerings. Jakarta plans to sell up to $1 billion of global sukuk by the second quarter of 2010, according to people familiar with the situation. Pakistan, the only other Asian nation to have issued offshore Islamic bonds, has just $600 million outstanding from its 2005 sale. It is looking to raise $500 million in Islamic bonds next year.
The Karachi city government is preparing to issue $500 million in municipal sukuk by February, 2010, a Pakistan finance ministry official said in September this year.
South Korea is looking to sell what would be its first ever sukuk as it continues to refine its tax laws to facilitate issuance. It wants to attract capital from Islamic nations to diversify its funding sources and reduce its refinancing risks. The Korean government has been planning a road show in Malaysia and the United Arab Emirates.
Since the start of this year, $8.1 billion of Islamic bonds out of the Asian-Pacific region have priced, exceeding the $6.4 billion volume in the same period last year, according to data provider Dealogic.
Last year's global economic crisis brought attention to Islamic finance as an alternative for both Muslim and non-Muslim customers. In an article, the Vatican newspaper Osservatore Romano voiced its approval of Islamic finance. The Vatican paper wrote that banks should look at the rules of Islamic finance to restore confidence amongst their clients at a time of global economic crisis. “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service,” the Osservatore Romano said. “Western banks could use tools such as the Islamic bonds, known as sukuk, as collateral”. Sukuk may be used to fund the "car industry or the next Olympic Games in London,” the article said.
Investors have been attracted by Islamic banking's more conservative approach: Islamic law forbids banks from charging interest (though customers pay fees) and many scholars discourage investment in excessively leveraged companies. Though it currently accounts for just 1% of the global market, the Islamic finance industry's value is growing at around 15% a year, and could reach $4 trillion in five years, up from $500 billion today, according to a 2008 report from Moody's Investors Service.
The unfolding debt crisis in Dubai is the severest test yet of the short life of the Islamic debt markets. The process and the outcome of the ultimate resolution of the debt crisis in the tiny Gulf Emirate will have a lasting impact on the future of the entire global Islamic finance.
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12 comments:
Islamic finance is something which has around maximum of 100 billion worth of bonds where as the whole debt market is worth trillion dollar world wide.
There are practical problems in the issuance of the bonds as the bond holder invariably seek the return of interest in the form of share of profit.
Coming to the dubai's real estate arm, the demand for the property has come down heavily. the price has fallen by atleast 50% across. Retrenchment has made many property vacant in dubai and the interest payment out of the rents become impossible. The rents has fallen minimum by 50%.
Unfortunate that the rich abu dhabi emirate having 800 billion usd as swf is not keen to buy out and bail out dubai as they are not coming in agreement on the pricing. So this will effect the interest rate of the company which seek international finance including companies based out of uae as dubai and abu dhabi is part of the uae
In fact i casually over heard that the lending cost are much higher for uae based companies in the international market compared to other countries.
In a lighter sesne dubai has learnt a lessoon from america and is trying to replay the same. That is allowing the companies to go defaulters and distance the government from the companies.
We have to watch to see whether dubai has the same muscle of usa.
You cannot look at this phenomena in isolation. Islam is not to be implemented so selectively (that is interest free bonds but no control on expenditures). Its therefore to relate Dubai crisis with Sharia compliant bonds when the emirate as a whole was violating all other norms of Sharia.
Islamic finance is basically a deception.It states that there is no interest but functions in a very similar way to address the basic issue of rewarding an investor to temporarily part with his money.
Basically I will only deposit rs 100 in a bank if after 1 year I'll get Rs 100+x, x being the amount to hedge against inflation and a small profit for postponing expenditure.
x is also known as interest rates which is simple,straight forward easily understandable and given the success of US,EU,Japan etc effective.
Islamic finance is basically complicated juggling to get around this 'we don't pay interest'dictum to come up with an investment vehicle which works exactly like interest i.e at the end of the year you are still getting x even though you don't call it interest.
AFP is reporting that Dubai and Abu Dhabi stock markets recovered on Sunday, Dec 5, amid an apparent return of confidence, closing up more than one and almost four percent respectively, after heavy losses over Dubai’s debt woes.
Here's some welcome news from Dubai in today's Wall Street Journal:
Dubai World's promise to repay Nakheel's debt (including sukuk) and a separate move by the emirate to set out a legal framework for future talks may not be enough to repair the damage to Dubai's reputationamong international investors over the handling of its debt restructuring, investors and observers said.
While Dubai's moves go a long way toward restoring confidence, they aren't "a magical pill that will clear the air and erase the confusion," said Jawad Ali, a partner at law firm King & Spalding in Dubai, which represents at least one Dubai World creditor.
Sheik Ahmed bin Saaed Al Maktoum, chairman of the Dubai Supreme Fiscal Committee, in a statement said that Monday's actions were taken to reassure investors and others that "our government will act at all times in accordance with market principles and internationally accepted business practices."
On Monday, Abu Dhabi agreed to provide Dubai $10 billion to settle some of Dubai's obligations, including a $4.1 billion debt payment related to an Islamic bond, or sukuk, that matured Monday. (Abu Dhabi and Dubai are the two biggest emirates of the United Arab Emirates. Abu Dhabi, one of the world's biggest oil producers, serves as the federation's capital.)
Islamic Finances uses as a tool what is known in US as lease financing. of course, the property bubble has hurt investors in it. But, lease finance can be used as a vehicle for financing in other ways as well. US reveals that in spades and the state of your location is a major user of this financing technique.
Riaz Sahib, It seems like a default on Islamic financing should, by definition, be impossible. it is basically equity participation, and so if the investment goes under both partners lose.
would you care to shed some light?
Ahmed: "It seems like a default on Islamic financing should, by definition, be impossible"
Ahmed Sahib, You are raising a very good issue. It is the subject of debate among Islamic scholars and financiers today.
When defaults in market sukuk structures result from contractual covenants imported from conventional bonds, such defaults would not necessarily be enforceable in a Shari’ah adjudication, regardless of decisions made in foreign courts.
Islamic finance continues to develop as a viable form of investment, not only for Muslims but also as an alternative for non-Muslims. It would seem logical that as the products evolve – while holding true to their philosophical underpinning of risk-sharing and not risk transfer – both Muslim and non-Muslim investors will continue to invest in them. Blaming Islamic finance for sukuk defaults is both simplistic and misinformed. The ‘defaults’ occurring in instruments today would not necessarily qualify as genuine Islamic defaults because such provisions effect the kind of risk-transfer that is inimical to Islamic finance.
Condemning Islamic finance for provisions already identified as problematic by leading authorities, and which contravene the Accounting and Auditing Organization for Islamic Financial Institutions’ (AAOIFI) Shari’ah guidelines, is actually an incrimination of disingenuous structures rather than Islamic finance itself. Islamic finance will continue to grow if it develops products that are genuine and offer the ethical foundation of risk-sharing rather than risk transfer.
http://www.risk.net/credit/analysis/1565919/sukuk-default-default
Unfortunately, Dubai's recent request for a debt standstill for Nakheel, one of its biggest state-owned companies, has raised the possibility of the largest Islamic bond or "sukuk" default on record, raising alarms in the global Islamic debt markets. It's likely to hurt a lot of investors, particularly Muslim investors who bought sukuk and invested in property there.
The flip side is that many of these gulf investors will look at Pakistan where real estate investments have always been winners, regardless of the political or economic environment. The supply has continued to lag demand for housing, retail and office properties.
According to BMI research, several major projects are being funded by risk-tolerant developers from regions such as the Gulf Cooperation Council(GCC) and government or government-linked landowners in Pakistan, but there is still a solid backlog. In a recent development, however, it appears that to the GCC players can now perhaps be added Malaysian developers, several of which are, according to Malaysian news agency Bernama in August 2009,negotiating to build some 500,000 low-cost houses annually in various parts of Pakistan.
http://www.marketresearch.com/map/prod/2466767.html
The corruption of Pakistani politicians is exceeded only by their incompetence. With economy in virtual recession, the FDI is dropping as reported by The News:
Thursday, December 17, 2009
KARACHI: Net foreign investment in Pakistan fell 25.6 per cent to $1.08 billion in the first five months of the 2009/10 fiscal year compared with $1.45 billion in the same period a year earlier, the central bank said on Wednesday.
Out of total foreign investment, foreign direct investment fell 52.2 per cent to $774.0 million in the first five months of the fiscal year which began on July 1 from $1.62 billion for the same months last year, the State Bank of Pakistan said.
But foreign portfolio investment flows reversed, with a $311.3 million inflow in the July to November period compared with an outflow of $162.9 million in the same period last year.
Authorities imposed a floor on the Karachi Stock Exchange benchmark index in August last year as political uncertainty and economic and security worries drained investor confidence.
The floor discouraged new investment and also led to a sharp outflow of funds, as foreign investors sold holdings in off-market trade.
The floor was removed in December. The International Monetary Fund (IMF) saved Pakistan from a balance of payments crisis with a $7.6 billion emergency loan package in November last year. The loan was increased to $11.3 billion on July 31.
Pakistan’s economy is in virtual recession as gross domestic product growth in the 2008/09 fiscal year of 2 per cent is about the same as population growth. The IMF has projected GDP growth flat at 2 per cent this fiscal year.
Security concerns over a Taliban insurgency based in the country’s northwest and chronic power shortages have also put off investors.
Here's a ranking of ease of doing business in South Asia that puts Pakistan well ahead of India:
Bangalore: The business environment in Pakistan and Bangladesh is far better than in India. According to the latest 'Doing Business Index', India's business environment has become tougher during the years compared to other nations.
Economies are ranked from one to 183 on the basis of their regulatory environment being conducive to business operations. All of India's neighbors except Afghanistan have been ranked better. While India is ranked 133, Pakistan is ranked 85th followed by Sri Lanka (105), Bangladesh (119) and Nepal (123).
"India is a consistent reformer for the past many years. A country's rank in the index is an average of 10 indicators, each with 10 percent weight in the index. India increased the number of judges in the specialized debt recovery tribunals, which led to a major removal of blockages. While India reformed in the area of insolvency, other countries reformed in more than one area," World Bank's Senior Strategy Advisor, Dahlia Khalifa told Economic Times explaining why India has been overtaken by other nations.
The 2010 Doing Business Report prepared by World Bank and the International Finance Corporation averages a country's percentile ranking on 10 topics, made up of a variety of indicators. This includes examining a country's business environment in terms of starting a business, dealing with construction permit, employing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts and closing a business.
The first place is occupied by Singapore, which is followed by New Zealand, Hong Kong and the U.S.
To see complete rankings and report, click here: http://www.doingbusiness.org/EconomyRankings/"
The BBC is reporting that Dubai crisis is impacting a remote village in Bihar:
In August 2008, Bharat Bhushan Tiwari - from Akhopur village in eastern Indian Bihar - took a loan of 71,000 rupees ($1,500) from a village moneylender to pay a local agent who had arranged a job for his son in Dubai.
Mr Tiwari - who runs a small shop - was hoping for better days for his family of five by sending his second son, Jay Kumar Tiwari, to the Gulf country.
Jay Kumar had got a job as a carpenter in a Dubai-based construction company and had big dreams - he wanted to earn a lot of money to pull his family out of grinding poverty.
But last month, their dreams came crashing down when Jay Kumar was asked by the company officials to quit by 6 March 2010.
'Cruel joke'
Dubai has been hit by an unprecedented financial crisis and the tremors are being felt in far away Bihar.
"This has been a cruel joke on our fate," Bharat Bhushan Tiwari told the BBC, trying to fight back his tears.
His other two sons are also unemployed and the Tiwari family now prays that the situation improves in Dubai.
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