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Iran's troubled bond market

Even if sanctions are lifted, Iran's debt market faces several obstacles to realizing its full potential.
EDITORS' NOTE: Reuters and other foreign media are subject to Iranian restrictions on leaving the office to report, film or take pictures in Tehran.

An Iranian woman stands in a currency exchange shop in northern Tehran January 3, 2012. The Iranian rial fell to a record low against the dollar on Tuesday following U.S. President Barack Obama signing a bill on  imposing fresh sanctions against the country's central bank.    REUTERS/Morteza Nikoubazl (IRAN - Tags: BUSINESS POLITICS) - RTR2VU75

TEHRAN, Iran — Plagued by the woes of Iran’s troubled banking system, many Iranian firms are considering raising capital by issuing dollar-denominated bonds once sanctions are lifted. However, the road to this end won’t be easy — and the lifting of sanctions alone won’t solve everything.

Iran’s exclusion from the Society for Worldwide Interbank Financial Telecommunication has meant that many Iranian companies have not been able to embark on capital raising through borrowing from overseas lenders, Ali Sanginian, CEO of Amin Investment Bank, told Al-Monitor.

While home to the world’s biggest Islamic banking sector — with assets estimated at $482 billion, larger than that of Saudi Arabia — Iran’s banks are in bad shape. Government-sponsored lenders, which are in charge of providing loans for companies, engaged in bad lending practices under the previous administration of Mahmoud Ahmadinejad, draining cash. Moreover, predatory lending practices that hit companies scrambling to survive have been accompanied by insolvencies. In an interview with Al-Monitor, Hossein Khazli Kharrazi, head of Keshavarzi Bank Brokerage, pointed to this perfect storm, saying lack of liquidity — which is hanging over the economy due to high interest rates and the recession — has pushed many companies to default.

There are numerous obstacles in the path of the development of the Iranian debt market. In order to make it robust, rating companies are essential to accredit firms. At present, the banks are in effect filling this role, as they function as guarantors. In this vein, the credit crunch and nonperforming loans are tough challenges for already troubled banks. Iranian Vice President Eshaq Jahangiri announced in April that overdue debts had reached an unprecedented amount of $30 billion, calling it a major obstacle to proper banking practices.

Furthermore, at present, Iran does not have an integrated debt market. Rather, it has been embedded in the capital market and is mostly focused on participation bonds. The burden of engaging in fundraising aimed at tackling the prevailing recession thus hangs over the Central Bank of Iran.

Given the Tehran Stock Exchange’s mixed returns over the past two years, bank deposits and participation bonds in local currency, which guarantee up to 22% returns, have become investor safe havens. However, capital needs remain immense.

According to parliament’s petrochemical subcommittee, Iran seeks $85 billion for its petrochemical sector alone as it aims to boost production. Sanctions have severely impeded petrochemical output, preventing the country from reaching its output target of 100 million tons this year. Underscoring the sector’s needs, semi-finished petrochemical projects in Iran are worth $70 billion, Deputy Oil Minister Abbas Sheri Moqaddam said.

Reza Soltanzadeh, board member of Middle East Bank, confirmed the Iranian economy’s huge capital needs to Al-Monitor, but underscored that it is nonetheless attractive. The reason for this, he explained — as is the case with the energy sector as well as infrastructure — is that borrowers will in essence have a sovereign collateral. “On the corporate bond side, the petrochemical industry is by far the most lucrative with a high internal rate of return built in their economic models, allowing for easy debt service.” Indeed, as sanctions are to be lifted, Sanginian of Amin Investment Bank told Al-Monitor, “Oil, petrochemical and power plants are expected to issue dollar-denominated sukuk [Islamic bonds] in the near future.” Iran has plenty of room to raise capital through this path. According to the World Economic Forum, Iran’s total government debt was just 11.4% of gross domestic product last year — lower than 90% of the tracked countries.

With the Iranian currency in effect stabilized, dollar bonds are a cheap method of fundraising through international lenders. Yields may differ in various cases, but are expected to be around 7%, which is attractive to all parties. As such, Iran’s reconnection with global debt markets means many firms “are eager to tap into the global debt market, as rates are much lower compared with local rates,” Hans Humes, CEO at Greylock Capital, told Al-Monitor.

And this interest goes both ways — the Iranian bond market is also attractive to foreign fixed-income funds in search of low risk but high yields, Soltanzadeh told Al-Monitor. “All bonds floating in the capital market are well-collateralized with solid assets and cash flow being able to service the debt, even at the current high-interest environment.”

In preparation for an expansion of the debt market, the government is reportedly slated to introduce new bond instruments. Adding to murabaha, musharakah and ijarah — the three prevailing types of sukuk with various maturities — Islamic treasury bills are scheduled to make a debut in the near future, Amir Hamooni, CEO of Iran Fara Bourse, told Al-Monitor. Islamic T-bills are sovereign, meaning return on investment is guaranteed directly by the government. Moreover, their liquidity is much better than comparable securities. The Iranian government is expected to issue them in a bid to raise funds for its massive debts to local banks, which greatly built up under the previous administration. Both retail and institutional investors are likely to be attracted, as Islamic T-bills are considered a safe investment option.

The crux of the matter remains that bank loans — extended by lenders who face an array of woes — still greatly overshadow bonds. Moreover, banks control the bond market, too. Iran Fara Bourse has a bond-trading platform in its secondary market, yet its market share is only about 20%. According to Hamooni, “$1.47 billion worth of bonds was handled via the Iran Fara Bourse in the year that ended March 20, 2015. But it is a tiny share compared with the $7.12 billion worth of bonds issued via banks.” He further pointed out that bank loans still dominate capital raising in the country, with “backbreaking interest rates of between 22 to 27%, totaling $204.24 billion in the same period.” Given the high level of nonperforming loans, which has drained bank resources, the necessity of an integrated debt market where bonds have a greater role is both necessary and inevitable.

With many projects in need of major capital, there is plenty of work to be done to enable capital flows as sanctions are lifted. Unless measures are taken to further prepare the opening of the Iranian economy, Iran will not be able to fully benefit from its reintegration into the global economy. 

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