The Islamic bond market in Iran was first kick-started in 2011, with Mahan Air’s issuance of ijara sukuk on the over-the-counter Iran Fara Bourse (IFB) to finance its purchase of an Airbus passenger jet. Though President Hassan Rouhani’s administration sees the shifting of financing to the capital market as a way to ease the burden on cash-stricken local banks, things have not turned out as expected. The government, municipalities and state companies are now the largest issuers of debt on Iranian exchanges. Indeed, at present, 88% of the 450 trillion rials ($13.8 billion) of outstanding debt on securities markets is issued by state actors.
Official data indicate that private firms merely account for 10% of overall financing on debt markets, while the rest goes to state organizations and companies. Alireza Tavakoli Kashi, director of modern financial instruments at IFB, told leading business weekly Tejarat-e Farda in November that high financing costs is one of the major obstacles in the way of privately run firms raising cash on debt markets. In this vein, he noted that the cost of financing through bonds on IFB is in the region of 21-25%, adding that “for many private companies, this is not affordable.”
The government’s budget deficit is thought to be the key driver of the spike in the yield of Islamic bonds offered for sale on the exchange markets. Mohammad Reza Pourebrahimi, head of parliament’s economic commission, addressing the 2nd Financial and Islamic Seminar at Alzahra University on Jan. 1, highlighted that financing has been prioritized for state companies rather than private firms, and that this has pushed up return rates in debt markets.
In this vein, the hefty borrowing by state-controlled firms has also compelled the low share of corporate bonds when it comes to the issuance of sukuk (Islamic bonds). Not only does government bond issuing dent corporate offerings, but the high yields the government is presently paying to sell its bonds put private companies in a much more fragile situation to use the market to their advantage. This has raised eyebrows among market players and pundits, since they view this policy by Rouhani’s Cabinet as detrimental to the general health of the nascent debt markets. They argue that utilizing the bond platform for short-term financing requirements is against the very essence of these markets, which are in effect designed for long-term funding purposes.
This dilemma is primarily attributed to ever-growing calls for cash from bankers. Considering the market cap of the debt markets — estimated to stand at approximately $8.4 billion — with that of the money market, Islamic bonds stand no comparison. Thus, this leaves no room for privately held entities to use the capacities of debt markets. Moreover, high interest rates in the debt markets are neither attractive nor economically sound for private companies. Accordingly, these firms avoid tapping capital markets for financing and rather seek loans from government-subsidized banks or apply for discounted loans granted by the country’s sovereign wealth fund, the National Development Fund.
Indeed, the total financing through the issuance of sukuk in the previous Iranian calendar year (ended March 19, 2016) amounted to just less than 200 trillion rials ($6.1 billion), jumping almost eightfold in value compared to the year before. These figures underpin the fact that the state sector was the major benefactor of Islamic bonds owing to the lack of proper guaranteeing of such instruments, complicated bureaucracy and contentious feasibility of expansion schemes, alongside the high yields.
For one, the decadeslong imposition of sanctions on Iran has forced leading credit rating agencies such as Moody’s and Fitch to abandon the country. This has pushed Iranian firms seeking to sell debt on the country’s debt market to turn to domestic guarantors in a bid to gain the necessary approval of the market regulator, the Securities and Exchange Organization (SEO). In this situation, guarantors act to secure repayments of the coupons and the principal of issued securities on time and at maturity date to avoid possible default by the bond issuers.
The processes involved in gaining SEO approval of local guarantors has proven to be a time-consuming process. Habib Reza Hadadi, CEO of Omid Investment Bank, in an interview with the leading economic daily Donya-e-Eqtesad on Nov. 17 noted that the red tape related to the underwriting of carmaker Saipa’s Murabaha sukuk took more than nine months. Saipa is the second largest automaker in Iran. Hadadi suggested that the only viable solution to this problem is the establishment of local credit rating agencies, stressing that such firms would negate the need for bond issuers to introduce guarantors to the SEO.
Indeed, being able to borrow and secure bond issue permits from the SEO has never been an easy undertaking. In the absence of ratings agencies, the SEO requires a bank or syndicate of banks to sponsor debt repayment by the bond issuer. Naturally, banks charge fees to offer this service and consequently this obligation escalates the cost of issuing for corporate bonds and hampers interest in entering this market for nongovernmental enterprises.
Equally important is the issue of future economic prospects in Iran. With the crisis over the credit crunch still ongoing in the banking system, coupled with uncertainty over the future state of international trade and poor domestic growth prospects for industry — at least in the medium-run — companies are not able to convince authorities responsible for issuing debt sale licenses of the feasibility of their expansion plans.
Nonetheless, the SEO’s decision to set up the first credit ratings agencies with the cooperation of renowned foreign firms might smooth the route to easier financing via debt market for nonstate enterprises. Indeed, instructions to create such agencies were ratified by the SEO’s board members in April 2016. As such, despite the many challenges faced by private firms in accessing financing on debt markets, the outlook for the latter seems set to improve.
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