July 23, 2007
MENA Business, Liquidity, Speculation, Fatwas and Egyptian Belly Dancing
Being bored on the TGV, some time to catch up on comments. In this instance on various MENA economy items that caught my eye in the past month.
So, some quick reactions to the massive amount of liquidity flowing about the region now, and globally, and fatwas on IPOs. Sorry no actual Egyptian dancing as such, but the investment equivalent with Ministry of Finance blithering on.
(edited formatting 23/7/07 18h00 GMT+2)
First, with respect to sovereign debt and the liquidity bubble, as reflected in MENA:
Egyptian Pretensions to Investment Grade Status from FT of 12 July amused me to an extent, although the ability of Egypt to launch own-currency denominated sovereign debt is good for them, and at 8.875% (5 yr) is a good for them. For the buyers, well, I guess the thirst for yield continues. Lovely, over-liquidity, for borrowers. Now, someone taking 10 year plus risk on Egyptian Pound denominated paper as “longer maturities [are] to follow” strikes me as daft as I would not have that much confidence in the E£ being stable over such a long term, above all having seen the whackiness the Egyptians indulged in on their initial floatation.
Interesting also, for a reflexion on the thirst for paper that liquidity is driving is this
Dr Boutros-Ghali [Min of Fin] said the issue had not been affected by the upheavals in the credit market, which have halted some corporate bond issues in recent weeks, although sovereign debt has proved resilient. “Turmoil in the market has not affected the appetite for Egypt. Our offering was 2½ times oversubscribed,” he said. “People are convinced Egypt has a serious story to tell, and that we are operating a serious programme of reform that has already proven its effectiveness.”
Well, convinced is a bit strong; desperate enough for yield to convince themselves that it’s firm this time.
But what really amused me what this:
S&P has assigned a ‘BB+’ long-term senior unsecured debt rating to the bond issue. Egypt is ranked one notch below investment grade by all three major credit ratings agencies, S&P, Moody’s and Fitch.
“Investors already see Egypt as investment grade – the ratings agencies will catch up soon enough,” Dr Boutros-Ghali said.
Investors already see Egypt as investment grade? I know BG is MoF but come now. Regional investors with same risk and risk investors, but that’s not the meaning of investment grade.
A wider look at the same issuance in FT from Emerging market debt takes on local flavour of 17 July
The landmark sale sent the strongest signal yet of one of the defining trends in emerging market debt: a marked shift from debt denominated in hard currencies, such as the US dollar and the euro, to debt denominated in local currencies. The deal was two times subscribed in spite of the wider jitters in the market.
“It has been a long-term trend that is now snowballing,” says Jerome Booth, head of research at Ashmore Investment Management, an emerging markets specialist. Other investors and analysts agree that the move towards local currency debt will accelerate in the next five years.
One of the turning points came last year when trading in local market instruments hit a record high of $3,687bn, accounting for 57 per cent of overall emerging market debt trading volume of $6,500bn – itself a record. This compares with a 47 per cent share in 2005 and 45 per cent in 2004, according to data from EMTA, the principal trade group for the emerging markets investment community.
After nine years of gains for emerging market bonds, traditionally comprised of debt denominated in dollars and euros, investors are still bullish about the prospects for the asset class, says Randal Goldsmith, lead fund analyst at Standard & Poor’s Fund Services. But some are starting to question how much longer the sector can continue to outperform other asset classes, he says. Risk premiums on emerging market external debt are at historically low levels.
Thus a growing pool of investors – which now includes central banks, pension funds, life assurance groups and retail investors – is entering the niche corners of the market in search of higher yield. The market is being flooded by billions of dollars in local currency global bonds being sold by governments and companies.
Emphasis added, but the key reason:
“We are driven by the need to find something new to generate outperformance and that means going beyond traditional sovereign external debt,” says Paul Murray John, executive director of emerging market fixed income at Threadneedle.
Returns in local currency debt markets have been often higher than returns in hard currency markets. Interest rates tend to be higher, compensating investors for higher currency risk. In fact, currency appreciation has helped boost some investors’ returns.
That is a dangerous game, above all with historically unstable currencies. Very dangerous game.
Well, for the traders who do the deal, no worries, but for those holding the paper….
Also of interest:
The growing investor bias towards local debt has come at a time when the supply of external debt is shrinking, due to vast improvements in many emerging market economies, helped in part by the boom in commodity prices and – in many cases – better financial management by governments.
The volumes of so-called Brady bonds, which accounted for half of emerging market debt trading a decade ago, is now only a fraction of the volumes being traded today. Early redemptions and exchange offers reducing the stock of dollar-denominated debt have fuelled this trend. Many emerging market governments, particularly in Latin America, are increasingly borrowing in their own currencies.
Smart for the countries, not necessarily stupid for the investors, but an Egypt is a far different case than a Brazil (or the rest of Latin America) in my opinion. Of course the increasing scarcity of emerging market paper driven by the commodities boom – I think I buy into the idea that this is a long term upswing and not a bubble – is a good signal for those investing in emerging markets, but there are emerging markets and frontier markets – not the same profile.
An interesting comment on the difference between hard currency and local currency investing:
Peter Eerdmans, head of emerging market debt at Investec Asset Management says the trend also means investors need to apply a new host of skills. “Hard currency investing requires you to assess whether an issuer is able and willing to pay its debt,” he says. “Local currency investing requires you to assess that, in addition to currency risk, monetary policy, inflation trends and the local yield curve, to name just a few.”
[i.e. knowing the local market more intimately.]
The growing interest in local currency bonds is likely to sustain development in instruments that can help emerging economies protect themselves from potential external financial shocks. In the past, denomination of debt in dollars or another foreign currency has played a key role in virtually every financial crisis in the emerging market world since the early 1980s. According to a recent report into the subject by the Bank for International Settlements, “the conscious nurturing of local currency debt markets became a major objective of financial policy in many countries,” in the past decade.
But the rapid shift away from dollar-denominated debt does not come without risks, particularly since many local currency bond markets are still at an early stage of development.
“New risks and exposures for both borrowers and investors (resident and non-resident) have emerged, and the spread of new financial instruments has made risk monitoring more challenging,” the BIS report says.
Emphasis added in both cases.
Also in the category of moderately amusing yet revelatory in some key aspects is this article from mid-July from the FT: Fatwa unlikely to affect Saudi prince’s IPO
An entertaining note on Prince Alwaleed bin Talal’s Kingdom Holding IPO being attacked by “the kind of attack that is increasingly common in business in the region – a critical religious edict … [which] criticised some of the company’s investments as un-Islamic, underlining the influence of Islam on the conservative kingdom’s financial system.”
But no worries:
Analysts say the fatwa is unlikely to affect the fate of Kingdom Holding’s $860m (€631m, £427m) offering. “Islamic-minded investors will already know that commercial banks and hotels are off-limits – it shouldn’t have too much of an impact,” said Joe Kawkabani of Dubai-based asset management firm Algebra Capital.
Islamic minded investors may be profitably translated into “silly cretins who allow semi-literate religious pin-heads without a clue as to business or economics guide their investment decisions.”
In reality, a relative minority of money.
However, of wider policy interest:
The use of fatwas to influence investors is common in Saudi Arabia, where the popularity of Islamic finance is boosting the role of clerics. Mr Ossaimi issued a ruling advising Muslims against investing in last year’s Red Sea Housing IPO, which other clerics approved.
Giving religious people direct say in business and investment decisions is in the end inimical to both, corrupting to the former, disastrous to the later. But rarely can theocrats resist the urge.
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Call me weird, but I actually LIKE the fact that clerics are meddling in the economy (or at least try to) and get corrupted in the process. It proves that they're (oh so) fallible humans and takes away quite a bit of their ability to maintain a holier-than-thou image.
Posted by: MSK at July 23, 2007 08:47 AM
Do anyone have any experience with Feng Shui in finance?
Well, for the traders who do the deal, no worries,
And there, you've put your finger on it.
The nasty truth is that much investing is like fashion. Banks think up the flavor of the quarter and then push it out to their clients. You've always got to be on top of the Next Big Thing. Sure, there's reputational risk to the bank in pushing nonsensical crap but not to the traders and product guys. By the time the stuff blows up/melts down, assuming it does, they may not even be in banking anymore. They certainly won't be carrying the can for some deal whose revenue got booked three years ago.
I mean, seriously, how many pension funds call up banks desperately seeking Egyptian Pound Callable Snowballs or whatever? None. The banks push this stuff out and the investors take it. Most of the time, the investors don't really understand what they're buying. Hell, most of the time, the banks don't really understand what they're selling. Nor do they care because, once the revenue is booked, they can go on to the next must-have fashion investment and do it again.
Nobody is spontaneously says, "Wow! Look at Egypt. I've got to get me a piece of that!" I doubt if most investors could find Egypt on the bloody map, much less have a sufficiently intimate knowledge of the Egyptian political, social and economic scene to take a lengthy flier on their currency. They only know what whoever is pushing the paper tells them -- and that's nothing they don't want to hear.
Posted by: Anonymous at July 24, 2007 03:07 AM
All well and fine in theory, mate, but the near and medium term results are not what you think, in my opinion.
Posted by: The Lounsbury at July 24, 2007 05:10 PM
Agreed. Short- and medium-term, the involvement will fuck things up. But hey, I'm not invested in the regional economy & I arrogate myself the luxury of long-term thinking.
Maybe "Islamic" investors need to learn the hard way to separate the fuul from the pebbles, just as the Khalijis had to learn the hard way that stock markets don't surge forever ...
Posted by: MSK at July 25, 2007 09:53 AM
Afraid mate that with the fuzzy thinking that goes into such things, that the right people shall not pay the piper, but rather that the inevitable blow-ups in the Islamic finance bubble will be placed on evil World Bank or other convenient scape goats. And as you have seen recently in comments here, self-reflexion is not a wide spread skill.
Posted by: The Lounsbury at July 25, 2007 10:38 PM
I would also add that unless there's a clearly demonstrable long term benefit that compensates for short and mid term costs, then bets on long term at the expense of short-mid term are almost always losing. In this case, chances that all what those illiterate "ulemas" would do on the long term is put us at the point where we are today, a few steps back even. We'll have achieved what? Extended Muslim middle age for some more time, while other nations advanced?
I don't think that ulama meddling in finance could ever reach a level significant enough to stop economic prosperity in a serious way so as to "move things a few steps back."
What I'm talking about in terms of long-term development is to rip the masks of piety off the political ulama's faces. Iran already is a good example.
Posted by: MSK at July 26, 2007 02:44 AM
It's never just finance. Look at the IPO article - that is fundamentally talking about a faqih talking about business decisions.
Ulema meddling in economic policy can indeed have blocking influences where finance opens the door to religious meddling in management, in economic policy, etc. Finance is but one part of economics, but it is the fuel, and choking off the fuel to sectors/activities etc. you don't like for whatever reasons, well, that is power.
As for ripping of a mask... Iran a good example? Is the mask actually ripped off?
Posted by: The Lounsbury at July 26, 2007 05:03 AM
By the way, Anon the non-Anon, made an astute if sad observation here:
None. The banks push this stuff out and the investors take it. Most of the time, the investors don't really understand what they're buying. Hell, most of the time, the banks don't really understand what they're selling. Nor do they care because, once the revenue is booked, they can go on to the next must-have fashion investment and do it again.
The emerging melt-down in mortgage based securities comes right from that: no one really truly knows how robust much of the fancy-schmancy financial modelling is. Castles in the air, in my opinion really. I personally eschew fancy things - in emerging markets back to basics works best, and too fancy financial modelling and game playing merely lays a faux-certain facade over what is in the end gut judgement calls; although to be fair, I am not claiming financial modelling is useless - quite the contrary, if one recalls that values and probabilities thus generated are uncertain estimates although hopefully more rationally data based than pure gut, then it's useful.... but black swans and all that as Nassim puts it.
Odd thing I run into in emerging market "best in class" banks is excessive certainty over valuations. Actually that's everywhere, but here where we know the data is not only dirty, but positively dodgey, how in your right mind can you think your valuation is anything more than a very rough approx?
Posted by: The Lounsbury at July 26, 2007 09:18 AM
My wishful thinking would have it that either the cromagnons don't meddle with economics - which won't happen - or that, since they're going to anyway, that they're made a little bit more literate economics wise - but that's counting on the existing dysfunctional educational structures which can't deliver what escapes them too anyway. Still haven't found the implementable idea that would counter them.
Economically illiterate theologians with a caveman mentality pimping their version of "economics" is one of the biggest threats to Muslims today given the gullible lemmings they're rallying imo. It's second only to the innovation-killing individual-fading "Islam is about obligations and everything is forbidden unless very explicitely stated otherwise" approach that prevails among so many Muslims today (including those tortured consciences who adhere to it but won't practice it because it makes it too constraining) - as opposed to putting the emphasis on rights and freedoms.
Castles in the air, in my opinion really. I personally eschew fancy things - in emerging markets back to basics works best, and too fancy financial modelling and game playing merely lays a faux-certain facade over what is in the end gut judgement calls
Worse, modelling is too often used as a sort of anti-analysis. "If you explain this thing in a way that people can understand what's going on, it's an unsellable dog. Better crank up the model and break out the unreadable Power Point presentation with those equations we cribbed out of that General Relativity textbook."
As an example, about six months or so ago, I had a discussion with someone who had put together a dollar-denominated mortgage debt issue. This guy went on at great length about the different pieces of the deal, how great (and complicated) their modelling was and how solid the Class A notes were.
Sounds pretty vanilla, except that, it turns out, all the propery collateralizing the deal was in Russia. I pressed him about details one-on-one and, eventually, he admitted that 1) While the notes were denominated in dollars, they were subject to Russian law, 2) Evicting someone under Russian law is an extremely difficult and lenthy process -- in fact, up until about a year ago, it was impossible to evict someone under Russian law. 3) If you did manage to evict someone under Russian law, the property would be auctioned off in rubles.
In other words, this super-secured dollar-denominated, asset-backed security was actually a play on the USD/ruble exchange rate with a touch of speculation on the Russian housing market thrown in. Since all the borrowers were in Russia but paying in USD, the deal would go into massive default if the ruble were to take a dive. If you were, eventually, able to make your way through the foreclosure process, you'd end up with a bunch of rubles. As we're assuming that the ruble tanked, you'd still lose a big chunk of capital even if local housing prices hadn't tanked as well.
Now maybe, properly understood, these notes still had an acceptable risk/reward ratio. But they were definitely not the "safe-as-houses" collateralized notes they were being pitched as. You can coat a pig with feathers but that won't make it halal.
Posted by: Anonymous at July 26, 2007 04:08 PM
Ah brilliant example, absolutely brilliant. Highly dodgey assumptions wrapped up in nice "safe as houses" marketing rubbish.
Hidden risk piled onto hidden risk, all coated up in assumptions from developed markets that rather seem dubious even there.
Posted by: The Lounsbury at July 28, 2007 02:14 PM
One of the few genuinely business-helpful facts one can learn from legal field experience, not necessarily theoretical legal training but actual experience, is that the most important question to ask in anything involving a pursuit of wealth is "how easy will it be to implement and carry through collection in each possible scenario for the endeavor"?
Posted by: matthew hogan at July 28, 2007 07:33 PM
Interesting. The issue of the potential for corruption is one that I raised in a recent interview with an Islamic finance expert. He admitted that it could happen, but that it never had (to his knowledge).
A couple of years ago the head of one particular Islamic bank told me, sadly off the record, that Islamic finance was a "temporary fad" that he expected (and to my judgement, hoped,) would pass in a few more years or so.
The fact that there are only a handful of cleric-types properly qualified to sit on these shariah boards doesn't help matters.
I do like your take on "islamic minded investors" though.
Posted by: secretdubai at July 29, 2007 06:46 PM
potential for corruption is one that I raised in a recent interview with an Islamic finance expert. He admitted that it could happen, but that it never had (to his knowledge).
Given the people who are the ones sitting on the evaluation boards are the same ones that are on approval boards.... who is going to call spade a spade?
Gulf practices in this area are utterly without the slightest real standards on corporate governance.
Posted by: The Lounsbury at July 29, 2007 07:11 PM
"If you explain this thing in a way that people can understand what's going on, it's an unsellable dog. Better crank up the model..."
That's the Tom Friedman strategy.