This raises concern for investors and analysts of a deepening gap between the equity and debt markets. and further channeling of capital toward low-risk, high-return bonds.
The Cabinet recently gave the go-ahead to the Ministry of Economic Affairs and Finance to issue 100 trillion rials ($2.67 billion) worth of Musharakah and Ijarah sukuk to finance government projects.
The projects to be funded by securities include those run by the ministries of Petroleum; Energy; Roads and Urban Development; Information and Communications Technology; Defense and Armed Forces Logistics; Industries, Mining and Trade; Agriculture; Science, Research and Technology; Health and Medical Education; Sports and Youth; as well as the Atomic Energy Organization of Iran; and Iran’s Cultural Heritage, Handicrafts and Tourism Organization, Ijarah bonds, basically, exchange the future proceeds of the issuer’s assets for a lump payment. They are the most widely used form of the 14 types of Islamic bonds traded worldwide. In Iran, they were first introduced in 2011.
Musharakah bonds represent part-ownership of a particular project. Although they are similar to shares, they are subjected to a limited duration of time and can be adjusted to have a higher ceiling of profit for sukuk holders, Financial Tribune reported.
Controversial Yields
What raises concern for equity investors is the yield on these bonds. According to a report published by the Ministry of Economic Affairs and Finance, the return on one-year bonds stands at about 27-29% while the rate is down to 20-23% for bonds maturing in more than a year, Mehr News Agency reported.
“These rates do not reflect the actual reality of our economic condition and they will make investors shy away from the risk of investment in the equity market,” Ali Nikoogoftar, a senior market analyst at Bazar Saham Brokerage, told Financial Tribune in a telephone conversation.
Normally, bonds’ interest rates should be based on inflation, banks’ interest rates and the minimum attractive rate of return. What the debt market is offering, however, is higher return with significantly less risk compared to any other investment option.
Therefore, the relatively small debt market becomes a rival to the larger equity market and its repercussions eventually go even further.
“Government bonds ought to have low risk and low return. It is the other way around [in Iran]. This considerably raises the opportunity cost of opting for anything other than the debt market for investment,” said the market analyst.
Amin Investment Bank’s senior asset management and investment analystAli Khosroshahi, believes it is highly unlikely for the debt market to lure any liquidity away from equities.
“I don’t see the debt market as a rival to the equity market. They are two distinct entities,” he told Financial Tribune, adding that each is the default choice of a certain group of investors.
The analyst predicted that the upcoming government bonds will be met with lukewarm reception, as lack of liquidity is still an issue in the Iranian economy.
Khosroshahi noted that the same scenario unfolded in the last fiscal year (March 2016-17), as the private sector and non-constitutional investors predominantly stayed away from the bond market and the bonds were mostly bought by state-run banks and their investment companies.
Some of them were also given to contractors in lieu of the government debt to them.
A Paradox
The basic hierarchy of bonds dictates that the riskier they get, the more interest creditors demand to purchase them.
Governments are in fact considered the safest borrowers in the world, as they have the economic power of a whole country to support them.
Some of the most trustworthy governments, such as Germany and Switzerland, might actually demand interest to keep your money.
Banks and corporations are the next in line when it comes to lending risk.
In Iran, however, the situation is different. The government pays 20-29% on Islamic bonds it issues, while companies are borrowing at rates between 20-25% and interbank borrowing rate stands at around 20%.
Strange as it seems, the Iranian government is a riskier borrower than the banks it guarantees. The main reason is the state’s outstanding debt piled up in the early 2010s during Iran’s financial crisis.
According to Economy Minister Ali Tayyebnia, the current level of the administration’s and public-sector companies’ debts held by contractors and other entities stand at a whopping 6-7 quadrillion rials ($152-177 billion).