By Malek K Temsah of Al Baraka Banking Group
In early October 2012, the western South American nation of Peru signed a historic framework agreement with the GCC states aimed at strengthening bilateral trade and boosting investment flows. While the agreement was lauded as an opportunity to create a “strategic partnership” between both signatories, it is also a timely reminder of the potential next generation markets for Islamic financial institutions.
While Europe, the GCC and Asia have all witnessed a proliferation of Islamic banks, little mention is made of Latin America. An examination of the continent’s underlying fundamentals combined with an assessment of the winds of change currently under way in global trade flows reveal that Latin America could be the next growth story for the phenomenal growth we’ve witnessed in Islamic finance.
Yet, framing the investment imperative for the GCC’s Islamic financial institutions in Latin America must be made in the context of the realities which have thus far hindered the growth of Islamic finance in the continent.
While Latin America has an estimated Muslim population of five to six million inhabitants who are primarily concentrated in Argentina and Brazil, this in and of itself does not guarantee that Islamic finance will be instantly embraced throughout the continent. One need only look at Indonesia and Turkey, two countries with overwhelmingly Muslim demographics and a growing Islamic banking sector that nevertheless does not enjoy more than 4% to 5% of total banking assets in their respective markets.
Yet, for those Islamic financial institutions looking to develop their relationships with Latin America or directly invest in the continent, this article will shed light on three key areas: the potential opportunities that await those institutions willing to capitalize on the first-mover advantage; (ii) the considerable challenges that could serve as a setback; (iii) and the way forward.
The recently announced GCC-Peru framework agreement is reflective of the growing political and economic linkages between the GCC and Latin America’s member states. The forging of these linkages has been hastened, in large part, by the economic stagnation that has swept developed economies, a historic source of funding for Latin America’s natural-resource endowed, asset-intensive, and export-oriented economies.
With the US economy struggling to address stubbornly high unemployment and with Europe’s member nations squabbling over conditional rescue mechanisms and the future of a “fiscal union”, it seems almost logical that Latin America has come to the forefront as a potential investment destination for cash-rich Shariah-compliant investors in the GCC.
Moreover, with the GCC experiencing growing populations and in light of the entrenched political instabilities that dog the GCC and MENA region, the governments of the six-member council are increasingly pursuing policies of sustainable food security and as such have been heavily investing across their supply chains to ensure these strategic goals are met.
Given Latin America’s abundant natural resources such as timber, rubber, gold, coffee beans, iron and copper as well as the import-oriented nature of the GCC’s economies, there is an obvious strategic fit between what Latin America can offer and what the GCC needs.
As a result, by some estimates, total trade between the GCC and Latin American has now reached circa USD 30 billion, an increase of USD 20 billion over the past five years. The ever-increasing trade of tangible goods between these two parties presents a stark opportunity for Islamic financial institutions to capture significant trade finance potential, whether it is on the export or import finance side.
While a growing trade boom is currently underway between the GCC and Latin America, the South American continent is also enjoying a massive infrastructure investment boom in the energy and transportation sectors, particularly in countries such as Brazil and Mexico. Given the asset-intensive financing requirements moving forward, the GCC’s Islamic financial institutions can play a crucial bridge role in project financing throughout Latin America by acting as a source of capital.
While these thoughts reflect the significant opportunities for Islamic financial institutions looking to grow their business lines with Latin America, several challenges lie ahead. First and foremost, given the relatively large geographic distance between the GCC and Latin America, there remains a mutual lack of clear understanding of the credit fundamentals underlying the economies of both regions.
Moreover, while GCC entities have increasingly been investing in South America, there remains somewhat of a legacy averseness to South American exposure, which can be primarily blamed on the hangover resulting from the Latin American debt crisis of the 1980s. Nevertheless, since then, many Latin American countries have successfully transformed their debt dynamics via export-driven budget surpluses and structural macroeconomic reforms.
Subsequently, countries like Columbia, Brazil, Costa Rica, Mexico, Panama, Peru and Uruguay all enjoy investment grade status that cannot be understated given the stringent investment parameters of GCC investors.
Shariah-compliant institutions should work diligently to establish strong partnerships with third parties (such as Inter-American Development Bank, Islamic Development Bank) that could mitigate some of the risks associated with investing in developing / emerging regions. An example of this would be the Multilateral Investment Guarantee Agency (MIGA), an international financial institution that offers insurance guarantees to help investors protect their FDI in developing countries.
MIGA has previously issued guarantees for Shariah-compliant project financing and partnering with such organizations would be an important mitigating factor in addressing the concerns of investors considering debut investments in Latin America.
A key obstacle to the growth of Shariah-compliant financial transactions in Latin America remains the lack of the necessary regulations and incentives that would put Islamic finance deals on an equal footing with conventional financing facilities. In this regard, Islamic finance stakeholders (banks, regulatory bodies, supranational entities) should maintain ongoing communication with the business community of Latin American countries as well as their respective banking authorities with the aim of clearly articulating the benefits of tax-friendly legislative amendments that would facilitate the structuring of Islamic financial structures.
A good place to start would be to approach those countries within Latin American (Brazil, for instance) that have a relatively bigger and better regulated financial and legal framework that could serve as a springboard for pushing Islamic finance deals continentally. Additionally, Islamic finance stakeholders would be well-advised to hold workshops and seminars with South American conglomerates and businesses with the aim of educating them on the use of Shariah-compliant financial instruments (structured offshore) as a means to mobilize the massive liquidity sitting on the balance sheets of GCC investors.
For those Latin American businesses that currently have a presence in the GCC/MENA or which export to the economies of the region, the incentive to engage in Shariah-compliant financing schemes may be more relevant given the profile of their GCC-based clients and as such will prove to be a more enticing entry point for engaging the continent.
While the organic growth of the Islamic finance industry has been the underlying driver behind the expansion of the industry in Asia and the GCC, a more pro-active stance will be required for Islamic finance to take root in Latin America. In this regard, potential entrants need to engage multilateral development banks, regulatory authorities in Latin America, and above all engage its business community.
This is the time for the GCC and Latin America to seize the opportunity and deepen their economic and political ties for the benefit of both sides.
Malek K Temsah is head of sukuk investments at Bahrain-based Al Baraka Banking Group. His previous roles were with London-based European Islamic Investment Bank and Bank of America.
© Zawya 2012
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