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Saudi budget implies growing role for Islamic finance

By By MUSHTAK PARKER At first glance there is no direct mention of the role of Islamic banking and finance in the Kingdom's economy in the 2012 Saudi national budget announced last week in Riyadh.

But reading between the lines and judging by some of the initiatives launched by various agencies, banks and corporates in the Kingdom leading up to the budget announcement, it is clear that the Islamic finance industry is expected to contribute its fair share in crucial areas such as the financing of small-and-medium-sized enterprises (SMEs) primarily to generate employment especially for the youth; the provision of mortgage or housing finance and housing development finance; funding infrastructure and projects including through PFI (Public Private Financing); and helping Saudi corporates to diversify sources of funding away from bank finance to raising finance through the capital markets, predominantly through sukuk origination, which is expected to go viral in 2012 and beyond.

The involvement of Islamic finance in the Saudi economy is very real and potentially substantial, but in terms of government announcements it is more through nuances as opposed to official financial policy and financial inclusion measures.

For instance, the General Authority of Civil Aviation ( GACA ) in Saudi Arabia according to its director general, Prince Fahd bin Abdullah, has "agreed with the Saudi Finance Ministry and the Saudi Arabian Monetary Agency ( SAMA ) to launch sukuk to fund the new $7.2 billion Jeddah Airport project. The $7.2 billion sukuk program will be self-financing instruments of the General Authority of Civil Aviation , but if there is any shortage in the funding, the Ministry of Finance will cover it to curtail any delays in the project."

While this suggests that the issuance may carry Saudi government guarantees, with the Ministry of Finance being the issuer probably through a standalone special purpose vehicle (SPV) and the obligor, there was no reference to this in the 2012 national budget nor in any Ministry of Finance announcements. Nor was it mentioned in the 47th annual report of SAMA which was presented to Custodian of the Two Holy Mosques King Abdullah on Dec. 12 by the outgoing Gov. Muhammad Al-Jasser, who started his new promotion as minister of economy and planning on the next day on Dec. 13. The issuance in any case will be dependent on the restructuring of GACA into a stock-holding company with four separate constituent companies - one specializing in international airports, one in domestic airports, one in air navigation, and one in technology transfer and information services.

Another sign of the growing importance of Islamic finance in Saudi corporate fund raising is the announcement last week by the Capital Market Authority (CMA) that "in continuance with its efforts to develop and diversify investment channels in the capital markets via offers of securities," it has approved a request by Saudi Basic Industries Corp. (SABIC), the world's largest petrochemicals exporter, to issue and offer sukuk with a value that does not exceed SR5 billion. This would be SABIC's 4th sukuk issuance, easily the most proactive player in the oil and gas sector in the world to raise Shariah-compliant funds as part of a diversification of sources of funding strategy.

Several other Saudi issuers have reported interest in raising funds through sukuk including Saudi Electricity Company (SEC) and Saudi Aramco, the world's largest oil producer and exporter.

The fact that Al-Jasser is now the economy minister may turn out to be a blessing in disguise because he can leverage his experience acquired in Islamic finance when he was the SAMA governor from 2009 to 2011. This, especially to promote greater relevance of the banking sector, both conventional and Islamic, to the real economy and the sector to contribute a greater share to GDP. Al-Jasser's tenure at SAMA is relatively short and he did not even complete his full four-year term. On contrast, his predecessor, Hamad Al-Sayari, was governor for a staggering 26 years from 1983 to 2009. All eyes will be on the new SAMA governor, Fahad bin Abdullah Al-Mubarak, who assumed office on Dec. 13 for a four-year term.

The total 2012 budget amounts to SR1.392 trillion ($371.2 billion) of which total expenditure is projected at SR690 billion ($184 billion) and total revenues are projected at SR702 billion ($187.2 billion). This is based on an oil price of $74 per barrel. But in reality the actual budget expenditure and revenues can markedly differ especially for an economy such as Saudi Arabia's because of its dependence on oil exports and thus also the volatility in the price of crude oil. This in turn can have an impact on the prices of other commodities especially if transport costs increase sharply because of higher oil prices.

Not surprisingly the budget is conservative in that it is based on a relatively low price of oil at $74 per barrel given that only a few days after it was announced the actual price of crude oil was hovering at the $100 per barrel. The budget has also been characterized by no lesser person than King Abdullah as one for economic growth and jobs. The government also wants to see the nonoil public and private sector contribute more to real GDP.

New development projects are allocated SR265 billion with education, transport and health infrastructure getting the bulk of the expenditure.

The Kingdom has also earmarked the construction of 500,000 new housing units at a cost of SR250 billion. This was not allocated in the 2012 budget. Instead SR250 billion of the 2011 budget surplus was deposited in a special account at SAMA to fund the program starting in 2012. This is where Islamic finance has a main chance. Already five Islamic mortgage (home finance) companies have been established in Saudi Arabia, including Saudi Home Loans Company; Deutsche Gulf Finance, Tamweel, Amlak and the proposed mortgage company by the Jeddah-based Islamic Corporation for the Development of the Private Sector (ICD), the private sector funding arm of the Islamic Development Bank (IDB) Group. The limit of housing loans extended by the Real Estate Development Fund too was increased from SR300,000 to SR500,000 which will hopefully provide more houses for citizens and constrain the inflationary pressures stemming from the increase in house rents.

"I do not think the SAMA will give any more licenses in the Islamic mortgage finance market space. We will focus on the Saudi market. The housing sector is the big mover in the Kingdom. The government has announced that it will be spending SR250 billion on this sector over the next 10 years to build 500,000 units. The Kingdom's demography is also very young. The housing gap is 150,000 units a year. What would make the sector really flourish is the adoption of the Saudi mortgage law," explained Khaled Al-Aboodi, CEO of ICD.

Al-Aboodi, however, warned that ICD has hitherto not incorporated the company because it is waiting for the mortgage law to be adopted. But the corporation's board of directors recently took the decision to start the incorporation process of the mortgage finance company which will of course be Shariah-compliant. And which it is hoped will be finalized by the early part of 2012.

Another target group in the budget are SMEs especially funding them directly. In the past this was done through bank finance which would be extended financing to SMEs. "We are also using our Ijara companies to facilitate financing directly to the SMEs and through the creation of SME investment funds. We are establishing the first SME Investment Fund in Saudi Arabia which will be a SR1 billion Shariah-compliant SME fund, which will be the first of its kind. We will be financing companies that are not big enough to progress on their own. It will involve a lot of technical assistance in terms of business processes, financial reporting, ownership structures etc. The goal is once the companies are restructured and on a sound footing, ICD will exit the investment. We want to leave a sound company that would be able to attract future lines of financing from ICD or local banks, explained Al-Aboodi.

Even this fund will target the real estate and mortgage sector. "We are thinking of focusing on the small real estate developers who are building say 30 to 40 villas. They have a good business model but they are relaying on their own resources. It takes them a year to turnaround their projects. We want to support them, transform them and finance them as and when required. Real estate sector is important because it is also moving the other sectors such as the construction and the building materials industries. The demand for housing units is there. The annual gap for housing in Saudi Arabia is about 150,000 units," he added.

© Arab News 2012