At current interest rates; Bonds and Sukuk are not appealing for investors
All over the world, in finance, the “financial system” is the system that allows the transfer of money between savers(and investors) and borrowers. Financial and capital markets channel household savings to the corporate sector and allocate investment funds among firms in both short and the long - term.
All over the world, in finance, the "financial system" is the system that allows the transfer of money between savers (and investors) and borrowers. Financial and capital markets channel household savings to the corporate sector and allocate investment funds among firms in both short and the long-term. Financial intermediaries as institutions that connect surplus and deficit agents have a great significance to mobility and efficiency of the financial system. Intermediaries in "financial markets" include commercial banks which are internationally renowned for their long history. By contrast, investment banks assist individuals, corporations, and governments in raising capital. Unlike commercial banks and retail banks, investment banks do not take deposits. Banks are currently facing the issue of "bad assets" or "toxic assets" (Toxic asset is a popular term for certain financial assets whose value has fallen significantly and for which there is no longer a functioning market). Thus authorities pursue
the policy of capital market development in order to assign several roles of commercial banks to investment banks. Capital markets have the merits of transparency, discipline and cost advantages (economy of scale). Since the development and growth of capital markets in Iran which goes back to 2003, 55000 billion rials worth of securities have been issued (Corporate bonds, Sukuk al Ijarah, Sukuk al Murabaha and Sukuk Salaf). Since awarding the first dedicated investment banking license in Iran in 2007 and enactment of capital market law, innovative financial instruments have been developed in the country to assist entities in raising capital.
Challenges and limitations
Assigning more tasks to investment banks is a challenging job. During the past months Iran's economy has been struggling with recession, as a result of which stock market has tumbled. Corporate sector is facing the issue of liquidity and working capital. Demand-side negative shock and export limitations resulted in decline of "average capacity utilization rate" in manufacturing plants, inevitably to cover the rising costs (energy, raw materials and wages) and maintain their previous year profit margin, manufacturers increased the price of goods and services and put a burden on consumers. To tackle the issue government policy makers pursued the policy of "price ceiling". Apart from this, Iran needs the right "investment culture", there are no real investors or speculators in Iran's stock market.
Ambiguities in Iran's economy, unfinished projects, downward trend of Iran's national currency (30% decline per annum), factory closures, unemployment, revenue/spending imbalance, rising pension contribution to GDP, taxation issues and high interest rates prove obstacles in the way of financing through capital market. In order to develop the financial system, infrastructural policies need to be formulated to deepen the market. Daily volume of trade in Iran's stock market is currently standing at around 200 billion tomans with debt instruments (bonds and Sukuk) in small proportion. Depth of market is of crucial importance in Iran. Value of total share transaction of "Apple Inc." in a single day equals 9% of the value of all transactions in Iran's capital market (bourse, FB, Iranian Oil Bourse, Iran Mercantile Exchange) in one year!
Issue of interest rate
With current high interest rates and an atmosphere of expectancy (nuclear talks outcome), bonds and Sukuk prove no attraction. Point-to-point and expectation of inflation are currently standing at below 15%, while banks and credit institutions offer interest rates of 22% and higher. "Cash flow" is all that matters for banks. Analysts speculate operating loss (OL) in the first six months of Iranian year of 1393 (2014) for majority of banks, meanwhile they offer high rates. Due to lack of trust among investors increasing bonds and Sukuk rates would not be an effective solution to the problem and, moreover, it places a financial burden on issuers.
Will investors embrace Sukuk?
Financial instruments to be attractive need to take investors' risk and return preference into account. Names and titles do not prove attraction. Capital raised by the government and municipalities between 2011 and 2013 is equal in value of 2010. This proves that government had plans to raise significant amount of capital issuing bonds. Despite bank guarantees investors didn't find them appealing, in consequence, instead of cash payments government used them to pay off its debts to contactors. Iran plans to issue 66000 billion tomans in bonds in its 1393 (2014) state budget that seems unlikely to be fulfilled. Despite guarantees to repay the face value on the maturity date and periodic interest payments, due to low rates comparing to bank deposits and lack of trust, buyers and investors will not welcome the securities. Due in part to lack of information on risk and return, it is hard to predict whether or not Ministry of Roads and Urban Development's plans to raise capital by issuing "Sukuk al Ijarah" will be successful.