Sukuk Funds: Post Dubai

I append this article by Dr. Lin See-Yan.

It is worth reading if you are investing in sukuk funds in Malaysia or else where.

"The Gulf city state’s debt problems offer an important lesson – unpredictable, unsustainable and unclear policies are a no-no.

After two difficult years, most come away with the thought that financial markets the world over should have stabilised. Sure, the extraordinary steps taken to stop the panic resulted in flooding the global system with trillions of US dollar liquidity.

In all, governments have spent, lent or guaranteed close to US$12 trillion and central banks held interest rates to near zero to end the financial crisis. Even so, as to be expected, most of the previous excesses were never quite worked off.
They can’t just make all these excesses go away, no thanks to continuing flows of cheap money around the world. So, we should not be surprised to see over-leveraged Dubai stumble towards the end of November.

Inevitably, it had to cut its debt burden down to size. Around the world, financial markets quivered. Investors – mainly banks – found themselves in a flare-up they feared would happen, but had hoped would not.
Dubai’s caustic lesson

The problems of Dubai are already well known. It is a property play that turned into a bubble that burst. The boom was fuelled by easy credit and a poorly regulated market overrun by speculators, and it was cheered on by a go-go Dubai during the heyday of the pre-financial crisis. Since then, residential real estate prices have slumped by nearly 50%. Across the United Arab Emirates (UAE), it has been reported that some US$450bil of construction work had been scrapped.
It all culminated in the recent announcement by Dubai World, the UAE’s largest state-owned conglomerate, that it wanted to impose a six-month standstill on debt repayments.

Because Dubai is not rich in oil, it borrowed heavily to fund its grand ambitions. Nakheel, a government-sponsored developer, used part of these funds to develop the Palm Islands and other spectacular land reclamation projects.
On Monday (Dec 14), Nakheel is due to repay US$3.52bil to holders of its Islamic sukuk bonds. This is part of the US$26bil debt that its parent, Dubai World, is seeking to restructure.

In all, Dubai’s sovereign and its state-controlled companies’ debts could reach US$80bil, in excess of the size of its gross domestic product (GDP) (nobody knows for sure).

Viewed in perspective, Dubai makes up less than 0.1% of the global economy and the UAE, just 0.4% of outstanding global cross-border lending.
What caught investors “feeling wrong and wrong-footed” were reports that Dubai’s ruler had only weeks earlier assured investors that enough funds would be raised to meet “current and future obligations”, the emirate had only hours earlier raised US$5bil from two state-controlled banks in Abu Dhabi, having raised US$10bil from this neighbour in February, and banks in particular felt sure that the emirate would make good on publicly traded papers (particularly Nakheel’s sukuk) rather than lose face and damage the reputation of the Gulf as a business and financial hub.
So, investors can no longer take the “UAE umbrella” for granted. In the end, there are hints that it may still “pick and choose when and whom to assist.”
Over the past year, moral hazard appears to be firmly embedded throughout the global financial system. So for bankers, Dubai offers an expensive lesson. Most had expected the government to stand behind its “ward” (Dubai World).
In the wake of the Dubai debacle, it looks like Dubai is set to make investors share the pain, rather than foster moral hazard. Indeed, lenders are still reeling from the spectacular Saudi defaults not so very long ago.
Fair enough, Dubai World was technically not government-backed. But investors had perceived it to be so and acted accordingly. Dubai’s repudiation of such an implicit guarantee leaves a bitter taste in the mouth of most investors, something they are unlikely to forget anytime soon.

Tail risk resurfaces

Credit worries are back. Two years ago, few investors would worry about “fat-tail” risk. This refers to the occurrence of seemingly remote risky events, carrying with it blotted (hence, fat) devastation. The rest is history.

But the lesson is not easily unlearnt. Indeed, the mere sound of a crack can get everyone running for cover. Little wonder for the knee-jerk reactions to recent developments – from the sharp rise in risk premium for Greek bonds and Turkish as well as Hungarian credit default swaps (following their profound budget mess) to the Dubai debacle when investors fled from risks.

Wall Street tells us government debt is “risk-free.” Don’t you believe it. History is littered with sovereign defaults.
The charade continues. Early this week, reality came home to roost. Greece’s and Spain’s sovereign credit rating were downgraded. Even Britain and the US are not spared.

Moody’s rating for them were set apart from other top-rated sovereigns, calling them “resilient” and not “resistant” (a label kept for Germany, France and Canada).
In Dubai, lack of confidence continued to spread. Tuesday’s tumble in Dubai’s stocks wiped out its whole year’s gain; Moody’s downgraded six Dubai government-controlled companies, citing lack of government support. The carnage goes on.
The moral of the Dubai saga is clear: nasty fiscal shocks are not confined to just emerging nations. Markets soon realised that debt fundamentals in Dubai are no different from those in developed nations, even Britain and the US. Indeed, the line between emerging and developed gets more blurred; the rush to judgement that stability has returned is premature; fundamental imbalances created during the crises (for example, excess leverage) have yet to disappear. Beneath it all, huge vulnerabilities remain. The Dubai saga is a welcome wake-up call.

Sukuk’s dilemma

No doubt, the problems of Dubai will have a chilling impact on the market for sukuk bonds.

These are a class of financial instruments that complies with Islamic investment principles, which prohibit the payment of interest (ironically, bonds theoretically are associated with interest payments).
In the past decade, the market for such US dollar denominated debt-like instruments has gained popularity. This year, US$19bil was raised in the international sukuk market; it peaked in 2007 with US$25bil.

The range of issuers, investors and instruments has since widened and deepened. About a month ago, General Electric’s financing arm became the first western industrial company to issue a sukuk bond for US$500mil. It attracted a new source of investors.

The debt standstill sought by Nakheel has thrown a spanner in the works and so close to the repayment date of Dec 14. In the past week, activity in sukuk bonds came to a virtual standstill in the face of its potentially biggest default.
By any standard, sukuks are small potatoes in the bond world. Less than US$1 trillion of such debt is outstanding – smaller than the amount of new bonds sold by non-financial institutions this year alone.

Nevertheless, it’s a big deal since it is now unclear how sukuks can be restructured. It will be a test case for how well investors are protected because these are viewed as quasi-sovereign credit, i.e. akin to government debt.
There have been at least two defaults so far – one in Kuwait and the other in the US by a small oil and gas company. At issue is whether investors can take possession of the underlying assets or are simply entitled to the assets’ cash flow.
There are no precedents in the Dubai courts. Further, sukuks are structured to comply with Islamic law but are created under English law. Further complications can arise since Nakheel’s assets are situated in the UAE. Moreover, investors have the benefit of Dubai World’s guarantee whose enforcement is subject to some local law issues.

Be that as it may, the episode looks likely to be long drawn out. Bankruptcy in UAE do allow for a protective moratorium, which can be a double-edged sword. Whatever the outcome, Dubai’s action has done the sukuk market a great disservice.
While Islamic finance wasn’t at the root of Dubai World’s problems, investor reaction so far in the face of delicate markets and an uncertain global recovery make people nervous about the future.

At the very least, short-term activity in sukuk will remain stalled. Credibility in the manner restructuring is being handled will determine the future. Indeed, investors are fast learning that no matter how buoyant potentials look, resources are not limitless.

Looking past the sandstorm

As it now stands, the Gulf markets are soft and under continuing pressure. To be fair, the structural underpinnings of these markets need to be viewed in perspective over the longer term.

Lest it’s forgotten, Dubai’s hydrocarbon-rich neighbours – Saudi Arabia, Kuwait, Qatar and Abu Dhabi – command two thirds of the world’s oil and 45% of gas reserves.
Debt levels are very low and high oil prices have enabled them to accumulate more than US$1 trillion in reserves. A few key elements set the stage.
These Gulf nations need some US$2 trillion in infrastructure spending to diversify from oil. This fiscal spending can be financed out of current reserves (viable even at US$40 oil price); offer strong benefits viz no taxation, cheap feedstock, and virtually free land; give rates of return on equity hovering historically around 25%, as against 10%-15% in other emerging markets; and provide access to low-cost funds made possible by accommodative monetary policy, with Gulf currencies pegged to the US dollar.

As with any market, risks loom large. It is always possible for oil prices to fall below US$40 per barrel; geopolitical risks don’t lend readily to being well managed; and opaque family groups dominate markets that are not really transparent.
But these oil-rich nations are known to be basically conservative. No doubt the Dubai excesses present lessons to be learnt. Throughout history, nations have defaulted and live to fight again, and succeed, even prosper.
To regain confidence, a number of things need fixing: call for fiscal transparency, opaque family business groups need to heed the lessons of Korean chaebols, and clarity on the road-map to government prudence over the longer term. This includes a credible plan on debt management once global recovery becomes sustainable.
Dubai teaches an important lesson. Unpredictable, unsustainable, unclear and uncertain policies are a no-no."

[Former banker, Dr Lin is a Harvard-educated economist and a British chartered scientist who now spends time promoting the public interest. Feedback is most welcome at starbizweek@thestar.com.my.]

Singapore: No More Angpow packets!

This is one interesting article. Does it foretell about the return of the banking sector health in Singapore?

Let us read this article which I appended unabridged.

"If anyone doubts the strong recovery of Singapore’s banking sector, just ask Alvin Tan, the ang pow king who, two months before the Chinese New Year, is turning away new customers.

“It was unexpected that the market would recover so fast,” said Tan, co-founder and creative director of Caston Pte Ltd, which this year marks 20 years of making the red packets, mainly for banks. Banks make up 80 per cent of Tan’s customers.

“I have slowed down order taking. I can’t do more new customers, only regular customers,” said Tan. The reason is that the raw material — paper and foil — has to be ordered from Europe and the United States which requires four to five months lead time. “My production schedule has reached full capacity,” he revealed.

Last year, because of the financial crisis, Caston’s ang pow sales fell 15-20 per cent due to smaller orders from foreign banks. Some customers disappeared, such as Lehman Brothers which collapsed in September 2008.

Tan estimates that sales this year have risen 10-15 per cent as overseas orders have increased as well as new private banks setting up in Singapore. In addition, local customers such as DBS and OCBC Bank have increased their orders to cater to their expanding overseas branch networks such as in China.

Orders from the local banks run into several million pieces while foreign banks can buy from 50,000 to 500,000 pieces.

New foreign bank clients have come from Europe and Australia, Tan said. Caston has also got around 20 private bank customers, up by three to four from before, he added.

Caston’s deluxe ang pows are in such demand that it gets orders from banks based in China, Hong Kong, Taiwan and Malaysia — markets which have thousands of ang pow producers.

Caston expects to produce about 60 million pieces of ang pows this year. Prices range from 3.5 cents (RM8.4 sen) to 25 cents (RM0.60 sen) apiece. — Business Times Singapore"

Looks like Singapore is getting its old financial health back. Can Malaysia follow suit?

Malaysia: Oil-Cursed?

Petronas founder and former Finance Minister Tengku Razaleigh Hamzah lamented that Malaysia had squandered its oil wealth and had become an “oil cursed” country dependent on it like a narcotic for quick fixes.

In his most scathing remarks to date about the management of the country's oil reserves and the economy, Tengku Razaleigh said oil money had been used as "a giant slush fund that has propped up authoritarian rule, eroded constitutional democracy and corrupted our entire political and business elite."

"Our oil receipts, instead of being applied in the manner we planned upon the formation of Petronas, that is, according to its original developmental purpose, became a fund for the whims and fancy of whoever ran the country, without any accountability.

"The oil that was meant to spur our transition to a more humane, educated society has instead become a narcotic that provides economic quick fixes and hollow symbols such as the Petronas Towers. Our oil wealth was meant to help us foster Malaysians capable of building the Twin Towers than hire foreigners to build them, a practice in which we preceded Dubai. I would rather have good government than grand government buildings filled with a demoralised civil service," he said in his speech at the Young Corporate Malaysians Summit here today.

He said that when he started the national oil company in 1974, he did not foresee that he would one day wish that the country had not discovered oil.

The Umno veteran said that Malaysians were no longer productive and no longer used their ingenuity to improve themselves to take the leap forward.

This he blamed on the mismanagement and abuse of the country's oil reserves.

"Our nation is blessed with a modest quantity of oil reserves. As a young nation coming to terms with this natural bounty in the early 1970s, our primary thought was to conserve that oil. That is why, when Petronas was formed, we instituted the Petroleum Development Council. Its function was to advise the PM on how to conserve that oil and use it judicially for national development. We knew our reserves would not last long.

"We saw our oil reserves as an unearned bounty that would provide the money for modernisation and technology. We saw our oil within a developmental perspective. Our struggle then, was to make the leap from an economy based on commodities and low-cost assembly and manufacture to a more diverse, economy based on high-income jobs."

He said the government then had planned to apply oil royalties to strategic investments in human capital.

The government, he said, was to have used whatever money was left after making cash payments and allocations for development funds, and place it in a Heritage Fund for the future. The Heritage Fund was for education and social enrichment.

"Instead of being our ace up the sleeve, however, our oil wealth became in effect a swag of money used to fund the government’s operational expenditure, to bail out failing companies, buy arms, build grandiose cities amidst cleared oil palm estates. Instead of helping eradicate poverty in the poorest states, our oil wealth came to be channelled into the overseas bank accounts of our political and politically-linked class. Instead of being the patrimony of all Malaysians, and for our children, it is used as a giant slush fund that has propped up authoritarian rule, eroded constitutional democracy and corrupted our entire political and business elite.

"Malaysia is now an ‘oil cursed’ country. We managed to arrive at this despite not having a lot of oil.”

Tengku Razaleigh said that his generation's failure had been both "political and moral."

"We have allowed greed and resentment to drive our politics and looked the other way or even gone along while public assets have been stolen in broad daylight.

"I encourage you to take up the cause of national development with the ingenuity that earlier generations of Malaysians brought to this task, but the beginning of our journey must be a return to the basics of public life: the rule of law, honesty, truth-telling and the keeping of promises," he told the young corporate leaders in his speech.

“So before we can reinvent ourselves we need to recover our nation. That larger community, bound by laws, democratic and constitutional, is the context of economic progress, it is the context in which young people find hope, think generous thoughts and create tomorrow."

With less than possibly 10 years of commercial oil reserves left,aren't we just too late to right the wrong? Or should we just start crying over spilt milk?

Putrajaya: The Other Pole of Malaysia1?

Say what you want. Putrajaya is inhabited by almost 100% of a particular major community in seclusion. As such, a special modern enclave has been deliberately created which will see a stumbling block to the realization of PM Najib's Malaysia1,whatever it may be.

There was this report written in the Singapore Straits Times worthy of reading. I append it below.

"By day, the administrative capital of Putrajaya is a place of majestic buildings bustling with thousands of civil servants and visitors.

But by night, the area is virtually a ghost town as nearly everything grinds to a halt.

“Putrajaya is often perceived as a boring spot — too far away and just an administrative city,” said marketing executive Puteri Yasrina Yusoff, who works for the city's only shopping mall, the Alamanda.

With that, she summed up one major problem faced by a city that critics condemn as a waste of money.

Putrajaya is the brainchild of former premier Tun Dr Mahathir Mohamad. In 1995, he decided to move the government ministries to what was then a palm oil plantation, so as to ease congestion in Kuala Lumpur.

Housing all the ministries in one area was also intended to improve communications. At the time, some were spread across different buildings in KL because of the rapid expansion of the civil service, which now employs around a million workers.

Located 25km south of KL, Putrajaya takes its name from Malaysia's first prime minister, Tunku Abdul Rahman Putra, and the word “jaya”, which means success in Malay.

The 5ha city boasts scenic lakes, ornate landscaping, pristine parks, well-planned office buildings and housing, its own hospital, a train station and plenty of space. There are no traffic jams, and civil servants living there can travel between their offices and homes within minutes.


Indeed, while critics say there is not much to do in Putrajaya and that it is too far from KL, many of its 60,000 residents love living in the self-contained city.

Puteri Yasrina said the mall — which has two supermarkets, retail outlets, a cinema, a bowling alley and a karaoke centre — sees about 40,000 visitors a day.

Of course, residents have few other choices since Putrajaya has only a handful of small grocers and eateries. Puteri Yasrina, however, noted that the city offers a water sports complex and a rock climbing facility as well.

Former resident Wan Esuriyanti Wan Ahmad, 37, who lived in government housing there for four years while working for former premier Tun Abdullah Ahmad Badawi, said she enjoyed the convenience.

“It took me less than five minutes to get to work. I could go home any time in case of emergencies,” she said. “And I've never stayed in a city so clean.”

The recreational facilities are top-notch, she added. Her family regularly used the cycling and jogging tracks, as well as the public swimming pools.

However, detractors say building Putrajaya has cost too much. According to Tun, as of last year, the price tag had swelled to about RM12 billion.

The city's grandiose buildings are also expensive to keep picture perfect. Just maintaining the Prime Minister's official residence there cost RM158,051 a month, Abdullah told Parliament last year, while his deputy's house required another RM94,166.

Meanwhile, the diplomatic community has resisted moving to the designated diplomatic enclave in Putrajaya.

“Most of our work is in KL,” said a diplomat who declined to be named. “KL is also much more liveable in terms of amenities and entertainment.”

Wan Esuriyanti pointed out another problem. She decided to move out of Putrajaya and buy a property in a nearby suburb because she wanted her children to grow up in a racially balanced neighbourhood.

“Putrajaya is almost 100 per cent Malay,” she said. “I don't want my children to grow up not knowing about other races and cultures.”

Yes, Putrajaya is almost like Kampung Baru of Kuala Lumpur. The racial segregation continues.