* Big step for Islamic finance in North Africa
* Officials' projection of money to be raised is overblown
* But many Gulf investors would be interested
* Legal wrangling over sukuk structure must be resolved
* Issue likely towards end of this year
DUBAI/CAIRO, March 6 (Reuters) - Egypt is pinning its hopes
for a return to the international capital markets on Islamic
bonds. It is likely to be successful, provided it can hold
parliamentary elections and resolve domestic legal wrangling
over how to structure the bonds.
Struggling to narrow a big budget deficit and boost foreign
currency reserves that are at critically low levels, President
Mohamed Mursi's government last week approved a draft law that
would allow the state to issue sukuk for the first time.
With its credit rating repeatedly downgraded to junk status
by international rating agencies over the past year, and its
economy undermined by political instability, Egypt might seem an
But analysts said strong investor demand for sukuk
worldwide, potential interest among cash-rich Gulf funds, and
the low global interest rate environment meant an Egyptian issue
could attract heavy orders.
"Naturally, there will be question marks in the minds of
investors, both regional and international, and appetite will
depend on how the issuer can address such concerns," said Chavan
Bhogaita, head of markets strategy at National Bank of Abu
"It all depends on yield. Investors around the world are
still looking for yield and are willing to venture outside their
comfort zone to get it."
An Egyptian sukuk issue would be seen as a major step for
Islamic finance in North Africa, making it easier for other
governments in the region to follow suit.
The regime of former Egyptian leader Hosni Mubarak, ousted
in February 2011, neglected Islamic finance for political
reasons; Mursi's government, backed by the Muslim Brotherhood,
is keen to promote it for both financial and religious reasons.
By themselves, sukuk will not come close to resolving
Egypt's financial problems, and the government's projections for
how much it could raise through them are almost certainly
overblown, analysts and regional debt traders believe.
Finance Minister Al-Mursi Al-Sayed Hegazy predicted Egypt
could raise around $10 billion a year via sukuk, but traders in
the Gulf think international issues of $1 billion or $2 billion
annually would be more realistic.
Domestically, the government might be able to boost its
ability to borrow from Egyptian savers, particularly religiously
conservative ones, by offering them Islamic instruments
denominated in Egyptian pounds.
But the amounts raised are likely to be dwarfed by the
government's budget deficit, which officials say could hit 180
billion pounds ($26.7 billion), or 10 percent of gross domestic
product, in the fiscal year through the end of June.
Nevertheless, debt traders said an international sukuk issue
from Egypt could attract strong interest from Gulf funds which
had not found enough sukuk to buy locally.
"Elections at the end of April will be key, but I am a big
believer in Egypt," said one regional debt capital markets
banker, declining to be identified because he was not authorised
to speak to media. "There will be lots of cash buying this for
many different reasons."
The banker said that once the political situation was
clearer - perhaps towards the end of this year - Egypt could
probably issue a sukuk at a yield in the high 5 percent or low 6
percent area. Other traders estimated yields of up to 8 percent.
Egypt's outstanding $1 billion conventional bond, which
matures in 2020, is currently bid at about 93 cents on the
dollar to yield 7 percent, according to Thomson Reuters data.
In a sign that the government is gearing up for debt issues,
a new head of the finance ministry's debt management office was
appointed this week: Hamdy Samir, previously head of fixed
income and money markets at National Bank of Egypt, a top
Two things will need to happen to permit an Egyptian sukuk
issue, however. One is for the country to hold parliamentary
elections, which are due to begin next month but, under Egypt's
drawn-out electoral process, end only in late June.
The elections are expected to clear the way for Egypt to
resume detailed negotiations with the International Monetary
Fund on a $4.8 billion loan. An IMF deal could unlock other
international aid to Egypt and it would be seen by investors as
an important endorsement of the government's economic policies.
The other necessary condition is a resolution of the legal
wrangling that has plagued the drafting of the sukuk bill.
Hegazy, a former academic with a background in Islamic
economics, said last week that it would take at least three
months to push through regulations necessary for a sukuk issue.
The bill has been referred to the Islamist-dominated upper house
of parliament and is then to receive final approval from Mursi.
But like many economic policies in post-revolution Egypt,
the bill has been slowed by accusations that the government is
abusing its power. Two previous versions of the legislation had
to be amended after protests from critics including religious
scholars at Cairo's prestigious Al-Azhar university.
Because Islam bans interest payments, sukuk are based on
real assets and are supposed to pay investors with revenue from
those assets. The scholars complained the legislation could let
officials abuse their control of public assets or expose those
assets to seizure by private investors in case of a default.
This struck a chord in Egypt because of its history. Khedive
Ismael, a 19th century ruler, borrowed excessively from abroad,
falling into debt that eventually forced the sale of Egypt's
shares in the Suez Canal Company to Britain. The sale launched
the era of direct colonial intervention in Egypt.
Asked by Reuters this week whether assets behind the sukuk
could be seized by creditors, Hegazy insisted there was no risk.
"I would like to reassure you the lands won't be mortgaged.
It is a use of the project assets for a limited time, then the
entire project will return to the Egyptian people," he said,
adding that investors in the sukuk would bear the risk of the
assets behind them performing poorly.
However, the latest version of the bill appears to address
the problem by banning the use of current state assets to back
sukuk but allowing the use of "new" government assets - a
distinction which may not satisfy critics.
"It is a tricky wording," former finance minister Sameer
Radwan told Reuters. "There is a belief that any problem can be
sorted out by altering words. This is possible in politics, not
David Butter, associate fellow at Chatham House in London,
said the government's struggle to pass the sukuk law had to some
extent distracted it from the vital task of securing the IMF
"The political and economic context makes the approval of
the Islamic finance law complicated," he said.
(Additional reporting by Mala Pancholia in Dubai; Editing by