* Kazakhstan seeking to diversify fund sources post-crisis
* First Islamic bank opens, second to follow
* Sovereign sukuk issue will be key step
* Balancing act within government on how to proceed
By Robin Paxton
ALMATY, Aug 23 (Reuters) - Seeking to diversify its financial industry after a banking crisis, oil-rich Kazakhstan is drawing on Arab and Malaysian investment in an effort to build an Islamic finance industry among its 13 million Muslims.
Its success may depend on the fate of pioneer investors and the commitment of its secular government to clear the way for a long-awaited sovereign issue of sukuk, or Islamic bonds, which could prompt other issuers to follow.
“If we are able, Inshallah (God willing), to create a strong base of corporate clients, it will allow us to devote more attention to medium-sized and small retail business,” said Adlet Aliyev, chief dealer for Al Hilal Bank in Kazakhstan.
Al Hilal, owned by the government of Abu Dhabi, was the first bank to respond when Kazakhstan passed new laws last year to allow an Islamic finance industry. The bank opened its Kazakh offices in March 2010.
Though modern Islamic finance began three decades ago, its major principles, such as a prohibition on paying interest, would have been familiar to Muslim traders on the medieval Silk Road through Kazakhstan and Central Asia.
Sixteen million people live in Kazakhstan, about 80 percent of them Muslim. Vast oil and metals reserves have helped its economy, at nearly $110 billion the largest in Central Asia, to expand by an average 9 percent a year in the last decade.
“They have an abundance of assets and they have deep pockets to invest,” said Razi Pahlavi Abdul Aziz, consultant with Amanie Business Solutions, a Kuala Lumpur-based firm which advises on sharia or Islamic law.
Al Hilal employs 45 people in its pristine, glass-fronted head office on the upper slopes of Almaty, Kazakhstan’s largest city and financial centre. A handful more work in a branch in the capital, Astana, and a second branch is planned in Shymkent.
The bank aims to invest $250 million in Kazakhstan this year, rising to as much as $1 billion over the next two years.
It intends at first to finance the corporate sector, Aliyev said, particularly large businesses. It is engaged in about 20 projects, offering finance via the commodity murabaha structure, which allows clients to buy an asset on deferred payment terms before selling to a third party, a method compliant with the requirement that all financial transactions involve an asset.
Muhammad Husain ibn Usman Alsabekov, Kazakhstan’s deputy chief mufti, believes grass-roots demand for Islamic finance will grow as the population becomes more aware of the sector.
When he was appointed 23 years ago, Kazakhstan had 68 mosques. Today, there are approximately 2,500. Almaty’s blue-domed Central Mosque is big enough to hold only half of the 14,000 worshippers who attend Friday prayers each week, he says.
“For a simple Muslim, there is no need for interest. Money should be for the benefit of all.”
Investors, though, are cautious. The financial crisis humbled the once-proud Kazakh banking sector; international creditors were forced to write off billions of dollars of debt in a restructuring process that followed local bank defaults.
“Islamic banking is looking for high returns and safety hubs — which is not Kazakhstan,” said Yekaterina Trofimova, director of financial institutions at credit rating agency Standard & Poor’s.
“But Kazakhstan needs diversification in all aspects of banking and this adds a little more colour and diversity.”
Analysts say it is no coincidence that Kazakhstan passed laws to facilitate an Islamic finance industry during a crisis. As Western credit dried up, new money from Asia ensured that 2008 and 2009 were record years for foreign direct investment.
“On the government level, the idea must have been to look for all available avenues to diversify the country’s funding base,” said Milena Ivanova-Venturini, head of research for central Asia at investment bank Renaissance Capital.
“Kazakhstan, being a majority Muslim country, can play this card and tap into the Islamic pool of funding.”
As global financial markets recover and more familiar financing avenues reopen, however, promoting Islamic finance could become harder. High-profile defaults and rising costs have soured the appeal of Islamic bonds for some conventional borrowers in the Gulf. [ID:nLDE66D11A]
Respondents to a Reuters poll in July estimated global sukuk sales this year at $23-25 billion, barely changed from last year’s $23.3 billion and substantially below previous estimates. [ID:nSGE66I01J]
The issuance of a sovereign sukuk would therefore be an important step in Kazakhstan’s development of its Islamic finance industry. But the country’s cancellation of a $500 million-plus Eurobond issue this year, in favour of domestic borrowing, suggests the government may not be in a hurry.
The Finance Ministry told Reuters it was examining the possibility of a sovereign sukuk issue, but it has declined to give details about the possible date or size.
A London-based banker, who declined to be named, said he expected a delicate balancing act between those in the secular government who take a strictly Islamic approach towards sukuk issuance, and those who question the cost and effort involved.
Support will come from the Regional Financial Centre of Almaty (RFCA), a vehicle to attract investment that is regulated by a state agency with a direct line to Nursultan Nazarbayev, the 70-year-old president who has been in power for two decades.
Timur Omarov, head of Islamic finance at the RFCA’s regulatory agency, said preparatory work was under way to create the legal basis to issue sovereign sukuk.
“We would like to see the creation of a benchmark in order that corporate issuers — Samruk-Kazyna, KazAgro and others — can issue sukuk,” he said, referring to Kazakhstan’s sovereign wealth fund and its state-run agricultural holding firm. Al Hilal Bank’s next challenge, says Aliyev, is to “popularise” Islamic products via seminars and client meetings.
Investors from Malaysia, the world’s largest sukuk market, are planning to establish a second Islamic bank in Kazakhstan. Malaysian financial firm AmanahRaya will participate in the three-way venture with local brokerage Fattah Finance and state-run Development Bank of Kazakhstan.
“On the one hand, it’s a rival,” said Aliyev. “But on the other hand, competitive markets grow the quickest. It’s a good incentive always to be on top form.” <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ (Click on [ID:nISLAMIC] for more Islamic finance stories and ISLAMIC for a speed guide) ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> (Additional reporting by Liau Y-Sing in Kuala Lumpur, Cecilia Valente in London and Maria Gordeyeva in Almaty; Editing by Andrew Torchia)