Best bank in the Asia region: CIMB Islamic

With activity in the Gulf having been so subdued since the Dubai near-default in 2009 – and, more recently, upheaval in the Middle East – the bank that leads the way in Asia has its strongest ever claim to be leading the way worldwide too. Step forward CIMB Islamic, whose market share as an underwriter of global Islamic sukuk, based on Dealogic’s numbers, hit a remarkable 24.2% in the 2010 calendar year.

Sukuk are clearly not the only way one should judge an Islamic bank, but they provide the most international comparable criterion for influence in the global Islamic markets. And apart from being pm the most deals, and dominating global volume, it was on the deals that mattered. It was, for example, the only regional lead manager (the others were Barclays Capital and HSBC Amanah) on the pivotal US$1.25 billion five-year sovereign sukuk from Malaysia in May, which was the largest ever dollar sovereign to issue Islamically, and came in the middle of the sovereign debt crisis in Europe, hitting a $6 billion order book with more than a quarter of demand coming from the Middle East.

CIMB Islamic is full service, from investment banking to consumer banking and asset management, discussed in more detail in the Malaysia award. But the asset management arm in particular cements the sense of an institution that is regional more than local. CIMB’s Islamic asset management offering runs alongside the CIMB-Principal Asset Management business, jointly owned by CIMB and the vast 130-year-old US house. And almost everything it announces these days has a regional bent: the absorption of Thailand’s BT Asset Management into the CIMB-Principal business in August, allowing CIMB to sell a full range of mutual funds into Thailand, including Islamic; the launch of the CIMB Islamic Global Commodities Equity Fund last year, which gave exposure to Shariah-compliant global equities benefiting from commodity demand. It is one of the world’s leading Islamic asset managers.

While many of its most notable efforts have been domestic, some of them have a global impact. CIMB Islamic CEO Badlisyah Abdul Ghani was instrumental in the development of the Bursa Suq Al-Sila’, the world’s first Shariah-compliant commodity trading platform, which is attempting to streamline commodity trading – and, through it, bank liquidity – across the Islamic world. As a lender, some of its most significant deals have been for multinationals, notably a 12-year $100 million loan, structured around the bai’ al-inah form, for Hewlett Packard in October. And then there are the bricks-and-mortar investments CIMB has built in the Islamic world, from its Bank Niaga stake in Indonesia to its ventures in Bahrain and Brunei. Malaysia wants to be a global hub for Islamic capital, and CIMB more than any other Malaysian bank is its flag-bearer.

Best bank in Malaysia: CIMB Islamic

CIMB Islamic continues to impress in domestic Islamic banking in Malaysia. There are banks that can compete on branches, or assets, or number of mutual funds, or research, or advisory, but it would rarely be the same bank twice. What stands apart with CIMB Islamic is that it is either the leader or a close second in every area from investment banking to consumer and asset management.

We don’t yet have the 2010 full-year numbers, but as of September 30 CIMB Islamic had RM34.8 billion in total assets, a 27.4% increase in just nine months, and entirely in keeping with the stellar growth of a business that had just RM0.5 billion as recently in 2005. Deposits (R0.4 billion in 2005, RM21.25 billion in September) tell a similar story, but actually one can look at any metric in the business – total gross financing, home financing, hire purchase – and see the same picture. And that’s just the consumer side.

In investment banking, CIMB clearly stands supreme in sukuk – with its role on the US$1.25 billion sukuk for the Malaysian sovereign, discussed above, the clear standout – but is also powerful on the equity side, with Shariah-compliant deals including Petronas Chemical Group and JCY International during 2010. It continues to win the important domestic sukuk deals too: a bookrunner role on a RM1.1 billion sukuk for Pembinaan BLT, a state-backed issuer, in January is illustrative.

Whether in esoteric capital markets or mum-and-dad personal finance, CIMB continues to innovative. The ijarah concept is gaining in popularity in Malaysia – previously it was mainly a Gulf staple – and in 2010 CIMB applied it to home financing for the first time in Malaysia, through its Ijarah Property Financing-I product. Its RC-I CM product is a Shariah-compliant revolving credit facility based on commodity murabaha. And then there’s the excellence in Islamic asset management, discussed in more detail in the regional award, as is the bank’s support for the Bursa Suq Al-Sila’ commodity trading platform. In credit cards, financing, wealth management, transaction banking and treasury there is a full-service range of products available and most of them have included some market firsts.

For all that, investment banking is still seen as CIMB Islamic’s strongest suit, and in that respect its immediate prospects are somewhat dependent on both the debt and equity markets, and their appetite for new issuance. But Badlisyah Abdul Ghani runs a business that has consistently stayed ahead through innovation and steady growth, and has seen off tougher markets than this one.

Best bank in the Middle East; Best bank in Saudi Arabia: Al Rajhi Bank

The world’s biggest Islamic bank, Al Rajhi continues to be considered the leader not only in Saudi Arabia but the Middle East region. It is, by Islamic banking standards, vast: at the end of 2010 it had total assets of SR184 billion, upon which it generated profits of SR5.1 billion for the first three quarters of its 2010-11 financial year. Its three million customers give it half of the national consumer finance market in Saudi Arabia.

Al Rajhi was, until very recently, just a Saudi Arabian story, but that changed in 2006 when it moved into Malaysia. It did so in a big way, and has 20 branches already, with plans to open many more. Unlike Kuwait Finance House – its obvious rival for the title of best bank in the Middle East – Al Rajhi opted to go into Malaysia with a full service offering, with all of its core banking products including retail. It is a grand ambition that can only be attempted with deep pockets.

With critical mass attained in Malaysia, Al Rajhi has now turned its attention to its own region, with approval gained in 2009 to open branches in Kuwait and Jordan. Kuwait has been the first to get underway, and again Al Rajhi says it has gone in to “serve all the needs of its retail and corporate clientele,” suggesting a full service offering in due course. In 2010 Al Rajhi announced plans to open five branches in Jordan within a year.

Still, there’s no question Al Rajhi is chiefly a Saudi story; the reason it qualifies for a regional award is in large part because Saudi matters more than almost all other Middle Eastern markets put together. Within that market, Al Rajhi excels on every metric: assets, profitability, headcount, customer base, branches, points of sale and lending.

More than sheer scale, it continues to launch new products and be innovative. Cash management and trade finance services, both undergoing electronic revamps, had excellent years in 2010. And the bank led a new Shariah-compliant bond, sukuk al-amanah Li al-Istithmar, in Malaysia. This is worth looking at in some detail: Al Rajhi was a lead manager on this RM5 billion debt programme by Cagamas, the Malaysian national mortgage company, starting with a RM1 billion print. It was structured in such a way as to be tradable in the Middle East, which generally takes a more conservative stance towards sukuk than do the Malaysian markets. Correspondingly, 33% of the deal went to the Middle East, much higher than usual. This raises big possibilities for further cross-border, cross-tradable deals.

Al Rajhi is, too, one of the strongest players in asset management in Saudi Arabia, although the stand-out in that area is NCB Capital and its Al-Ahli range.

Best bank in Qatar: Qatar Islamic Bank

QIB is the clear leader in Islamic banking in Qatar: impeccably connected to the state and top institutions, and with a critical mass that is going to be tough for anyone to compete with domestically.

Islamic banking is relatively powerful in Qatar: 31% of the total market, accounting for QR149 billion in total assets as of December 2010. Within that, QIB accounts for 35% of the Islamic pool, and 11% of the total banking assets of Qatar overall (and 30% of financing).

The bank has built its name on project and real estate financing, both in the public and private sector. It has funded many of the significant infrastructure and real estate projects in Qatar in recent years, including a record QR4 billion syndicated Islamic facility for the Qatari Diar development group; financing for Qatar Airways; a 25-year US$250 million facility to build a power and desalination plant, and US$150 million on a similar financing for the construction of the RAF A1 desalination project; financing for Qanat Quartier, within the landmark Pearl development; and The Gate construction project, a mixed use real estate project in Doha’s West Bay.

But in recent years it has grown considerably in consumer business too, having moved from one branch in 1983 and eight in 2005 to 28 today and 35 by 2012.  A recent example of innovation in this area was its Hemaya investment product, a Shariah compliant investment vehicle that has proven enormously successful in Qatar.

Like several other of the bigger Gulf institutions, QIB has sought to expand beyond its home boundaries in recent years. It is the key shareholder in Asian Finance Bank, one of the three Gulf institutions that went into Malaysia with full-service licences in the middle of the last decade (the others are KFH and Al Rajhi); it is also a key shareholder in Arab Finance House, in Lebanon; and has interests in Indonesia, Yemen, Syria and the UK, as well as plans in France, Turkey and Kazakhstan. It has also signed a memorandum of understanding with Woori in Korea and BPCE in France.

QIB has the best possible local backers, since the QIA – the country’s sovereign wealth fund – is now the bank’s largest shareholder. This will help strategically and in expansion. It also has muscle: authorized capital of QR2.1 billion at the end of 2010; QR51.8 billion of assets (32% year on year growth); customer deposits and absolute investment deposits of QR30.3 billion (up 49%); and a financing portfolio of QR29.3 billion, up 30%. Return on average equity was 17.9% in 2010, and capital adequacy stands at 17.4%.

This strength helped QIB launch its debut international sukuk in 2010, a US$750 million deal that attracted some US$6 billion of demand.

Best bank in United Arab Emirates: Dubai Islamic Bank

You wouldn’t call Dubai Islamic Bank a business that is shooting the lights out, but it’s still the obvious leader in UAE Islamic banking. Where other Islamic banks around the world boast double digit growth rates, often more than 20%, DIB’s deposits are steady and assets (at just under AED90 billion) growing around the 7% mark annually. But then again, this is the first true fully-fledged Islamic bank, formed back in 1975, so perhaps it’s unreasonable to expect lung-busting growth every year.

It tells you something that, after the AED806 million profit number, the first figure DIB highlights in its 2010 results announcement is provisions, bulked up by AED864 million over the year. That’s a reflection of a crushingly difficult business environment in Dubai, though most in business there feel is a feeling the worst is over. Still, in that environment DIB logged a net operating income (before those provisions) of just under AED 1.9 billion, showing that the well-established core businesses continue to do what they’re meant to.

The simple things worked for DIB in 2010: a focus on balance sheet strength and growth in the retail franchise. DIB upped its presence to 68 branches nationwide in 2010, with six new ones during the year, serving 1.2 million customers in a country whose rather fluid population is usually around the four million mark. Retail accounted for 49% of group revenues in 2010. Perhaps the most salient figure on the whole DIB balance sheet at the moment is the capital adequacy ratio of 17.8% under Basel II, a key differentiator in these uncertain times. Both Moody’s and Fitch upgraded their outlooks on the bank in 2010 (it publicly parted ways with S&P) and at the time of writing it was believed to be the only major bank in Dubai with a stable outlook from both.

Like many of the highlighted Middle East banks in this report, DIB has impeccable connections: its chairman is Mohammed Ibrahim Al Shaibani, whose day job is director-general of His Highness The Ruler’s Court of Dubai. And it’s also in a position to take advantage of lower asset valuations and grow where prudent, which it did in 2010 by increasing its stake in Tamweel, the Islamic home finance provider, to 58%, becoming the majority shareholder. And even in a conservative year, there was still scope for innovation: DIB was behind Emirates REIT, Dubai’s first real estate investment trust, and launched a new personal financing product, Al Islami Salam Finance, and a host of takaful products. Finally, its Dar Al Sharia consultancy and advisory subsidiary has gone from strength to strength, under the guidance of UAE uber-scholar Hussain Hamed Hassan.

Best bank in Kuwait: Kuwait Finance House

By far the biggest Islamic institution in Kuwait, KFH is also one of the Middle East’s few true international players. The regional award is always a choice between KFH and Al Rajhi.

KFH has grown steadily over the last decade, outpacing its native Kuwait. Its asset base, which stood at KD2.4 billion in 2001, was KD12.5 billion by the end of 2010, making for an annual average growth rate of 18.1%. Deposits are up fourfold, to KD7.6 billion, over the same period, and shareholders’ equity six times over to KD1.29 billion, an 18.3% annual growth rate. Net profits have been less dramatic in their growth rate, but have nevertheless doubled over the last decade and stood at KD106 million in 2010.

Bader Abdul Muhsen Al-Mukhaizeem, the chairman and MD, described 2010 as a year of “consolidation and cohesion” for KFH, as it was for many in the Gulf. It shifted investment – both in terms of its own portfolio and its offerings to customers – towards fixed income, low risk, high-liquidity opportunities; it continues to build its consumer business, launching a new family card, the Al-Ousra, in 2010; and it is a long-standing leader in real estate and aviation finance. It is considered to have one of the best electronic systems in the region, manifesting itself both at the treasury level and the individual, with various new smart mobile offerings launched during the year; it’s also evident in revamped credit procedures, anchored around a new documentary credit system called Trade Wind.

Just as Al Rajhi has opened in Kuwait in 2010, so its regional rival is doing the same in reverse. Saudi Kuwait Finance House is up and running and has received a licence to provide a SR500 million real estate investment fund. KFH has long-standing strength in Turkey, which it continues to build upon, launching a new gold investment fund through the Istanbul stock exchange during 2010. It also has branches in Germany and Dubai, as well as its KFH Malaysia and Bahrain businesses, which have eight branches apiece.

KFH is the second-largest Islamic bank worldwide by assets, and continues to impress in the region for its financial strength. Fitch gives it an A+ long-term rating, S&P A-, and Moody’s Aa3. Capital adequacy ratios (14.22% total, and 14.15% tier one, as of December 2010) are down slightly from 2009 but still well above the regulatory minimum of 12%.

BRUNEI: Bank Islam Brunei Darussalam

Competition is not especially fierce in Brunei, the less so since two of the main Islamic banks in the country, Islamic Bank of Brunei and Islamic Development Bank of Brunei, merged to form Bank Islam Brunei Darussalam. BIBD wins the title: in a small country, 14 branches and 600 staff is plenty enough to be dominant. Add its two subsidiaries – Takaful BIBD, which offers Islamic insurance, and BIBD Al-Tamwil, which offers hire purchase financing for vehicles and consumer products – and the group has more or less cornered the market.

For a modest domestic customer base, BIBD is pretty much full service. Its BIBD Securities arm handles brokerage to help its nationals invest in Shariah-compliant equities in Kuala Lumpur and Singapore; its investment banking division has been building an asset and fund management team steadily since the merger; and it offers corporate advisory, wealth management, investment and retail services.

There are more dynamic institutions in the Islamic world than BIBD: the most recent financial statements on its web site date from 2008 and its news section is a host of releases on blood donation campaigns and Toy Story 3 promotions. But still, BIBD is in an interesting place. Brunei has long since wished to diversify away from oil, and set up its Brunei International Financial Centre in 2000, where growth has been modest but the penetration of Islamic banking has been around 40% of total assets – much higher than most other nations. Since the announcement of a banking and insurance order in 2006, and a takaful order in 2008, the legislative environment is now in place, and there is a Shariah financial supervisory board now established at a state level. If Brunei does succeed in making itself a hub for Islamic capital, then nobody is better placed for the opportunities than BIBD.

The bank is also growing steadily. In January it reported a 14.8% rise in profits for the previous financial year to B$101.99 million (though it tells you something that the figures from that January AGM were from 2009). It has B$4.42 billion in total assets, and it has been appointed as a joint lead on some significant sukuk issues by issuers including Islamic Development Bank and General Electric Capital Corporation.

Pakistan: Meezan Bank

Meezan Bank, the first and largest Islamic bank in Pakistan, consolidated its hold on this award over the last 12 months. Firstly, it makes a compelling case based on scale: in January it announced its 222^nd branch across 63 cities in Pakistan. Irfan Siddiqui, president and CEO, has always talked of providing quality Shariah-compliant banking “to every citizen of Pakistan at their doorstep”, and that vision moves closer by the day; some achievement, since when he started saying it eight years ago, it was the smallest bank in the country. It also has the best (local) rating among Islamic banks in the country, at AA.

Secondly, its results are consistently strong. In February it announced its full-year results for 2010, with 61% growth in net profit for the year to Rs1.65 billion. Earnings per share were comfortably up, deposits grew 31% to Rs131 billion, and investments increased 139% to Rs 55 billion. Shareholders received 15% bonus shares in an effort to boost paid-up capital to Rs8 billion (the State Bank of Pakistan had earlier declared a Rs7 billion minimum, a requirement Meezan has now met a full year earlier than scheduled).

Other developments during the year included setting up a new car financing partnership with Indus Motor Company, and the launch of a new Mudarabah-based business account called Meezan Business Plus. It is also an increasingly successful asset manager.

There is huge opportunity in being the biggest Islamic bank in Pakistan. The country has one of the biggest domestic Muslim populations in the world, interest in Islam is clearly increasing – with more and more people wanting to invest their money in keeping with their faith – and individual wealth is climbing too. As more and more people shift from conventional to Islamic banking products, Meezan is ideally placed to benefit.

Indonesia: Bank Syariah Mandiri

The market for Islamic finance in Indonesia, while little developed, is becoming extremely competitive, with five new commercial Islamic banks licensed over the last 18 months in addition to the entrenched players. Of those who have been here longer, two compete in terms of assets, brand and overall standing: the Shariah versions of Bank Mandiri and Bank Muamalat.

A case can be made for both, but we have opted for Mandiri, which is starting to bring the strength of the conventional parent into its Islamic operations too. It is the national leader in assets – in the third quarter of 2010, it had Rp28.05 trillion in assets, up from Rp22.04 trillion at the end of 2009. Profits are still modest, at Rp291 billion in 2009 (the most recent full-year figure yet disclosed), but that’s still a fourfold increase since 2006 and the trajectory is encouraging. It had already beaten that figure in the first nine months of 2010, earning Rp320 billion.

Mandiri has had time on its side: it has had a designated Shariah team ever since the merger that created the overall Bank Mandiri back in 1999, and Bank Syariah Mandiri was formed the same year. It claims some 513 offices operating in 33 Indonesian provinces – one would imagine this involves some overlap with the broader network, but it’s not simply a statement of the overall Mandiri branch count, which is over 900. As a free-standing Islamic entity it has, for example, 220 ATMs in its own right, and claims a staff headcount of some 7,000 in September 2010, although again it seems likely there must be some overlap with the parent in that number.

BSM was upgraded by Fitch in early January to AA(idn); Fitch also upgraded its subordinated Islamic bond from 2007. These upgrades were chiefly predicated on the support from Bank Madiri itself, which put in Rp200 billion over 2008 and 2009 and is believed to be adding an additional Rp400 billion this year in order to bolster the Shariah bank’s capital adequacy ratio to 12%.

Like Islamic finance more broadly in Indonesia, BSM hasn’t done a whole lot so far but shows potential. Fitch, in its upgrade, noted robust financing growth, higher financing yields, a satisfactory deposit mix, and a falling (but still high) non-performing financing ratio (4.2%). It also has a healthy 117.5% provision cover. In the year ahead the bank is expected to expand its micro and SME portfolio in order to lower the concentration risk it faces through corporate financing.

Bahrain: Al Baraka Banking Group

At a time when one of Bahrain’s biggest and oldest Islamic banks, Bahrain Islamic, was announcing a BD39.7 million (US$105 million) loss for 2010, its rival Al Baraka was announcing a $193 million net profit, up 15% year on year. While other banks in the increasingly troubled kingdom have shrunk, Al Baraka’s total assets went up 21% to $16 billion. While others have stopped lending and investment, finance and investments at Al Baraka rose 21% to $11.4 billion.

Customers are getting the message too. Deposits and investment accounts were up 23% to $13.6 billion at the end of 2010, a clear sign of confidence.

Al Baraka chairman Shaikh Saleh Abdullah Kamel attributes the relative strength of Al Baraka to “a model that reflects the true values of Islamic banking and far-sighted business strategies,” which may or may not be a suggestion that not everyone has stuck to those true values and is now suffering accordingly. But it certainly hasn’t come at the cost of expansion: Al Baraka is arguably Bahrain’s most outwardly ambitious Islamic group, and now has 370 branches across 13 countries. In 2010 it opened a new commercial bank in Syria, and launched a new head office for its Turkish business. In October, it completed a merger with Emirates Global Islamic Bank Pakistan and so was able to turn its existing Pakistan branches into a local commercial bank, creating an entity with US$710 million of assets and 89 branches across the country. Next up: Libya – although it’s possible that might now be on hold for a while. Nevertheless, it expects the total number of branches worldwide to hit 500 within the next three years.

Back home, it remains a powerful and comprehensive bank with a full range of operations on the retail and commercial side. It has revamped HR, technical and operational infrastructure, and is working on joint financing of new projects with the Islamic Development Bank.

At the time of writing, with the Saudi army crossing the causeway to Manama, it was not clear just how events were going to pan out in Bahrain. “Not now,” said one person in Bahrain when asked for their opinion on the best Islamic bank. “There are gunshots in the back garden.” Bahrain has built itself on being a hub of stability and reason, and a loss of that status would have an immense impact on businesses there. But, set up in Bahrain in 1984, Al Baraka continues to look one of the strongest names in the country and the region.

“Basmati,” says Rajat Beg, “is the champagne of rice.”

As an executive of India’s REI Agro, one of the world’s major basmati producers, you might say he’s biased. But he has a point. Basmati – the word means “the fragrant one” in Sanskrit – isn’t just a source of sustenance: its rarity, and the sheer difficulty of producing it, has made it a status symbol in its own right. In class-conscious India and elsewhere, if you serve basmati rice, you’re making a statement.

Basmati’s prestige stems from the painstaking process involved in growing it. Everything from the temperature to the soil, the humidity, the timing and the storage of the rice is vital. It grows in only two countries in the world, Pakistan and India; and within India, which accounts for three quarters of the global harvest, it only grows in four provinces and constitutes barely 2% of the Indian national rice crop.

So what do you need to grow basmati? It’s a highly specific checklist. Basmati needs the rich alluvial soil that comes down in the snow-melt from the Himalayas, which is why it only grows in the foothill states of Punjab, Haryana, Uttranchal and a chunk of Uttar Pradesh. Those snow-fed waters are important too, and there needs to be a median temperature of 28 to 33 degrees Celsius and a minimum humidity of 60%. Even the hours of daylight and the gentle winds there are crucial. It’s a very picky breed of rice.

On top of that, the timing of sowing is important. Top growers sow in the nursery in the first week of June, then grow in the kharif season – through July and August, during India and Pakistan’s south-west monsoon season – and harvest from September to December. Everything about this timing matters: it smells better when it ripens in cool weather.

Next, basmati must be matured for 18 to 24 months before it is sold. It is dried, processed and carefully stored. If you buy a packet of top-grade basmati from a store today, it was probably harvested at the end of 2007 at the latest. “Basmati is like wine,” Beg says. “The fragrance and cooking qualities are enhanced with ageing.” Understanding why gets you into some complex science: as moisture reduces in the rice during storage, a cocktail of about 100 chemical compounds is formed, and that’s what makes the rice sweet with a unique nutty aroma.

This convoluted process makes it much more expensive. Whereas mainstream rice goes for around 20 rupees per kilo in India, premium basmati can be five times more than that. So why buy it? Partly, it tastes good: it’s aromatic, it doesn’t stick, and since it loses moisture when stored, it cooks better than normal rice. But it’s more than that. The rarity creates exclusivity, and with it, prestige. “Any family function or get-together in India is incomplete without the basmati recipe,” Beg says. As one producer slogan in India goes: “Basmati is no product. It is a status symbol. It doesn’t just feed; it elevates.”

And, while this social side certainly matters in India, it is still more potent elsewhere. About 60% of the Indian basmati crop – representing almost half the global total – is exported, and of that, almost half goes to Saudi Arabia, and plenty more to the other big Gulf states: United Arab Emirates, Kuwait and Yemen. This is where the prestige of basmati is most powerful: the sense that what you eat, and what you serve, says something about you and your wealth.

It’s a prestige Indians have been prepared to go to court for: when a Texan company won a US patent on basmati rice lines and grains in 1997, the furore went all the way to the top and caused a diplomatic standoff between the Indian and US governments. India didn’t follow through on a threat to take it to the World Trade Organization – the US company withdrew most of its patent claims instead – but to this day the WTO only allows certain varieties of rice grown in India and Pakistan to be labelled as basmati.

Indian scientists have developed molecular market systems – rice detectives, you might say – in order to authenticate traditional or evolved basmati from other forms of rice, so important is it to be sure that only the best crop is sold under the name. Exporters get a “purity certificate”. It’s quite something when your rice has to be fingerprinted: welcome to the exclusivity of basmati.

Pakistan believes it has met all the conditions required for the IMF to release a vital, delayed final tranche of its $11.3 billion emergency loan programme.

The tranche, worth US$1.2 billion, was originally due to be released at the end of March but was withheld over issues including power tariffs and a new VAT law. But Sibtain Fazal Halim, Secretary for the Economic Affairs Division in Pakistan’s Ministry of Economic Affairs and Statistics, told Emerging Markets yesterday: “We are confident we have met all conditionalities and we are hopeful the next IMF tranche will be released soon.”

The IMF is likely to discuss the issue in the middle of this month before making a decision. One of the main areas it will focus on is progress towards a VAT law, which Pakistan must have in force by July 1 to meet the formal terms of the loan. Pakistan has a sales tax on goods and services and has laws under consideration by the federal parliament and four regional legislatures to replace the tax with a VAT. “We hope to have them declare in time,” before July 1, Mr Halim said. Since these laws clearly will not be passed before the IMF meets to discuss the loan, the question will be whether it sees significant commitment to the new law to justify releasing the funds.

It will also consider power tariff increases. Pakistan has already increased power tariffs by 12% in the last year – not a popular decision when Pakistan’s citizens face constant problems with power brownouts – but had been required to impose a further 6% hike by April 1. “It shall be done: maybe before we leave Tashkent, maybe in this month, but it will be effective from the first of April. That’s what the plan is,” Mr Halim said.

Getting the final tranche is vital for Pakistan, and not just because of the money. A failure to receive it would rock already shellshocked investor confidence. A successful disbursement would help sentiment, while the VAT itself would help the country’s funding base enormously. “Our tax to GDP ratio is a little under 10%,” said Mr Halim. “Our aim is to push it up to 15% and if we can do that, we won’t need any assistance.”

Foreign direct investment fell 46% to $1.9 billion in the nine months to March 31, but portfolio flows have started to look slightly more positive: National Bank of Pakistan said in April that $200 million had flowed into local stocks from overseas since the start of the year. Mr Halim blamed the drop in FDI on the global financial crisis and the security situation, but said interest was increasing and “I can tell you with confidence that the foreign investment from overseas will definitely increase.”

He said he believed foreign brokers like Credit Suisse, Citi and JP Morgan, who have all pulled out of on-the-ground presences in Pakistan, could “absolutely” be coaxed back. “These foreign investors did not leave by choice. They left by sheer force of circumstances emanating from the terrorist threat” rather than lack of profitability or a poor business environment. With an improvement in security, he said he believed they would return.

Mr Halim defended his government’s achievements in the two years since it was elected to power, saying that foreign exchange reserves have been restored to pre-crisis levels, inflation has almost halved in a year (albeit to a still-high 13%) and economic indicators have improved. “I would not say it is a complete reversal but an appreciable reversal in negative trends,” he said.

Author’s note: this is one of three articles in a Global Edge special report on Islamic asset management. It was followed by an intensive, 200-page report on Islamic finance published in January 2009, with detailed proprietary data. That report cannot be published on this site but can be purchased from www.cerulli.com

The Shariah-compliant asset management industry is by now a key component of the world fund industry. Just how key, though, is a moot point.

It is commonplace to hear people refer to Islamic finance as consisting of around US$500 million of managed assets, handled by 300 institutions. Some think higher still: literature from the Malaysia International Islamic Financial Centre expects to reach a trillion-dollar Islamic wealth and fund management industry before long.

It is trickier, though, to find the source of these figures, and to ascertain what is meant by ‘managed assets’. Cerulli is conducting its own research to try to come up with a definitive number, which will be released at the end of this year, but it is already clear that mutual funds account for barely 10 per cent of that figure: there are approximately 650 such funds if one includes the various different investment classes of the same fund separately (EurekaHedge, a leading database of Islamic funds, counted 662 as of late July) and between them Cerulli estimates they contain around US$50 billion in assets.

To put that into perspective, there are believed to be around US$800 billion in Islamic bank deposits. A mutual fund figure equivalent to 6% of bank deposits is not particularly high, and there is certainly scope for growth, particularly since bank deposits themselves are also on an upward trajectory.

The dynamics for Shariah fund management growth start with the strong positions of many Islamic economies, most obviously the Middle East. In today’s miserable global credit environment, the Gulf states are some of the only nations with anything positive to say in economic or market terms, largely a consequence of the high oil price. At both an individual and an institutional level, wealth is growing, and at the same time, the willingness to invest in diversified portfolios of managed assets is growing too.

In the major Asian Muslim countries, the picture is varied because the disparity of wealth is wider, from the high standards of living and individual wealth in Malaysia to the poverty of half the population in Bangladesh. Indonesia and Pakistan, the two most populous Muslim countries in the world, fit in between. Nevertheless all of these countries boasts a high GDP growth rate, and growing per capita income, and in each location (bar Bangladesh, where intermediated financial services are in their infancy) the mutual fund industry is growing.

That’s half the story for growth. The other half is the increasing interest in Shariah investment styles. The degree to which this has taken off varies widely from place to place, and the two locations that stand out for their progress are Saudi Arabia and Malaysia.

Saudi is one of the few countries where Shariah funds outnumber conventional ones, both in terms of assets under management and overall number. The most recent data from Tadawul, Saudi Arabia’s stock exchange, lists 229 funds available in the country, of which 127, or 55%, are Shariah compliant. Measured by assets, the picture is sharper still: Tadawul shows that of the 84.65 billion Riyals of net asset value in Saudi mutual funds, R65.09 billion of it is from the Shariah funds – that’s 77% of the total.

Malaysia stands out for different reasons. Shariah funds are not nearly as dominant as they are in Saudi Arabia, but in sum they are more numerous: according to the Securities Commission, as of June 2008 there were 136 Shariah-based unit trusts out of a total of 530. By assets, though, they are much smaller, with a NAV of RM17.98 billion out of a total industry of RM159.85 billion, or just 11.2% of the industry.

Where Malaysia stands out, though, is in the lengths it has gone to to build an environment that is accommodative to Islamic finance. It has the most sophisticated regulatory, legal and training environment in the Islamic world. In other areas of finance the effects of this approach are much more clearly visible – in 2007, for example, 76.4% of approved bonds were the Islamic variety, called sukuk – and there is expectation at a regulator and policy level that unit trusts will eventually follow the same pattern (although the true popularity of these structures is still in some dispute – see distribution section).

In particular, Malaysia has been notable for its willingness to open its doors to others to come in on favourable terms. Earlier this year the Securities Commission approved three financial institutions – Kuwait Finance House, DBS Asset Management and CIMB-Principal Islamic Asset Management – to launch Islamic fund management companies in Malaysia. The idea is that by being inclusive of foreign participants, the overall industry, and Malaysia’s role in it, is strengthened.

Elsewhere, Shariah funds are significant if not dominant: 33% of the Qatar market, 30% apiece in Kuwait and the UAE. They are a vital area for Bahrain, which like Kuala Lumpur has attempted to set itself up as a regional hub for all things Islamic finance, including asset management; by early this year it hosted 87 Islamic funds managing US$1.3 billion, although only a minority are physically run from Bahrain itself. (Many Kuwait funds, for example, are domiciled in Bahrain, which is considered to be an easier place to do so.) In Indonesia and Pakistan, considered two markets of great potential for Islamic finance, development is very much in its infancy: only 1.7% of mutual funds in Indonesia are Shariah compliant, and in Pakistan, 2% of banking assets generally, although both nations expect rapid growth from here. Islamic fund management industries also exist in several non-Islamic countries, notably the UK, USA, Canada and South Africa; still other states are attempting to establish themselves as centres for Islamic finance, which will likely include asset management, despite having negligible Muslim populations of their own, chiefly London, Singapore and Hong Kong.

While Islamic asset management will doubtless grow at a local level in all these countries, the big question is when – if ever – the multinational fund managers will start launching ranges of Shariah compliant funds. Only two of note have done so: Deutsche’s DWS arm and HSBC Amanah, and neither is believed to have had huge success so far, although naturally both have gone in with a long term view. Many groups have produced Shariah-compliant investment products, but these often come from the investment banking arms of these businesses and take the form of structured products. UBS is a prominent example.

There are signs of multinationals coming on board. Franklin Templeton is understood to be launching a range later this year. And when Cerulli surveyed international managers who were active in the Middle East last year, 87 per cent of those who responded said they planned to launch Shariah funds in the future – a remarkably high number given that, again according to Cerulli research, only 0.26% of assets under management for international fund managers in the Middle East were Shariah-compliant at the time of the survey.

On the face of it, it seems very simple: apply a Shariah screen to an existing global equity product, and you have a Shariah-compliant international share fund to sell in the Gulf or southeast Asia. But fund managers point out that it’s not as simple as that. Simply screening out a certain percentage of stocks skews allocations in a way that portfolio managers may not be comfortable with; a whole separate portfolio construction model needs to be used.

But the reason more multinationals have not launched mutual funds is because they are not convinced of the market. If an institutional client such as a sovereign wealth fund wants a portfolio to be managed in a Shariah compliant way, most big international fund managers are quite capable of doing that (although, as the distribution section of this report points out, not that many do make such requests in practice), but the infrastructure and expense involved in setting up a mutual fund is not taken lightly. It is common for fund managers to talk of US$100 million, or sometimes twice that, as a minimum level of subscription they need to be sure of before launching such a fund. Invesco, for example, can run a Shariah screen if a mandate requires it but does not feel the need to go out and launch a range of Shariah products.

The disconnect between the supposed riches of this sector, and the unwillingness of international fund managers to launch product to cater for it, basically comes down to a widespread belief that Shariah-compliant asset management is at heart a retail story, and reaching that part of the market requires a particular approach to distribution. In brighter economic times a year ago it looked very much as if the tipping point was being reached where foreign managers started to tackle the Islamic opportunity in earnest. Today, fund managers have other things on their minds, though it’s surely a question of delay rather than abandonment. But how to approach the market? That’s the subject of the following article.

Author’s note: this is one of three articles in a Global Edge special report on Islamic asset management. It was followed by an intensive, 200-page report on Islamic finance published in January 2009, with detailed proprietary data. That report cannot be published on this site but can be purchased from www.cerulli.com

So, he’s gone. After nine years, Pervez Musharraf has resigned as Pakistan’s president. Western media has in the main taken his departure as a positive, a representation of democracy in action. But, while there’s no question that seizing power in a military coup is a desperately unfashionable way to take government these days, the achievements in Pakistan’s financial sector and privatisation programme do bear scrutiny, and raise big questions about the future.

Here are some figures from Pakistan’s Board of Investments. They show foreign direct investment, combining greenfield and privatisation proceeds but not portfolio investment. 2001-2, not long after Musharraf’s 1999 seizure of power: US$485 million. Then $798 million, $949 million, $1.52 billion, $3.52 billion, $5.14 billion and for 2007-8, $5.15 billion, a more than tenfold increase in six years. Total foreign investment including portfolio flows came to minus $8.4 million in 2001-2, and hit $8.43 billion in 2006-7. If foreigners were queasy about a military government, it didn’t show.

Pakistan’s privatisation programme during that period has been described, with reason, as one of the most successful in Asia. Progress wasn’t always smooth: by 2006, problems had arisen in the sale of 26% of Pakistan Telecom to Dubai’s Etisalat, while the sale of Pakistan Steel Mills was derailed by the Supreme Court. But as one Karachi banker told us then: “I can’t think of any country which in five years has sold its three large banks, a telecom company, a refinery, two fertiliser companies, and is about to privatise its gas and petroleum marketing companies.”

Then there’s the banking sector. Things have been going so well here that before the global credit crunch, State Bank of Pakistan central bank governor Shamshad Akhtar had had to start asking banks to do a bit less well; the net interest margin of the industry, representing the difference between the rate banks pay customers on deposits and what they charge them on loans, got as high as 7.7% in 2006, more than double the average for the rest of Asia. She had to exert what she called “moral suasion” to get them to show a little largesse, although in the end sub-prime and inflation did it for her.

In recent years Pakistan has won the approval of the global capital markets too, with highlights being the $800 million Regulation S Rule 144A sovereign bond, including a 30-year tranche, and a groundbreaking GDR from Muslin Commercial Bank (now MCB).

Sacking judges and wearing a military uniform years after promising to remove it seem destined to have a longer-term place in the popular view of Musharraf’s legacy, but the business and finance side thrived under his strong-armed stewardship, and particularly that of finance-minister-then-prime-minister Shaukat Aziz, the ex-Citibanker.

Asking what happens next raises the thorny question of whether true democracy, while clearly the only way to empower a population, rather gets in the way of growth while doing so. This is the India/China debate: are the multitude of national, federal and local electorates, the unions and the protests and the people power, the reason that India has barely any decent highways and China can build a high speed train most of the way to Mount Everest? In the Pakistan context, did Musharraf achieve so much because he got a clear run for most of his nine years to sort things out unimpeded by meaningful opposition, with both his main political rivals deported?

Everyone who matters in the new ruling coalition has talked about a continuation of Pakistan’s policy towards privatisation, foreign investment and the banking sector, but these are never priorities when there’s a struggle for power going on. At the time of writing the coalition was falling apart; expect, at best, a period of turmoil before things move forward again in Pakistan.

One day, an Islamic bank will fail. That’s a fact. It’s not because there’s anything wrong with Islamic finance; indeed, these institutions have come out of the sub-prime and credit crunch crises in much better shape than many of their conventional counterparts. But banks do fail from time to time, and Islamic banks will too.

And that raises some big issues, because just as so much of Islamic banking is a voyage into the unknown, so are the consequences of a collapse. When a bank operates under Shariah principles, but in a common law jurisdiction, which governing law or courts will handle its bankruptcy, or any creditor claims on the institution? And since Islamic finance is underpinned by the concept of an equal sharing of risk, does that mean that when a bank goes under, all its depositors share in the losses? Generally, when there’s a risk of that happening in the conventional financial world, a government steps in to bail out the individuals. Would that happen in an Islamic banking collapse?

“In theory, the depositors of an Islamic bank are on the hook for the losses of the bank,” says Abdulkader Thomas, president and CEO of Shape Financial, a consulting and training group in Kuwait and the USA. “If there are no profits, they should not make money, and if there is a loss of capital, they can be at risk to lose their capital. But that, to my knowledge, has never happened.”

In theory, though, it could. “At this stage, those governments that are promoting Islamic finance find it in their interests not to let an Islamic bank fail,” Thomas says. “Eventually, though, someone is going to build a large Islamic bank, get into trouble, and the secular authorities are going to say: well, this is how the system works, the depositors contracted to participate in the loss.”

One of the complications of Islamic banking is that the status of the banks’ owners differ from those in the conventional financial world. In particular, the role of the depositor is crucially different. “There is a difference between conventional and Islamic finance that adds another dimension to corporate governance,” explains Mark Stanley at Ernst & Young in Bahrain. “In Islamic financial institutions there are two types of owners: the shareholders, as in conventional institutions, and the investment account holders, or depositors. The relationship between the investment account holder and the [Islamic bank] can be compared to that of a collective investment scheme, in which participants [the account holders] have authorised their fund manager [the bank] to manage their investments.”

If you start digging into how Islamic contracts work, you start to see the distinction. Mudaraba contracts, which are the basis of the relationship between banks and their account holders, specify that the account holders, as owners of capital, have what’s called a mudarib relationship with the bank – that is, an agency agreement. In other words, they are sharing risks and rewards with the bank, and effectively providing a form of equity to it in a way that is not the case in conventional banking. “As a result, investment account holders are liable to incur unexpected losses in the same way as shareholders because there is effectively no cushion, as provided by equity from the shareholders in conventional institutions,” Stanley says. Some banks handle this uncertainty by using something called a profit equalisation reserve to smooth out returns to their account holders, so they can offset poor performance and continue to give out a good rate, although this practice does tend to raise eyebrows both in terms of its transparency and its sustainability. And, in any event, it doesn’t help the depositors in the event of a collapse.

Knowing this, shareholders would then be very likely to object if they were to find themselves suffering losses in a bank collapse at the expense of depositors. “If you ask the shareholders to bail out investment companies, those shareholders can take you to court,” says Professor Rifaat Ahmed Abdel Karim, Secretary-General of the Islamic Financial Services Board, headquartered in Kuala Lumpur. “They would say: ‘when I entered this, there was a contractual relationship which says these are the investors who bear a risk. Now you are displacing that commercial risk from the investors to the shareholders, and I was not meant to be holding that.’ That can put pressure on regulators: we don’t know what the outcome of that is, we don’t have certainty in enforcement.”

So what can be done about that uncertainty? “That’s what I’m saying, this will be the challenge for the industry,” he says. “This is why we have to follow a road where we should attempt to mitigate that risk. And hence the natural course we have now is on prudential standards that are being issued.”

The IFSB’s mission has been to try to develop standards that would put the behaviour of Islamic banks on a par with those in the conventional world following best-practice regulation and standards like Basel 2. It’s a long road – developing the regulations is one thing, getting central banks in Islamic countries to adopt them is quite another – but the approach is partly to ensure that the whole industry has a decent understanding of, and practice for, risk.

For example, when Asiamoney asks Rifaat if the recent turmoil in conventional credit markets presents an opportunity for Islamic banking to prove its worth, his response is cautious. “It would only provide that opportunity if the Islamic financial service industry can establish that it has an inherent resilience to a similar crisis,” he says. “I am aware of those who say it does, and I am aware of those who say it does not. The test will be when it takes place, and God forbid it takes place in the near future. But we should not be complacent, we should try to understand the specificities of the risks that there are in this industry.” He says adoption of the IFSB standards “would certainly enhance the soundness and stability of the financial system.”

Rifaat’s efforts are chiefly to stop collapses happening in the first place. But what issues arise when one comes along?

One is that bankruptcy hasn’t really been tested under a Shariah code. “Islamic scholars in the modern era haven’t discussed what they think bankruptcy to mean,” says Thomas. “Some countries have no bankruptcy code, or have an antiquated 19^th century or early 20^th century bankruptcy code. Whether it’s Islamic or conventional, it’s just not equipped. And some bankruptcy codes haven’t been meshed with Islamic issues, so that’s a problem.”

Regulators and central banks are looking at these issues with varying concern. In Pakistan, Shamshad Akhtar, the governor of the State Bank of Pakistan, is one who has tried to think it through. “Since Islamic banks are based on a different risk sharing methodology, there is a lot of investor education we have to do,” she says. “We need to talk about the displaced commercial risk associated with these transactions.” Separately, Pakistan is now developing a safety net program for depositors, since 80% of deposits (in the conventional or the Islamic system) now fall outside of any official guarantee.  Legislation is also being prepared for a deposit insurance scheme. “So that’s one coverage that Islamic banks will have,” she says.

Others see little difference between the failure of an Islamic or a conventional institution. “We do not believe that sharing of risk and insolvency processes are likely to be very different between Islamic and conventional banking,” says Michael Zamorski, managing director, supervision at the Dubai Financial Services Authority, which is responsible for the authorisation, regulation and supervision of financial services firms in the Dubai International Financial Centre.

In his view, it all comes down to the individual contract. “Determining where the risk lies and how a receiver or liquidator would deal with the underlying asset of a particular contract will always come down to the terms and conditions of the contract, what type of security the bank has taken over it and how he or she can perfect that security.” That’s the case whether the governing law or code of the contract is conventional or Shariah. The DIFC today has no wholly Islamic banks under its watch, although it does have significant Islamic banking activity, and the centre’s exchange, the DIFX, hosts a greater volume of listed sukuks (the Islamic equivalent of bonds) than any other exchange. Zamorski says he belives the regulatory framework and risk management structures are strong enough in Islamic banking. “Our expectations of corporate governance and risk management structures for firms are essentially the same for Islamic and conventional intermediaries,” he says.

It’s likely that the stronger the country, the more orderly the treatment of a collapse would be, if it were every allowed to happen. Malaysia in particular has a strong and ordered regulatory environment for its financial sector with very clear laws and regulations for Islamic finance. Bahrain has a sophisticated code, and the new financial centres in Qatar and Dubai have based their regulatory models on the UK. The greater uncertainty is perhaps with those countries which have less clarity in their legal codes and judicial processes, among them Saudi Arabia and the United Arab Emirates outside the DIFC (although one could equally argue that those countries, with a high level of state involvement in their financial services industries, would be more likely to bail out a flagging Islamic bank before a collapse became an issue anyway).

The better news is that Islamic banks are apparently less vulnerable to collapses than conventional banks anyway. It’s not necessarily a matter of great visionary thinking that no Islamic banks were exposed to CDOs – generally, their Shariah committees would never have permitted it in the first place. “The structures necessarily prevent an Islamic bank from having the same risk profile as a traditional bank,” says Thomas. “So they are never going to be able to leverage as much as somebody else. The theory should be that an Islamic bank rescue is less costly, and the risk of loss to shareholders and depositors is lower, than in the traditional environment.” Take, for example, a Murabaha structure, a staple structure of Islamic banking. “You can’t sell it down, and tranche it, and sell it off,” says Thomas. “There’s an asset there, with a residual value.”

One can argue – and some do – that the credit crunch shows why Islamic banking is inherently more sound than conventional banking, given the insistence on real, tangible assets, a deep suspicion of speculation, a lid on leverage and a sharing of risk.

But the fact that Islamic banks were prohibited from the riskier assets of the moment does not automatically mean that they follow best practice in terms of risk management, credit research or investment processes. It would be cruel to say that Islamic banking has fluked its current resilience – Shariah avoidance of excessive speculation and leverage is there for a reason – but it is also fair to say that credit and risk assessment expertise is in its infancy in much of the Islamic world. Few doubt there is room for improvement.

BOX: What history tells us.

Twice before, Islamic banks have run into trouble. On neither occasion has the government let them fall.

The most recent example involved Bank Islam Malaysia, which was the country’s first Shariah-compliant financial institution when it opened for business in July 1983. It was for many years the flagship Islamic bank in Malaysia; even today its own website calls it “the symbol of Islamic banking in Malaysia” and “the flagbearer of the country’s Islamic financial services industry.”

All went well for years, until a shock announcement that the bank had incurred losses of RM457 million in the year ending June 30 2005, thanks to a RM774 million provision against bad loans and investments. Most of them had been incurred by the bank’s Labuan branch, which had been converted from a subsidiary to a branch the previous December. The bank had a gross non-performing loan portfolio of around RM2.2 billion.

The precise reasons for these losses have, in some people’s eyes, never been adequately explained, but they threatened the bank’s future. Bank Negara Malaysia swiftly became involved, allowing suitors (initially Bahrain’s Unicorn Bank and then Malaysia’s own Bank Commerce Tijari) to open talks about taking stakes in the bank. Bank Negara also then set up a special purpose vehicle with bank Islam to manage and restructure the debt and loan portfolio, ring-fencing RM1.6 billion, with the remainder (comprised mainly of Islamic home financing loans) staying on the bank’s books.

By October 2006, a recapitalisation had been completed. Bank Islam issued 845 million new shares for a cash injection of RM1.014 billion. 690 million of the shares, representing 40% of the bank, went to Dubai Financial, part of the Dubai Investment Group, for RMB828.2 million. Another chunk, worth 9%, went to Lembaga Tabung Haji, a fund designed to help Malaysian Muslims with their religious pilgrimages. Bank Islam has since returned to profitability, delivering RM253.68 net profit in the first nine months of its 2007-8 financial year.

The Bank Islam scandal followed an earlier crisis at arguably the most well-known Islamic bank of them all – Dubai Islamic Bank. Founded in 1975, Dubai Islamic is widely considered the first major Shariah-compliant financial institution, and while it is partly state-owned and is closely linked with the Dubai government, this actually dates only from 1998. At that point, a fraud believed to be worth almost $300 million caused a run on deposits, endangering the bank’s future.

The government underwrote the losses and took a 30% stake in the bank, a level of holding it retains today (the UAE Federal Pension Fund also holds 4%).

Dubai Islamic is once again under scrutiny for fraud. A number of high-profile people have been detained in Dubai as part of a fraud investigation, though the precise circumstances have not been disclosed. Among them is Omair Mooraj, head of Islamic banking for the region at JP Morgan, who previously headed project finance for Dubai Islamic (and was quoted in this supplement in Asiamoney last year). Also under detention is Rifat Usmani, a vice president in structured finance at DIB. (Usmani has separately filed a suit against the bank in a court in Miami for “conspiring to detain, torture, and cause Platintiff’s forced disappearance”, according to a report by locally-based media outlet Zaywa Dow Jones, which claims to have seen the documents. Asiamoney has not seen this document.) Separately, the chief executive of one of Dubai’s largest real estate developers, Deyaar Development, is also under detention and investigation; DIB owns 41% of Deyaar.

The latest scandals notwithstanding, the Dubai Islamic and Bank Islam problems illustrate that even when an Islamic bank gets into trouble, it’s not a foregone conclusion that the depositors in the banks will suffer with them. As is the case in conventional finance, it’s accepted that the government or central bank will first try to broker a way of keeping the bank solvent, whether through its own involvement or by facilitating the entry of other stakeholders. So while the theory of equal risk among all participants in Islamic finance is still there, in practice it has yet to happen.

“Let me tell you,” says Shamshad Akhtar, the governor of the State Bank of Pakistan. “From where I sit, this is the most challenging task I have ever undertaken in my career.”

She is referring to a tension that afflicts most Asian central bank governors today: striking a balance between two goals which, on the face of it, are mutually exclusive. In one corner: the need to foster and stimulate growth in a market hit by US slowdown and the global credit crunch. In the other: the dangers of inflation, a situation made worse by the day by rising oil and food prices. One requires a loose monetary policy, the other, a tight one. You can’t win.

In Akhtar’s case, it’s even worse: she’s doing so against a backdrop of unprecedented political instability in Pakistan. The last six months have seen an assassination that resonated around the world; a change of government, to a shaky coalition that has already seen a founding member drop out; and growing animosity between the president and the judiciary. It’s hard to think of worse circumstances in which to be a central banker.

It’s hard to know which challenge to ask her about first, but Asiamoney opts for the political climate. Because the truth is, Pakistan had been travelling remarkably well under the team of President Musharraf and the ex-Citibanker prime minister, Shaukat Aziz. Foreign direct investment hit US$8.42 billion in the 2006-7 financial year, an 88% increase on the previous year, and a 15-fold increase in four years. Pakistan’s economic growth topped 7% for four years in a row up to mid-2007. But that was achieved against a background of political stability, however uneasy the methods of its achievement (Musharraf came to power through a coup, and had consistently failed to follow through on a promise to relinquish his uniform as head of the army).

Recent months have been anything but stable: Benazir Bhutto, having survived a bomb that killed 140 in October, was assassinated in December; an election brought opposition to power, but in an uneasy coalition between two parties; and the day before Akhtar met Asiamoney, Nawaz Sharif, the former prime minister and a key coalition leader, withdrew his ministers from the government.

So how does Pakistan fare in such an environment? “I think it is important to recognise that Pakistan has actually weathered a number of shocks, both domestic and external,” she says. “The net result today, of still having positive economic growth of a fairly decent kind, should give a sense of the resilience of the economy.” She notes the challenges, but adds: “One has to keep track of the baselines relative to the noise. I think that, touch wood, the baseline is intact: the fundamentals are there, and this year’s disruption to macroeconomic stability will have to be accepted and moved on.”

And the politics, while distracting, do reveal an important point. “At least we have achieved a democratic transition. Of course the coalition is going through its challenges right now, but hopefully, I have confidence that the political set-up will come out of it.”

It does appear, though, that the country is beginning to suffer, whether because of political noise or global malaise. FDI for the first three quarters of the 2007-8 year stood at $3.6 billion, suggesting that the full year total is likely to be half of last year’s. Portfolio investment in particular has fallen away, reaching barely 4% of the 2006-7 figure so far. The stock market, which has always shown remarkable resilience to political disruption, is actually one of the better performers in the region, but these numbers suggest that it’s not foreign participation that’s keeping it buoyant.

One particularly alarming element of the new administration has been its vigorous criticism of the fiscal data reported by its predecessor government. “There was a lot of inaction and mismanagement, under-budgeting, and as a consequence of that we have had a huge budget blow up,” finance minister Ishaq Dar told Asiamoney at the Asian Development Bank meeting in Madrid in May. Dar says the budget deficit was heading for 9.5% when he took over, but believes it can now be brought below 7%. But isn’t an attack on previous fiscal reporting an attack on the central bank too?

“Well, we are not involved in the fiscal preparation per se,” Akhtar says. “We do comment and give feedback to the government based on a regular review of what’s going on in the budgetary projections; we recommended the government curtail its borrowing from the central bank, and we maintain that.”She notes that several things factored into previous budget scenarios ended up being far worse than expected, notably oil prices, but also the passing through of food price hikes to consumers.

And this brings us to the second great challenge: the macro story. Akhtar’s approach, faced with this tension between growth and inflation, has opted for monetary tightening, which suggests she sees inflation as a bigger threat than slowing growth. It is not an approach that has made her particularly popular. “From 2005 the central bank, despite facing the displeasure of the industry and various other stakeholders, has been taking measures which are not popular but which are very important to maintain the demand pressure being contained,” she says. Doing so is a challenge anywhere; in a big country with a lot of people below the poverty line, it’s worse. “In the most informed developed economies it is a challenge to do this public communication,” she says. “In a developing country context it is an added challenge. Often I have to face this unfortunate task of announcing the measures and dealing with the public as we go along.”

Akhtar has been among the most vocal of Asian bank governors in saying that commodity price rises are not a spike, they’re here to stay, and people had better get used to dealing with them. “We have to position ourselves at a new level,” she says. “Prices are moving upwards, not back and forth, and it is hard to predict where it will land.” And she is visibly angry about the causes of the oil price rises in particular. “There are clearly corrective actions being taken for food prices on all fronts, some good and some bad, but on oil prices regrettably there is no global concerted effort. I wish there were more questions being asked about why it is the world is not collectively sitting at a table and hammering the suppliers for more production.”

Consequently, when Asiamoney asks what she thinks about a proposal from Thailand to form an OPEC-style cartel for rice production to help stabilise prices, she gives it short shrift. “OPEC has failed us as an institution and as a body to stabilise international prices. It is because of OPEC’s behaviour the world is facing this crisis. If the world was hit by this crisis uniformly, you would have had a different perspective. But now, with the oil producing economies enjoying the benefits at the expense of poorer economies, there is virtually no international noise.”

In the international community, analysts are cautious. “Political uncertainty, tighter monetary conditions, adverse weather and poor agricultural policies are likely to take their toll on GDP growth in fiscal year 2008,” said Citi in April. The cotton crop could be 20% lower this year than last, denting the agricultural sector, while the manufacturing sector has been hit by high lending rates and power shortages, says Citi, expecting the slowdown to spill into services.

“Pakistan’s current account deficit in the first eight month of fiscal year 2008 was 44% higher than the corresponding period a year earlier,” says Citi, noting that the situation is much more serious than last year, when a 4.9% gap (measured as a proportion of GDP) was easily financed by incoming FDI. “The immediate challenge facing the external sector is to secure external funding… we believe the new government will need to step up its efforts to attract petro-dollar surpluses into real estate investment and refining,” says Citi, noting it is optimistic Pakistan can secure the funds it needs.

Other analysts find spots of value in individual companies. Merrill Lynch, for example, likes Pakistan Petroleum.

For her part, Akhtar has been a regular fixture at world summits lately spreading a message with some common themes: that there is no decoupling between Asia and the US, inflation is a vast threat that must be addressed, high commodity prices are here for the long term, and Asian central banks need to tighten monetary policy. It’s not a popular message. “Often people have very unpleasant things to say, she says. “But you have to go on with your work and build your courage to move on with life.”

BOX: THE BANKS

It’s remarkable how the challenges in Akhtar’s day to day existence have changed in recent years. In a previous interview with Asiamoney, one problem was to keep the extraordinary strong performance of the country’s banking sector in check. The gap between what banks were paying on deposits and charging on loans was the highest in the region by a distance, creating one of the most vibrant financial services sectors in Asia. In the midst of this, alongside what she called a process of “moral suasion” to try to make the banks a little fairer to their customers, she required more up front provisioning, “which made a lot of owners unhappy.” That’s starting to look a smart move. “Profits have been lower but in an economic sense the banks will benefit from this provisioning.”

The health of the sector had prompted a number of foreign banks to buy in to Pakistan. Standard Chartered’s US$413 million purchase of 80.86% of Union Bank in August 2006 was the landmark deal, but others have included ABN Amro purchasing Prime Bank, and institutions like Merrill Lynch and JP Morgan staffing up on the ground. Citi, Deutsche and HSBC are already here in their own names.

This seems to be one area that has maintained interest despite the shocks. Barclays has approval from the State Bank to open 10 branches this year, and is expected to start operations in June. There has also been interest from the Gulf (such as an ownership transfer in Saudi-Pak Commercial Bank, and an investment by Bank Muscat) and Japan. In fact, interest has reached a point where Akhtar is already wondering when to say enough is enough. “There is continued interest, but we have to see at what level we say: enough foreign bank stakes, because it creates some resentment in the domestic community.”

The biggest area of growth in Pakistan financial services is in Islamic finance. Pakistan was a late arrival here, taking longer than many Muslim peers to develop an enabling regulatory environment, but since doing so it hasn’t looked back. “It’s been growing at 40% plus and is positioned to grow at that level,” she says. And it’s driven from the grass roots. “Pakistan’s biggest trend of Islamic finance will come from the masses themselves. There is a huge need to enhance the penetration ratio of the banking system, and I see Islamic banking playing a key role in trying to enhance financial penetration.” Pakistan has 160 million people, mostly Muslim. “We are already at 3% of the banking sector [in terms of deposits] in the last two years, and we think that in the next five years we should get to 12 to 15% of the market.”

BOX: THE MARKET VERDICT

One gets a keen sense of what the world thinks of a country’s political climate and outlook when that country’s companies and agencies approach the global capital markets. The vote, so far, seems to be reasonably optimistic.

In May, Lucky Cement priced a GDR issue in London to raise $110 million. It covered its books two and a half times over, attracting 40 institutions following a global roadshow; 20% apiece of demand came from the US and Europe, with the bulk from Asia and the Middle East. The deal priced at a 9% discount to its underlying share price, which isn’t especially high for a GDR given the country’s national circumstances. Merrill Lynch led the deal, with its local partner KASB Securities as financial advisor.

Locally, fund managers believe investors are prepared to separate the political noise from the fundamentals of investments. “The last seven months have seen markets worldwide being more subdued,” says Nasim Beg, chief executive of Arif Habib Investments in Karachi. “In that context, the Pakistan market has continued to do well despite a year of political turmoil around the election. Clearly, most institutions who look at emerging and frontier markets would look at Pakistan as a market that tends to hold its value. There is a high investment return rate here.”

Earnings growth is still good, he says, “and a company like Lucky Cement is poised to do well, both in terms of domestic demand and regional demand for cement.” Another observer says: “There is a very strong reception towards this transaction, because it’s really a play on Middle East construction growth. There is a strong shortage, Pakistan is well positioned to provide it, and cement prices are at all time highs.” He adds: “No matter what governments do, they still have to build roads.”

Beg expects the new government to continue with a policy of using GDRs to privatise state assets, and “my expectation is there will be demand for such stock internationally.”

So should investors be worried about the political climate? “Clearly this will be of concern to international investors, but then whoever has taken exposure to Pakistan in the last 12 months – including the assassination of Benazir Bhutto – has seen that throughout the market has shown remarkable resilience.” He’s right: in the 12 months to June 9, the KSE 100, Pakistan’s benchmark, was down just 1.1%. Over the same period Australia is down 10.3%, China 9.4%, Japan 18.5% and the Philippines 22.3%.

MA Samad, chief investment officer of Atlas Asset Management in Karachi, says that five years of GDP growth, strong remittances from overseas Pakistanis and rising FDI have given Pakistan “a shock absorber. If something goes wrong in the short term for the local economy, it can cope with it.”

Still, we haven’t yet had the chance to see how the state itself fares with an international deal. A planned exchangeable bond of between US$750 million and US$1 billion was axed earlier this year following the change of government. The deal, expected to be exchangeable into shares of Oil & Gas Development, was well advanced: ABN Amro, Barclays and JP Morgan had been appointed as bookrunners in April. However in May finance minister Dar confirmed that Pakistan would be visiting the debt markets in the near future.

Also closely watched will be an international equity issue by Habib Bank, in order for the government to reduce its stake in the bank from 45 to 25%. Habib had originally planned a GDR, but will now undertake a cross-border placement of local shares. At some point the long-planned issue of GDRs by National Bank of Pakistan, which had been mandated to Deutsche Bank and Morgan Stanley, will return to the markets too.

Asian ministers and bank governors have described some of the toughest challenges they have ever faced as they try to balance two opposing forces: threats to growth from a slowing US economy and high food and oil prices on one side; inflation on the other.

Shamshad Akhtar, governor of the State Bank of Pakistan, described today’s environment for monetary policy as “almost the most challenging task I have ever taken in my career.”

And Margarito Teves, finance secretary of the Philippines, said the food price crisis could undo much of the hard work the country has done in almost balancing its budget.

Ms Akhtar said the challenge of “striking an adequate balance between growth and inflation risks… keep central banks worried – up the whole night sometimes”, in particular the rise in oil and food prices.

“It has to be recognised the current trend in global commodity prices is not one of distortion, or a cyclical spike,” she said. “The global commodity price upswing reflects growing population stress and is likely to stabilise to a new and higher level.” On food prices, she said she hoped financial support could help rejuvenate food production, but added: “I believe it’s already late and the damage will leave some scars.”

Mr Teves said the tension between growth and inflation was “a dilemma, because we have a large number of people who are still below the poverty level, and inflation is a major factor in terms of their well-being and ability to cope. At the same time, we also need to make sure we retain a higher level of growth because we need to provide jobs for people.”

The Philippines faces what Mr Teves called “a double whammy” in that the country is not self-sufficient in food or oil. “We have not really pushed self-sufficiency [on food] as a policy because in the past the supply of rice internationally was available,” he said. The gradual removal of supply from the international markets, coupled with a failure to push through a planned irrigation program and increasing input costs such as fertiliser, has made self-sufficiency more of a priority. “We need to stress food security: 88 or 90% [self-sufficiency] is still a bit risky given the situation we are faced with today.” He said in three to five years the country aims to reach 95 to 100% sufficiency.

In the meantime, though, the country’s fiscal position will be under threat. In one of the most successful fiscal consolidation programs anywhere, the Philippines had reduced the budget deficit from over 30% of GDP four years ago to 0.2%, or P12.4 billion, in 2007. “We don’t know what will happen in the months to come… it’s going to be stressful,” he said. “The issue of balancing the budget is not a sacrosanct goal at this point in time. Some of these things are really beyond our control.”

Ms Akhtar argued that challenges in Asian economies “dispel any notion of a decoupling with the US economy. The size and scale of interaction between Asia and American brings immeasurable benefits when the going is good, but will bring a measure of misery when economies are in trouble.” She called upon Asia central banks and governments to work more closely together to mitigate risks for the future.

Pakistan has a lot to worry about at the moment, but you wouldn’t know it from looking at its banking sector. Despite the crippling political uncertainty that afflicts the place today, greatly exacerbated by Benazir Bhutto’s assassination, Pakistan’s banks boast the highest return on equity of any in the region.

This month’s top 10 looks at the banking sector, and it has a very subcontinental feel. Six of the top eight names on the list are from India and Pakistan, including the leader, which for the second consecutive year is Pakistan’s MCB. Only one developed-market name, Hang Seng Bank, makes the top 10, with the remainder coming from Asean countries. There’s none from Singapore, or Korea, and none from mainland China.

The fact is, despite the political problems, Pakistan as a country is doing exceptionally well. Foreign investment inflows were $8.4 billion for the 2006-7 financial year, an 88% year on year increase, according to Pakistan’s Board of Investments. The economy has been growing at or around 7% a year for five years now and the country has enjoyed one of the most successful privatisation programs in the region. The banking sector has thrived in this environment, aided by a population which is growing in wealth but lacks the sophistication to explore many other savings options outside of bank deposits. For several years the net interest margin – the difference between what banks pay customers on deposits, and what they charge them on loans – has been  by far the highest in the region.

But there is a feeling this golden period can’t last. This time last year State Bank of Pakistan governor Shaukat Aziz told Asiamoney how she wanted to rein in the difference a bit for the sake of the consumer (she called it “moral suasion”); and although her efforts are not yet reflected in ROE numbers, which by their nature are always historical, things may well look a bit different in another year.

The State Bank now requires banks to make greater provisions against loan losses, which is likely to cause a headline hit to numbers, if only for a year. Competition is increasing as foreign banks enter the market through acquisition – Standard Chartered and ABN Amro being the biggest recent examples – and there is already evidence of softening lending rates. And in November the Pakistan Banking Association announced what it calls “a consensus view of the industry” to raise deposit rates for savings accounts to a minimum of 4%, which will naturally cut the net interest margin. It will take a while for these shifts to come through in reported return on equity numbers, but when they do, Pakistan’s banks may fall back to looking healthy rather than invincible.

It is interesting that many of the other banks in our top 10 have specialisations in areas like microfinance, agribusiness and rural areas. Bank Rakyat Indonesia, for example, pledges to put over 80% of its loans to microfinance or small and medium businesses. Among its strategies is the Agriculture Revitalisation Program, in which investment loans are made directly to farmers or through plantation companies to support development of alternative energy projects, with farmers paying 10% loan interest and any excess being subsidised by the government.

Then there’s Syndicate Bank, founded in the unlikely financial centre of coastal Karnataka in India’s south. This bank was founded to serve the local weaving industry and now, more than 80 years on, maintains a small business and rural focus. Its flagship product is called the Pigmy Deposit Scheme, which dates back to the late 1920s; through a network of over 3000 agents the bank collects as little as a rupee a day at the doorstep of deposits for a savings scheme. Today the scheme collects over Rs26 million a day. On the agriculture side, the bank has offered credit products ever since launching the Agri Card in 1967, and has consistently brought new offers for the farming community, most recently a scheme to provide need-based credit to tenant farmers through a joint liability group approach.

You don’t hear the global heavyweights of banking talking about these areas, but it’s clear they can support sustainable and profitable businesses. While they seem risky, Credit Suisse analyst Mirza Adityaswara notes that at Bank Rakyat, non-performing loans are declining (from 5.5% in June to 5% in September) and that “provision coverage is high at 154%”. Bank Rakyat’s net interest margin has been declining, from 11.4% in the second quarter to 10.8% in the third, but that’s still an impressive margin by any standards.

Some analysts believe Asean offers the best banks from an investment perspective. Macquarie Research strategist Tim Rocks reckons they are more immune from a global slowdown than economies further north in Asia, and the group’s bank analysts agree: “We consider Asean banks to be the best play on the reflation theme,” says a late November report. “Strong currencies, low interest rates, healthy domestic demand and manageable inflation marking these economies suggests a strong likelihood for this trend to continue.” The bank particularly likes Indonesian, Malaysian and Thai banks, and thinks Indonesia is the best way to play the reflation theme. Indonesia, it says, has the second fastest loan growth in the region after India (it should be mentioned that Macquarie doesn’t cover Pakistan); the lowest loan penetration; good liquidity; high margins, with the scope to rise; and the highest profitability.

THUMBNAILS

1. MCB, Pakistan: 32.5%

Profiled in last year’s feature, MCB (formerly Muslim Commercial Bank) is one of the leading banks in Pakistan and continues to grow strongly. Like many of its peers, it has had a convoluted history – formed at partition in 1947, nationalised 1974, privatised 1991 – but has emerged as one of the most professional outfits in the region, acting as something of an ambassador for the country when it launched a successful GDR issue in 2006.

2. Hang Seng Bank, Hong Kong, 31.7%

Hong Kong’s largest locally-incorporated bank, and increasingly a Greater China play, with 23 outlets across China. Two years into a new strategy focusing heavily on wealth management, commercial banking and the mainland; interim profits were up 43.2% year on year, to HK$8.87 billion, suggesting it’s working. See profile.

3. HDFC, India, 31.3%

Financial services group founded in 1977 to promote home ownership by providing long term finance to households. Perfectly positioned to benefit from the immense demand for housing in India (around two million units per year, according to the National Building Organisation). 2006-7 net profit, at Rs15.7 billion, is four times higher than at the start of the decade.

4. Allied Bank, Pakistan, 29%

Another Pakistan bank, Allied Bank actually predates the country itself. Privatised in 1991 like MCB; acquired by Ibrahim Group in 2004 and amalgamated with Ibrahim Leasing the following year. Universal bank with emphasis on retail; claims the largest on-line network in Pakistan.

5. Bank Rakyat Indonesia, 28%

Indonesian bank with a strong focus on microfinance and on agribusiness. Net profit grew 17.43% year on year in the first half of 2007 to Rp2.36 trillion with growing contribution from fee based income and increasing penetration in agribusiness and other infrastructure projects. Committed to keeping at least 80% of total loans for micro, small and medium clients.

6. United Bank, Pakistan, 24.8%

Another major Pakistani bank. Enjoyed 14% growth in assets (to Rp498 billion) and 13% growth in advances (to Rp288.7 billion) between December 2006 and September 2007, although full year headline profit numbers are likely to end up looking weak after the bank changed its method of calculating provisions in order to come in line with new State Bank of Pakistan requirements. This will have a full year impact of Rs3.95 billion to the total portfolio, split between the last two quarters of the year; United is the first bank in Pakistan to take the charges into its accounts.

7. Syndicate Bank, India: 24.6%

Indian bank historically most active in lending to the rural sector. Its flagship product is the Pigmy Deposit Scheme; it recently added a new doorstep banking facility, SyndSmallCredit, to encourage entrepreneurs lacking capital. Aggressively building branch network, but is increasingly profitable too: net profit went up 11% year on year to Rs2.27 billion in the September quarter.

8. Kotak Mahindra, India, 24%

Indian financial services group covering commercial banking, stock broking, mutual funds, life insurance and investment banking. Employs about 15,300 people worldwide and serves 3.2 million customer accounts. Now going it alone after severing a long-standing partnership with Goldman Sachs. See profile.

9. Bank Central Asia, 24%

A far cry from the institution that had to be bailed out in the Asian financial crisis a decade ago, BCA today has seven million customer accounts and 796 branches. Net profit was Rp3.4 trillion for the first nine months of 2007, up 7.7% year on year, with third quarter loan growth up 28.2% (to Rp68.8 trillion) and consumer lending in particular doing well, driven by new mortgage products.

10.  Public Bank, Malaysia, 22.4%

One of Malaysia’s largest banking groups, and the largest not linked to the government. Core business is retail banking but it is also active in commercial and investment banking, insurance and other financial services. Took over Asia Commercial Bank in Hong Kong in 2006, giving it greater regional reach.

Ones to Watch

Just outside our top 10 was Indonesia’s Bank Danamon, with a 22.4% return on equity. Danamon’s third quarter numbers were impressive: net profit up 75% year on year to Rp1.6 trillion; loans up 22% to Rp50 trillion, driven by the mass market and retail businesses; and a net interest margin of 11.1%. Danamon is 68.16% owned by a consortium called Asia Financial (Indonesia), in which Fullerton Financial Holdings (owned by Temasek) holds 85% and Deutsche Bank 15%. The rest is publicly held.

Bank Mandiri is Macquarie’s top banking pick for Indonesia and the region; Macquarie estimates its 2008 return on equity as 21.3%. It also likes Kasikornbank in Thailand and AMMB in Malaysia, among others.

The highest ranked Korean bank is Industrial Bank of Korea, with a 21.7% ROE. It seems an unlikely champion: 51% government-owned (or 67% if you include indirect state holdings through KEXIM or Korea Development Bank), it is mandated to serve public policy in promoting small and medium sized enterprises in Korea, and reports annually to the Minister of Finance and Economy. But total assets have grown from KW77.6 trillion in 2004 to KW123.1 trillion in the third quarter of 2007; earnings per share have almost quadrupled, to KW3,101, over the same period.

Hang Seng Bank

When Hang Seng delivers its annual results next month [MARCH 3] it is expected to build on a period of outstanding recent performance that has put it among the region’s leaders in terms of return on equity. The largest Hong Kong-incorporated bank, increasingly styling itself as a Greater China enterprise, is two years into a new growth strategy, and so far it appears to be working.

The roadmap for the future was set out at the time of the 2005 annual results, and boiled down to a handful of priorities: growing wealth management and commercial banking; expanding personal and commercial lending; and extending the business in mainland China.

The interim results for the first half of 2007 showed progress on all these fronts. In a great result in which attributable profit rose 43.2% to HK$8.87 billion, and earnings per share 43.2% to HK$4.64, it was wealth management and commercial banking that underpinned the improvement. Securities turnover, sales of investment funds and of structured products all set records; wealth management income was up 58.2% year on year, to HK$3.42 billion; and pre-tax profit in the private banking division was up 62.4% to HK$459 million, putting the bank on track to achieve a five-year target of doubling 2005 pre-tax profit three years early.  Commercial banking is travelling well too, with average customer deposits rising 19.5% and average customer advances 22.7%.

But it’s China that must be the driver of future earnings. Hang Seng investor presentations tend to have the tag-line “a leading financial institution in Greater China”, but is still predominantly a Hong Kong institution, with 150 branches and automated banking centres in Hong Kong and another in Macau.

The 12 months have been important for Hang Seng’s China presence, with the formal incorporation of a wholly owned mainland subsidiary, Hang Seng Bank (China), a particular highlight in May. Today the bank has 23 outlets on the mainland, including nine branches; within them are 22 prestige banking centres, again reflecting a focus on wealth management. It has Shenzhen rep offices in both investment management and insurance, and has won approvals from the State Administration of Foreign Exchange for both QFII and QDII services (covering flows of capital into and out of China). Total operating income from mainland operations grew 86% in the first half to HK$225 million; analysts expect this to be maintained for the full year.

Hang Seng, in its quiet period ahead of the annual result, declined a senior interview, but chief executive Raymond Or gave some indication of his thoughts in his address to the CLSA Investors Forum in late 2007. He spoke of the dangers of US subprime and inflation but said he was optimistic about opportunities in China, saying the bank will focus on the Pearl and Yangtze river deltas and the Bohai Economic Rim, “as well as exploring potential opportunities in western China.”  He said Hang Seng aims to have more than 2000 staff and over 50 outlets on the mainland by 2010.

“Our strategy for the long-term expansion of our business is already yielding encouraging results and has prompted the market to reassess its perception of Hang Seng as an ex-growth stock,” he said.

Analysts agree: ABN Amro’s Simon Ho, for example, raised his 2008-9 financial year forecasts by 7-8% in October based on expectations of higher wealth management income. He rates the stock a buy, despite the fact that following a major re-rating since the interim results the stock trades at a 30% PE premium to Bank of China Hong Kong. At Macquarie Research, Chris Esson upgraded his own price target back in July and still rates the stock an outperform. The first half result, he said, “has demonstrated the value of Hang Seng’s affluent Hong Kong customer base while expansion into China adds a new source of growth.”

Shaukat Aziz became Pakistan’s prime minister in 2004. A Karachi-born career banker and a Citibank executive for 30 years, he entered public life when invited to become finance minister by General Musharraf following the General’s assumption of power in 1999. He has found out the hard way about the perils of public service – he survived a suicide bombing that killed his driver – but is credited for bringing about much of the financial reform which has underpinned Pakistan’s economic revival. Smooth and charismatic – and, to private sector eyes, an agreeable counterpart to the military-uniformed President – he spent half an hour with Institutional Investor’s Chris Wright in Islamabad. 

II: We’re speaking at a time of very strong economic growth in Pakistan. Is it sustainable?

Our medium term outlook is based on a growth target of 6 to 8 per cent. This financial year will be the fourth in a row we will be within that range. The reason these are sustainable growth rates is the transformation and transition of the Pakistan economy over the seven years since President Musharraf came in and all of us joined the team and started the reform agenda.

It was a two-track approach: one, address the macroeconomic issues; two, a structural agenda covered a very holistic menu from the justice system to security, agriculture, manufacturing, banking and so on. A fundamental philosophy drives everything: deregulation, liberalisation, privatisation, accompanied by governance, transparency and stability. If you have these ingredients you will have sustainable growth.

They stand out as one of the more pronounced reforms of any developing country in the recent past. We’ve made a lot of headway. Tax reform has increased tax collection dramatically and reduced corruption; the financial sector is totally deregulated with a level playing field, consistency of policy and a strong regulator; the economy in every area is growing, and has more than doubled in seven years, per capita; and Pakistanis are arriving on the global capital market scene for the first time [through government bonds and corporate GDR issues in London]. The Pakistan story is being heard louder and louder.

Like any country we have our challenges too: we have to sustain the path of reform, we have to show consistency and continuity of policy, we have to have total transparency and improve the quality of governance.

Last year total foreign direct investment was US$3.52 billion. And this year in the first quarter it is a record, over a billion. It all points to an economy which has a lot of promise.

 II: Those FDI numbers are vital given your trade balance and current account deficit.

Oil prices have been a big challenge and the FDI numbers have helped a lot. More than that, it is a vote of confidence by people who have a choice, they don’t have to come to Pakistan.

 II: You mentioned privatisation as a key initiative, and for a long time it has been seen as a success. Would it be fair to say progress has stalled with the situation at Pakistan Steel Mill [see privatisation article]?

No. We have had one, only one transaction which the honourable Supreme Court will not agree to. We have of course appealed. But the momentum of privatisation will continue unabated. We have a whole calendar, we have the Pakistan State Oil company [after the interview the deadline for bidders on to complete statements of qualifications on this sale was extended to January]. We have lots of entities on the list. That reform will not stop, because it is a cornerstone.

 II: How damaging do you think the Pakistan Steel Mill decision was in terms of Pakistan’s perception in this regard?

 Obviously it impacted our program but we have to look ahead. Since the attractiveness of the privatisation program in Pakistan is based on reform, strong growth and the prospect of strong returns to investors we think we will ride over it.

 II: Is it chiefly strategic sales you are looking for in these programs or sell-downs into the market?

 We have both. We are looking at strategic sales which take longer, and selldowns through domestic and international equity markets. We have this month a very important GDR for Oil and Gas Development Corporation [it raised US$813 million at the end of November].

 II: That’s foreign stock markets rather than domestic. Do any of your current privatisation initiatives involve the domestic market?

Yes, this particular company already has a listing. When we do a GDR we do it only when there is a domestic listing. We allocated a little chunk here.

[We then discussed the National Savings Scheme; see asset management article for his comments on this theme.]

 II: When people talk about impediments to future growth in Pakistan they focus on infrastructure and power. Are you on top of those needs?

Absolutely. There is remarkable growth in electricity demand: 8 to 10 per cent a year, very high by international standards. We have encouraged the private sector and the public sector to come in and install new capacity, and several thousand megawatts are being planned. The power needs of course are seasonal, so in the peak season, the height of the summer, we will face some pressure at peak times. At the same time many companies have gone for self-generation and we are introducing more efficiency into our production. We have massive investment in power, lots of foreign interest, lots of local interest.

Then on infrastructure we have a major program of improving our logistics chain from Karachi, our major port, up to the north. We have plans to build more major motorways, we will have by end of next year one from Peshawar to Lahore, and are now starting one from Lahore to Multan. The ports are being made more efficient, they are being outsourced and managed by companies like Hutchison and Dubai Ports. We have good airports in Karachi and Lahore and have started work on a new airport in Islamabad. The railway system is being revamped: we are getting new rolling stock, improving the tracks. Then for oil movement in the country we have pipelines. This is all part of a logistics chain we are looking at comprehensively with the help of the World Bank, and I personally chair this committee.

We are also exploring oil and gas exploration domestically, and import of LNG, and a pipeline from Iran to Pakistan…

II: Is that ever going to happen?

 We reman optimistic but there’s a lot of work to be done. Then we are offering energy corridors, trade corridors, transportation corridors for the central Asian countries through Pakistan on to the Arabian Sea. Western China is very close to the Karachi port, and we have a road which is being improved jointly by Chinese and Pakistani governments. If you look at Pakistan in the next decade or so we see ourselves as leveraging our position by linking more to China, central Asia and Afghanistan, using these corridors to create economic activity.

 II: As someone who has lived widely overseas [he has lived in 10 countries and was based in New York when called back to Pakistan to become finance minister] do you consider the world’s expectations of Pakistan to be realistic?

The perception of Pakistan does not necessarily reflect reality, so we have work to do. People who have lived here, worked here and invested here are very comfortable. But people who do not know Pakistan are influenced by events in the region. We need to get the relevant people to come here and see for themselves what this place is all about. Pakistan is a moderate nation with tremendous human capital, playing a stabilising role in this part of the world, managed transparently where the leaders have a no-nonsense approach. The perception of security gets highlighted in the press, but you can see our biggest problem today is finding hotel rooms. The flights coming in are jam-packed.

 II: Do you feel the perception is damaged by the fact that the country’s president is also head of the military, and leads an administration did not come to power through conventional democratic methods?

 Actually him having dual office is a unique phenomenon which was necessary at the time for facing the challenges which occurred due to the situation in the region, particularly Pakistan. Pakistan is an evolving democracy. We have a very active political process, vociferous opposition, media which is very free, with almost 50 TV channels. We are a functioning democracy where the people have a voice, and we are also very conscious of gender involvement. We are a very tolerant society, everyone is allowed to practise their faith freely. I’m elected, I fought a direct election, so did the entire parliament.

 II: So given that progress, why is it still necessary to have a dual role as head of the military?

 As I said, it’s evolving.

 II: Do you feel that the renewed prosperity of Pakistan is flowing down far enough?

 In the last seven years almost 14 to 15 million people have come out of poverty. Poverty levels have come down in Pakistan from almost 34 per cent of the population to 24 per cent. We have to work harder and that is exactly what we are focusing on now, to transfer the benefits of economic growth to the masses. You can see the emergence of a larger middle class. Sales of consumer goods like motorcycles and cellular phones in the rural areas going up. People’s expectations are rising and they are meeting some of those expectations.

 II: You left a successful and presumably well-paid career at Citibank for a job which has very directly threatened your life. How do you feel about the move you made?

 It was a very good move for the country, for me personally, because any time you get the opportunity to serve your nation, you can influence things, take policy decisions, implement them, make a change. We brought a professional government which is chasing a multitude of challenges and creating many opportunities for its people. I feel very privileged that I’ve got this opportunity, it’s an opportunity of a lifetime, to help improve, enhance and build my country.

Author’s note: this interview was part of a 42 page report on Pakistan distributed with Institutional Investor in January 2007. Other articles will be added to the site in the near future.