FCDBs to Help Internationalize Iranian Equity Market

Issuing foreign currency denominated bonds is Tehran Stock Exchange’s top priority for the current fiscal year (March 2017-18).

TSE's CEO Hassan Qalibaf-Asl made the announcement during the 10th International Exhibition of Exchange, Bank and Insurance in Tehran.

FCDBs are aimed at providing TSE-listed companies with less costly financing compared to local offers.

“With the current 20-24% interest rates, no company is willing to borrow from local firms. And even the country’s single-digit inflation has not improved the situation,” he said.

According to the official, negotiations have been held with foreign organizations and those with Bank Muscat have made the most progress.

The Omani bank has held talks with 10 large-cap Iranian firms and expressed its readiness to cooperate with TSE.

Bank Muscat is the leading financial services provider in the Sultanate of Oman with a strong presence in corporate banking, retail banking, treasury, private banking and asset management. The bank’s assets are worth over $15 billion.

Emphasizing the importance of this undertaking, Qalibaf-Asl said FCDB issuance is a “national project”, as it will be a significant step toward internationalizing the Iranian equity market.

 Why Issue Foreign Currency Denominated Bonds?

When a sovereign government needs to borrow to fund its operations, there is an advantage in issuing debt in its own currency. If it faces trouble repaying bonds on the maturity date, the treasury can simply print more money. But there are limits to this approach.

When governments rely on increasing money supply to pay off debt, the currency is no longer worth as much. For instance, if bondholders earn 5% interest on a bond while the currency’s value is 10% lower as a result of inflation, they have actually lost money in real terms.

When investors worry about inflation and, therefore, demand high interest rates, countries can issue debt in a foreign currency. This is a common strategy for emerging and developing markets around the world.

These countries often choose to denominate bonds in more stable, marketable currencies, as it is easier to sell debt this way since investors no longer fear that devaluation will erode their earnings.

For Iran, however, there are quite a few hurdles in the way of issuing FCDBs.

 Banking Restrictions

A year has passed since Iran’s nuclear accord was implemented, but the business community believes there is still a long way to go until things normalize.

“Banking transactions are now possible,” says Mohsen Bahrami Arz-Aqdas, the head of Trade Facilitation and Export Development Commission of the Tehran Chamber of Commerce, Industries, Mines and Agriculture.

“Iranian businesses can now reopen letters of credit in a number of countries, but our problems with countries that work with US dollar have yet to be solved,” he added.

Since the removal of international banking restrictions in January, Tehran has established links with only a limited number of small and medium banks, as US sanctions remain in force and large foreign institutions still fear potential fines.

 Original Sin

The inability to control money supply is a double-edged sword for investors. While it offers protection against inflation, it also limits the government’s options to repay in the event of a financial crisis.

Borrowing in a foreign currency also exposes them to exchange rate risk. If the domestic currency drops in value, repaying international debt becomes considerably more expensive and effectively negates the positive aspect of issuing FCDBs. Economists refer to these challenges as “original sin.”

These risks came to light in the 1980s and 90s, when several developing economies experienced a weakening of their local currency and had trouble servicing their foreign-denominated debt.

Failure to overcome the challenges of original sin will lead to a lack of investor confidence in the country. Consequently, investors will look for other opportunities or demand higher yields.

 Credit Ratings

Iranian firms’ financial statements are mostly too opaque to correspond to international standards and have never been rated by global agencies, said Mohammad Gorjiara, investment manager at Behgozin Brokerage, in an interview with Financial Tribune’s sister publication Tejarat-e-Farda.

This spells further trouble for Iran, as roughly 95% of the global debt market are controlled by the Big Three credit rating agencies, namely Standard & Poor’s, Moody’s and Fitch Group. S&P and Moody’s are based in the US.

Fitch, however, is dual-headquartered in New York City and London, and theoretically capable of doing business with Iran.

Iran’s Ministry of Economic Affairs and Finance held extensive talks with the firm last year, but the recent turmoil in global political climate and Iranian firms’ general lack of adherence to international standards impeded progress. It seems unlikely for any new developments to take place in the short term.

Gorjiara added that Iran could turn to smaller, regional rating agencies controlling the rest of the global market. A majority of them are based in India, China and South Korea.

He believes one of the primary threats to issuance of FCDB is the bonds being denominated in undesirable currencies such as rupee, yuan or won, as Iranian bonds’ inherent risks might keep them from accessing more reputable global markets.

Pouya Jabal Ameli, an analyst with the Central Bank of Iran, believes that these bonds are unlikely to garner much enthusiasm both among local and foreign investors and that even if they do, the issuer must pay “considerably high yields”, which makes the process unfeasible.

There is also the issue of lack of public trust in the country’s monetary policy, especially the exchange rate system.

Iran’s double exchange rate regime will dampen investors’ confidence, he said.

Iran adopted single foreign exchange rates in the past only to return to dual or multiple rates when economic conditions worsened due to sanctions or unstable circumstances.

The unification of forex rates is considered a crucial requirement for the reintegration of Iran into the global banking system and payment networks. The private sector has also been calling for the unification of forex rates mainly to eliminate rent-seeking and corruption.

Iran sold €1 billion worth of euro-denominated bonds in 2002—its first and last foreign bond issuance since the 1979 Islamic Revolution, according to The Wall Street Journal.

The nation paid off the five-year debt in full and on time. Middle Eastern investors bought about two-thirds of that issue, with the rest absorbed by buyers in Europe.