Friends call me a magazine junkie. I once arrived at my airplane seat and dropped a stack of magazines on the armrest. The man next to me said, “Are you a speed reader? It’s only a 50-minute flight.”

My stack often includes Foreign Policy, a Washington-based publication serving the international affairs community. The December issue was devoted to the “Top 100 Global Thinkers.” (See www.foreignpolicy.com/2010globalthinkers.)

The list starts with the names you’d expect in a US-published magazine: Gates and Buffet paired as the most influential. President Obama is in the top tier; so is Federal Reserve Chairman Bernanke, as we wrestle with the aftermath of what could have been a financial apocalypse. Then, after the usual suspects, the list gets interesting.

To download the full article as a PDF file, please visit this link: Thought Leaders of the Islamic Crescent. Left-click the link to view the PDF online; Right-click and select “Save link as…” to save the PDF to your local computer.

Notice to Readers

Codexa Capital is a specialized investment banking firm concentrating on Islamic finance, serving institutions outside the United States. Codexa is not registered as a securities broker-dealer or an investment adviser either with the SEC or with any state securities regulatory agencies. The information, opinions, or recommendations in this article are submitted solely for informational purposes.

The information provided here has been obtained or compiled from sources we believe to be reliable; we cannot and do not guarantee the accuracy, validity, timeliness or completeness of any data made available. Opinions and estimates reflect current judgment as of the date appearing on the article; they are neither all-inclusive nor can they be guaranteed to be complete or accurate. Past performance does not indicate future returns.

This material is for general information only. Every effort has been made to ensure that it is accurate; however, it is not intended to be a complete description of the matters described. This document has been prepared without taking into account any personal objective, financial situation or needs. It does not contain and is not to be taken as containing any securities advice or securities recommendation. Furthermore, it is not intended that it be relied on by recipients for the purpose of making investment decisions and is not a replacement of the requirement for individual research or professional tax advice.

Ordinarily I avoid the World Trade Center site in lower Manhattan; the memories still smolder. But I traveled eagerly to West and Liberty Streets to view the “mystery ship”—or what was left of it.
In mid-July, the partial frame of an 18th century vessel was uncovered during construction activity near Ground Zero. It lay in a section of the site that was never excavated for the original World Trade Center project.

Backhoe operators unearthed what looked like a sodden woodpile, eventually identified as the 10-meter-long front section, ribs decomposing, of a brigantine. This two-masted workhorse of coastal transport may have carried lumber from New England or sugar from Barbados, traded for agricultural commodities grown on outlying farms. Once the ship’s transport life ended, its remains apparently served as landfill for the growing city.

Trade and maritime themes offer classic metaphors for the investment business. There may be lessons for global investors in this cargo ship, built for efficiency and re-purposed pragmatically, once it was derelict.

To read the full article, please visit this link Urbanization, Past and Present. Left-click the link to view the PDF online; Right-click and select “Save link as…” to save the PDF to your local computer.

Notice to Readers

Codexa Capital is a specialized investment banking firm concentrating on Islamic finance, serving institutions outside the United States. Codexa is not registered as a securities broker-dealer or an investment adviser either with the SEC or with any state securities regulatory agencies. The information, opinions, or recommendations in this article are submitted solely for informational purposes.

The information provided here has been obtained or compiled from sources we believe to be reliable; we cannot and do not guarantee the accuracy, validity, timeliness or completeness of any data made available. Opinions and estimates reflect current judgment as of the date appearing on the article; they are neither all-inclusive nor can they be guaranteed to be complete or accurate. Past performance does not indicate future returns.

This material is for general information only. Every effort has been made to ensure that it is accurate; however, it is not intended to be a complete description of the matters described. This document has been prepared without taking into account any personal objective, financial situation or needs. It does not contain and is not to be taken as containing any securities advice or securities recommendation. Furthermore, it is not intended that it be relied on by recipients for the purpose of making investment decisions and is not a replacement of the requirement for individual research or professional tax advice.

It is noteworthy, then, that Pirsomani’s sense of the ordinary extended to a man in oriental costume holding the tether of a Bactrian camel. Tartar Cameleer evokes the Silk Road, suggesting that the commonplace extended to caravans passing through Tiflis (now Tbilisi). In view of the painting’s 1914 date, the cameleer image may have been nostalgic, but it is a vivid, if rustic, indication of Georgia’s longstanding role as trade junction between Central Asia and Europe.

From the perspective of global investment strategy, Pirosmani’s portrait of the camel driver conveys the cosmopolitan nature of the Georgian economy. His worldview prevails into the present day as Georgia looks both East and West to affirm its progressive identity.

Georgian Economy in International Context

The Republic of Georgia is the western anchor to the land bridge that connects the Black Sea with the Caspian Sea (see map below). Armenia and Azerbaijan are neighbors to the southeast. Farther afield, the country has active diplomatic and economic agendas with the nations east of the Caspian Sea, including Kazakhstan, Uzbekistan, and Turkmenistan. In the other direction, Georgia has a dynamic relationship with Turkey. The Caucasus Mountains to the north not only separate Georgia from Russia, but also serve as a bulwark against the situation in Chechnya and Dagestan.

Key Statistical Comparison

Note: We compare Georgia with Singapore because of its favorable comparison in the World Bank’s Doing Business survey and similar population size.

Source: See www.doingbusiness.org and www.transparency.org. Other data obtained from most recently available CIA World Factbook, typically based on 2008 estimates. PPP (purchasing power parities) are currency conversion rates that also equalize purchasing power. Gini Index measures income distribution among citizens, ranging from 0 (perfect equality) to 100.

As a former Soviet republic, Georgia is often lumped together analytically with Eastern Europe. Actually, the similarity may end with its Orthodox-Christian heritage. In practice, Georgia’s position at the corner of the Black Sea has hosted a confluence of many traditions. The architecture of Tbilisi exemplifies the blend of Western and Eastern cultures. The 1851 Tbilisi Opera House, for instance, is a somewhat fantastical blend of Moorish embellishment and classic Western design.

Georgia thrust itself onto the world stage in 1991 as the first Soviet satellite to assert its sovereignty. As the nation weaned from central economic planning, it saw a sharp collapse in output, consistent with the experience in Eastern Europe. Multilateral organizations helped stabilize the economy during the 1990s. Unfortunately, under the stewardship of Eduard Shevardnadze, the country’s second president, Georgia was better known for cronyism than capitalism. A seismic shift occurred with the so-called Rose Revolution in November 2003, which up-ended the country’s power structure.

In 2004, the economy took a turn toward rapid growth as Mikheil Saakashvili became president. His administration—currently in its second term—is pinning the economy’s long-term potential on a deregulation and anti-corruption platform. Posters at the country’s two international airports remind visitors that official bribery is a criminal offense. The free-market policies of the Saakashvili administration appear to have succeeded: Georgia is now ranked 11th in the Ease of Doing Business Survey by the World Bank, sandwiched between Norway and Thailand. Russia, by comparison, is ranked 120th. See www.doingbusiness.org for further background.

Georgia Forecasts Economic Turnaround (Real GDP Growth)

Source: World Bank, National Bank of Georgia for 2009-10 estimates.

With the global credit crisis, Georgian economic activity declined dramatically in 2008-09 from the double-digit growth seen in 2007. The IMF has identified five causes of this collapse: contraction of export markets, lower remittances from citizens working abroad, the freeze in international credit-markets, falling commodity prices, and capital repatriation back to major economies. Importantly, these factors largely fell outside domestic developments. The Russian invasion of August 2008 may simply have been a caustic addition to an already volatile mix of international macro-events.

Despite the near-term set-back, the outlook for the Georgian economy remains attractive. The economy is heavily oriented toward agriculture (accounting for more than 50% of employment), with generous water resources to sustain above-average growth in the sector. Global macro themes such as hunger alleviation and food security bode well for Georgia. Meanwhile, its role as a trans-shipment corridor for nations to the east—especially in the hydrocarbon and mining sectors—will help national growth percolate upward as the global economy improves. Low labor costs make Georgia attractive for foreign direct investment. For perspective, real annual GDP growth averaged an impressive 6.6% in the 10 years prior to the credit crisis (1998-2007).

Access to the Hinterland

While Xian and Istanbul are known as the eastern and western terminals of the Silk Road, intermediate stops such as Tbilisi may be less commonly appreciated. This city lies on the Eurasian Steppe route that ran around the northern end of the Caspian Sea. The trade route helped forge a society deeply influenced by its diffusion of craftspeople, scholars, and emissaries over the centuries.

Source: Yahoo! Maps.

The Black Sea Coast of Georgia, stretching some 325 kilometers between the Turkish and Russian borders, has long been a preferred transit point to larger markets. This route steers clear of Iran and Turkey, which can be desirable for geopolitical as well as logistical reasons, depending on the state of regional and international diplomacy.

We focus on the potential for five markets that export and import through Georgia:

• Azerbaijan, though not an OPEC member, is a major oil exporter at an expected rate of about 1.2 million barrels per day in 2010, roughly half of what we will likely see from Norway. A decade ago the number was perhaps one-fifth the size. This growth results from of billions of dollars in investment from a range of international names, helping to diversify Azerbaijan away from Russia in both economics and geopolitics. For context, as long as China’s oil import requirement remains about the current 4.5-to-5.0 million barrels per day, Azerbaijan alone could satisfy one-quarter of Chinese demand. Yet Azerbaijan faces a de facto ceiling on oil exports imposed by the capacity of existing pipelines and non-captive transit routes. The country has long been flush with oil, especially in its Caspian Sea wells. When the first Baku oil gusher was struck in 1873, it took four months to cap because of its strength.
• Armenia is slightly smaller than Georgia geographically and about one-quarter the size of Azerbaijan in GDP terms. The country is in self-declared transition from a resource-driven to a knowledge-based economy. Its success will likely derive from its ability to attract foreign investment, in which it benefits from a large overseas population of Armenian descent. At maybe 10 million, the diaspora is about three times the population of the country itself. Meanwhile, mining and related industries will continue to play a key part in economic activity, with the government working aggressively to attract overseas firms that will raise standards to international levels of competitiveness. The Armenian Ministry of the Economy now heralds external investment in the mining sector from an array of North American and European companies.
• Kazakhstan, Uzbekistan, and Turkmenistan are the largest of the Central Asian Republics, with a combined GDP of some $280 billion. As a group, these nations comprise roughly the 40th largest economy in the world, slightly smaller than Hong Kong and roughly 13 times the size of the Georgia. Vibrant hydrocarbon industries define all three, but Uzbekistan and Turkmenistan also have important cotton export businesses. The Kazakh economy—despite credit-crisis-induced challenges faced by the banking system—is the most evolved because of its well-diversified resource base and relative political stability. Meanwhile, Uzbekistan and Turkmenistan have been working hard in recent years to integrate better into the regional economy. These two smaller economies face material governance hurdles, as indicated by their poor rankings in Transparency International’s Corruption Perceptions Index.

The South Caucasus states of Azerbaijan and Armenia, along with the larger Central Asian Republics, have in common a renewed orientation toward Georgia for improving access to international markets. These economies have traditionally relied mainly on trade with Russia—a relationship that periodically goes askew. There are countless examples of such turbulence, ranging from the recent pipeline spat between Turkmenistan and Russia to longstanding differences over Caspian Sea rights, whether resource ownership or naval protocol. Certainly the Georgian role in linking these hinterland economies with international markets helps to keep multi-lateral relations within the region as constructive as possible.

GDP per Capita

Note: Based on PPP (purchasing power parities) estimates, typically 2008 data for comparison purposes. Source: CIA World Factbook.

Understanding Development Issues

Like many developing countries, Georgia faces challenges both under and outside its control. The most critical issue may well be the outlook for global economic momentum. Within the context of local and regional affairs, however, we identify three issues with which Georgia will likely continue to wrestle:

• Relationship with Major Powers. Georgia has increasing aligned itself with the West under the leadership of President Saakashvili. While clearly benefiting the government in technical and developmental assistance, this alignment has heightened animosity with neighboring Russia, perhaps reaching a high watermark with the August 2008 invasion. Georgia is caught somewhat awkwardly between its Cold War heritage and its modern-day vision.
• Foreign Aid and Fiscal Exit Strategies. The double-barreled impact of credit crisis and Russian invasion led to significant foreign financing in the form of grants and concessionary loans. The Georgian government has shifted spending dramatically from defense toward social expenditure, with some 35% of the 2009 budget going to health, education, and the like. In the future, Georgia will have to rely more on the private-sector to sustain its desired growth trajectory.
• Hydrocarbon Management. The ongoing success of Georgia as an oil and gas transit corridor depends on the government’s ability to negotiate favorable agreements. Both the Baku-Tbilisi-Ceyhan oil pipeline and Baku-Tbilisi-Erzurum gas pipeline, for example, fit into this framework, but the arrangements need to be nursed carefully. Ongoing improvements in the road and rail infrastructure will further support transit channels. In general, Georgia needs to demonstrate strong engagement in the hydrocarbon transit businesses, reinforcing the confidence of international players.

We find Georgia to be a resilient and progressive country. Its deep track record of pro-growth reforms and aggressive external alignment with major liberal economies should give investors confidence in the business backdrop, especially as a center for regional activity.

Black Sea Coastal Trade

While exotic in its particulars, Tartar Cameleer typifies Pirosmani’s subject matter of people at work and play. Another work relevant to our topic, entitled Batumi, is one of the relatively few landscapes he executed. The painting shows a steam train chugging up the coast from the port, perhaps toward the village of Supsa on its way to the Samtredi junction, where it would turn toward Tbilisi and other points in the Southern Caucasus.

The painting also shows some eight ships moored in the harbor. They may be taking on goods for markets elsewhere, given the wind direction away from shore and the oarsman apparently maneuvering his pram to upload cargo to one of the waiting freighters. The density of traffic suggests a high volume of coastal trade.

In this landscape, there are no camels, only then-modern conveyances. Such features emphasize Georgia’s potential as a regional entrepot. That vision is now fast becoming a reality as Georgia asserts itself as an East-West trade bridge.

Acknowledgment

We acknowledge the contribution, to our observations, of the book Pirosmani: A Legend in Naïve Art, published in conjunction with an art exhibition by the Pera Museum of Istanbul in 2007.

Notice to Readers

This research commentary was prepared under the sponsorship of Black Sea Product Ltd. of Tbilisi, Georgia. Codexa Capital received compensation for the preparation of this article, in relation to its role as investment banker for the Seaport of Supsa development project.

Codexa Capital is a specialized investment banking firm concentrating on Islamic finance, serving institutions outside the United States. Codexa is not registered as a securities broker-dealer or an investment advisor either with the SEC or with any state securities regulatory agencies. The information, opinions, or recommendations in this article are submitted solely for informational purposes.

The information provided here has been obtained or compiled from sources we believe to be reliable; we cannot and do not guarantee the accuracy, validity, timeliness or completeness of any data made available. Opinions and estimates reflect current judgment as of the date appearing on the article; they are neither all-inclusive nor can they be guaranteed to be complete or accurate. Past performance does not indicate future returns.

This material is for general information only. Every effort has been made to ensure that it is accurate; however, it is not intended to be a complete description of the matters described. This document has been prepared without taking into account any personal objective, financial situation or needs. It does not contain and is not to be taken as containing any securities advice or securities recommendation. Furthermore, it is not intended that it be relied on by recipients for the purpose of making investment decisions and is not a replacement of the requirement for individual research or professional tax advice.

Over the past year, the government has served as white knight to the auto industry, tried to stimulate the housing industry with tax credits, and pumped untold additional billions into the financial system. Congressional legislation meanwhile has been chock-full of spending programs in an attempt to amplify the wave of hand-outs. When combined with the Federal Reserve’s asset-purchase program, the total stimulus package has amounted to almost 20% of GDP. The figure is staggering by developed-world standards.

This profligacy now seems justified by nascent economic improvement. Yet caution needs to be exercised in interpreting a handful of better-than-they-have-been statistics. The US economy is driven by the mighty consumer, and consumer spending remains feeble in the context of bloated debt levels. Moreover, unemployment nationwide is 9.7%, and substantially higher in states like Michigan and Nevada. The true level of joblessness, including discouraged and unwillingly self-employed workers, is likely even more sobering. Meanwhile, business investment remains lacklustre, despite an effective zero-interest-rate policy.

The economy is flush with Demerol. Yet what happens when the drug runs out? No one quite knows, but I suggest that the outlook is not so promising. Demerol is considered sufficiently addictive that New York State health authorities allow hospitals to administer it to a patient for only two consecutive weeks. There may be an analytical parallel here.

Demerol works quickly, setting off a “rush” at its onset and thereby creating a vicious cycle of dependence. Our economic perception has been distorted by recurring injections of the opiate. That suggests the likelihood of a nasty withdrawal period as the economy moves into fiscal detox. Officials need to figure out how to downgrade to a lesser painkiller… the economic equivalent of codeine.

Warnings of Demerol dependency may be found in the US Treasury market, with yields notching down during August. As a lifelong equity strategist, I rarely am willing to make such a capitulation, but the rapid “V”-shaped recovery suggested by the sharp gain in the S&P 500 since March is not realistic. The technicians support this view by arguing that the equity rally has been unusually thin in volume, a sign that institutional investors continue to hide—or run—in fear.

We are unlikely to see much of upward economic trajectory when the anecdotal evidence remains dreary. The State of California is even resorting to a jumble sale
of incidental government assets to help plug its budget deficit. Granted, the state has some unique taxation challenges, but California is the world’s eighth largest economy and chock full of information-age industries like entertainment and technology. Riddled by stumbling state economies, including other pivotal ones like Illinois, Florida, and Ohio, overall US activity will likely take longer to improve than suggested by Business Week’s recent prosperity-peddling cover, “The Case for Optimism.”

In this environment, our preferred asset class remains US corporate bonds. Certainly credit is not as cheap as it once was, but we are likely to see further buying opportunities. We especially target lower grade issuers, given selectively wider credit spreads, if the economy disappoints over the near-term.

The bond recommendation is admittedly pointless for our Shariah-compliant relationships because of riba prohibition. For these investors, we suggest exposure to equities influenced by Chinese growth trends. One of the surprises over recent weeks has been the strength of Asian growth in the face of frail activity elsewhere. Mid-cycle characteristics of selected investment opportunities in China, South Korea, and Singapore will afford comfort for those investors displaced by the volatility of early-cycle investments. In the complex neuro-system of global finance, China and its related growth themes may be a node worth emphasizing.

Longer term, we are enamoured with private equity, given the sharp discount in asset values we see just about everywhere. Our contrarian story in this asset class falls to Eastern Europe, where the debt overhang is scaring away conservative investors. Other players may find an allocation to South Asia to be better suited to their tastes. India survived the brunt of the global downturn because of its relatively limited exposure to merchandise trade, as well as regulatory prudence in the financial sector. Growth may reach 8% next year, making it the flavor of 2010.

Signs of Demerol dependency include a need to increase the dose to maintain its effects. Yet abruptly stopping Demerol intake is not recommended, because of an associated set of withdrawal symptoms ranging from severe anxiety to insomnia
to muscle spasms. These effects start within hours and can last for many days.

The analogy to government-stimulus spending is instructive. The US economy will likely need ongoing medical attention for some time, yet the formula for easing off public painkillers has yet to emerge. While we have not succumbed to the full-blown dark-future theory, the global investor might best let the US addiction subside, while selectively exploiting market vulnerabilities.

In an inaugural week, you would expect the international news weeklies to carry a cover story on the incoming US president. Time ran a feature on President Obama entitled, “Great Expectations.” The Economist did the same, but called it, “Renewing America.” Newsweek? Well, their editorial board decided to publish a special issue, labeled “Why China Works.”

Maybe that says two things: that the world does not revolve around Washington and that the global economy may be a bigger issue than who is in the White House. The subhead to the Newsweek cover story certainly had a sobering message for many US-focused economists: “Inside the command-capitalism model that will outrun all rivals.”

One reason why China works is that it has lots of cash. At maybe $2 trillion, its central-bank reserves—the world’s biggest—are staggering. This means that the US-China bilateral relationship may well prove to be the most important anywhere over the years ahead, as China recycles its cash into US Treasuries to prop up a deflated American economy.

The world’s biggest saver and most profligate spender are rather stuck with each other. While tradition would have President Obama head to Europe for his first overseas trip as the new face of America, it would say a lot more about concern for US economic wherewithal if he were to head to Beijing. Presumably his economic policy team should be in tow.

China is having its cyclical problems like everyone else. Real GDP growth for 2008 was recently announced at 9%, the lowest since 2001, but still above the generally accepted rate of 8% required to preserve some semblance of social stability. The slowdown was expected, given that exports may account for as much as one-third of China’s output. But, as a lagging indicator, the data are not surprising.

What may be more interesting is anecdotal corporate information. Just recently, Swatch Group (the watchmaker) announced intentions to open 15 stores across China. Alibaba (the online marketplace) said it intended to move beyond its China-centric model and pursue multilateral opportunities. Lurking in the details are the notions that China remains a buoyant market and that Chinese companies are likely to use their cash hoards to expand in ways that companies elsewhere simply cannot.

So why does China work? It may have much to do with its oft-derided government intervention in the economy. The great irony here is that economists have been arguing for decades that an open-market model is more advanced than a state-controlled model. In a bit of a turnabout, the opposite now seems to be true. Who would have imagined that the US would effectively nationalize its banking and auto industries?

To quote the Newsweek article, “Once seen as the bad habit of an immature economy, China’s state meddling is now seen as a bulwark of stability.” The piece goes on to conclude that the real key may simply be command capitalism’s ability to sustain confidence. And that is something sorely missing just about everywhere else in the world right now.

For the global investor, there is a certain strategic logic to exploring China-related ideas. China equals confidence, which in turn equals investment opportunities—all the more as the speculative money leaves Shanghai and Beijing. What is left is a playing field devoid of exuberance, on which one might actually have some true clarity on the investment prognosis.

Does that mean we should all run out a buy a Chinese equity fund? Maybe. But putting your money to work in such a product likely has an opportunity cost, until we see a whiff of global inflation and some sign of a worldwide recovery. In our view, better to invest in this bemired environment through a direct investment such as private equity.

Befuddled at where to head with our thinking, I contacted a banker-colleague who happens to work in the Gulf for an Asia-based financial institution. My question was simple: “How does a Shariah-compliant investor access the China story?” I intentionally asked someone closer to the origination side of the business, figuring that the perspectives of secondary-market players on where long-term opportunities exist were shaded by capital-market turmoil.

He affirmed that the China-related work of the internationally oriented Islamic banks has not been “sufficiently comprehensive,” yet there are meaningful ideas to explore:

• Middle-Class Growth. Despite the cyclical setback, major opportunities remain in traditional consumer businesses such as fast-food, retail shopping, and white goods.
• Agribusiness Development. Investors often think of China as the world’s manufacturer, but the nation’s western regions suggest a range of agricultural plays, including livestock production, farm equipment, and food distribution.
• Water Infrastructure. China is relying on the private sector to develop its water supply and sewage treatment facilities. Suffice it to say that maybe three-quarters of the country’s natural water supply is polluted.

During recent prime growth years, few Islamic financial institutions used their excesses to diversify into China. Gulf banks with bulging cash balances evidently decided that at-hand opportunities in nearby markets like Turkey and Pakistan seemed more user-friendly. Somewhat mind-boggling, on the other hand, is that the Kuala Lumpur-based institutions were slow at the draw.

Presumably, demand from Islamic investors for China-related transactions was diverted by the many seductive “bubble projects” afoot across the Muslim world. Under current economic circumstances, however, we suggest a major wave of Shariah-sensitive capital will make a pronounced shift toward China. Global investors may want to move ahead of the curve.

As a newly declared finance major in college, I recall my Money & Banking professor proclaiming on the first day of class, “Don’t ever forget that our banking system is most fundamentally based on confidence.”

It struck me as an odd statement at the time. Given decades of institution-building and multiple regulatory overlays in the United States, her notion seemed almost antique. Or was it?

The professor’s precept popped back into my mind 25 years later as the subprime crisis made it newly relevant. Certainly a foundation of confidence is a tenet that the Islamic and conventional banking systems have in common, in part because confidence in the economy (or lack thereof) is impartial and all-encompassing.

Islamic banks in general will likely weather the current storm better than most conventional banks, but they are not immune to the spillover effects of the subprime crisis. Indeed, to the extent that Islamic banks depend heavily on transaction volume for their profitability, they will be ensnarled with their conventional peers in the worldwide downturn. Suffice it to say that a receding tide—like a rising tide—takes most things with it.

To be clear, Islamic institutions do not have exposure to subprime-linked assets because of the prohibition of engagement with riba. This feature kept them outside of last year’s unfolding financial-sector drama. In addition, the underdeveloped interbank market for Shariah-compliant banks means that they generally have high cash balances to ensure proper operational liquidity. The “cash crunch” that eroded confidence in most conventional institutions never befell the Islamic banking sector.

Yet I find it misleading to argue that Islamic banks are unscathed by global developments. Especially in the Gulf, such institutions may have relied too heavily on real-estate backed products and structures to support their profitability. And of course the demand for such business and the value of underlying assets has eroded or even collapsed. Niche situations aside, there appears to be no market globally where real estate is a growth opportunity nowadays.

Islamic banks will likely not see a meaningful recovery in profit generation for some time. For perspective, conventional banks traditionally can build revenue both in an early cycle economic-growth stage (because of the potential for higher spreads as market rates begin to rise) and during the mid-to-late cycle because of greater transaction volume. Islamic banks, on the other hand, have an earnings structure that primarily builds mid-to-late cycle, when business volume is most pronounced. Given that the global economy may not recover until late 2009, in conjunction with a presumed US economic rebound, it could be 18-to-24 months before Islamic banks again approach the sort of earnings levels seen earlier this decade.

As a point of industry structure, Islamic banks may be further affected by diseconomies of scale in the wake of failed economic growth prospects. Marginal players will no doubt find it hard to survive in this environment. Consequently, governments may be prompted to step in to offer assistance under the cloak of administrative guidance. Certainly the rapid growth of the Islamic banking industry begs some consolidation in a low-to-no-growth environment. In addition to some non-starters, we may see a chain of Islamic banking mergers over the year ahead, albeit provoked by the desire for cost reduction rather than the need to repair balance-sheet holes.

We see only pockets of growth in the Islamic retail banking segment at this time. There may, however, be strong opportunities in the traditional investment-banking roles of advising and structuring, especially in the near term as slow growth raises balance-sheet and business-model concerns among corporate clients. Also promising is the potential for a new range of Islamic investment products focusing on cash-flow for investors, as well as those tapping into distressed asset situations.

Long-term prospects for the Islamic banking industry remain bright. A side-effect of the post 9/11 era has been a powerful sense of cultural demonstration across the Islamic world, albeit not without its dark side. As Shariah-sensitive companies and consumers continue to identify with their Muslim heritage, the industry will no doubt prosper. Certainly with regulatory and fiscal support from governments as geographically diverse as Saudi Arabia and Malaysia, the industry is positioned to build impressively on its early-stage foundations.

In this sort of environment, Islamic banks could be particularly effective in helping to rebuild confidence in the global economy. That calls for moving beyond the standard retail model to adopting a more pronounced role in issuer/investor transactions, in risk-shared financing facilities, and in economic development initiatives. Such focus is an unexpected way for the Islamic banking sector to take a pronounced role in global economic leadership. Indeed, the overall Islamic banking industry may be surprised at how receptive conventional markets are to its style and substance.