MIDEAST MONEY-Islamic finance down, not out in post-Mursi Egypt
* Islamic finance loses powerful political backing
* Potential demand among population still there
* Egypt increasingly reliant on Gulf economic ties
* Officials do not rule out sovereign sukuk issue
* Bankers see no impact on business since July
CAIRO/DUBAI, Sept 1 (Reuters) - With the fall of the Muslim Brotherhood, Islamic finance has lost strong political support in the most populous Arab nation. But economic pressures mean the industry remains likely to grow and the country will eventually start issuing Islamic bonds.
Islamic finance, which obeys religious principles such as a ban on interest payments, was neglected and even discouraged by authorities for ideological reasons in the three decades before the revolution which ousted President Hosni Mubarak in 2011.
The market share of Islamic banks in Egypt is only about 5 percent, well below estimates of roughly 25 percent in the developed Arab economies of the Gulf.
That seemed about to change when Islamist President Mohamed Mursi, a member of the Muslim Brotherhood, took power in June 2012. The Brotherhood made expanding Islamic finance one of its top economic policy planks, promising to issue sovereign sukuk, introduce rules to facilitate Islamic fund-raising by companies, and reform the operations of Islamic endowments.
This political backing has disappeared with the ouster of Mursi in an army-backed uprising in early July; the interim government which is to serve until elections early next year has much less fondness for Islamic finance.
But underlying demand among Egypt's mostly Muslim population of 84 million, the country's need to develop what financing sources it can, and the growing role of wealthy Arab countries in the Egyptian economy mean the sector may still grow.
"Sukuk will be available in Egypt particularly because they are the sole instrument used by some investors in the Gulf Cooperation Council and southeast Asia," Sherif Sami, the new head of the Egyptian Financial Supervisory Authority, told Reuters last week.
Sami stressed his body would only handle the technical side of sukuk issues, and any decision to push forward with legal changes to facilitate sukuk would be political.
The technocrats who dominate Egypt's new economic policy team, many of them with experience from the Mubarak era, have shown little personal interest in Islamic finance.
The image of political Islam has been severely damaged in the eyes of many Egyptians by Mursi's troubled year in office and his weak management of the economy.
But long-term demand for Islamic financial services has not necessarily changed. Only around 10 or 15 percent of Egyptians use formal banking services, analysts estimate; this implies great potential for growth in both conventional and Islamic finance, and sharia-compliant banking could be a way to draw many people into the formal financial system.
Abdel Rahman Al Kafrawi, head of Islamic transactions at Principal Bank for Development and Agricultural Credit (PBDAC), said he had noticed no negative impact since July on business at the 18 PBDAC branches offering Islamic finance.
The state-run bank, which caters to Egyptian farmers, launched sharia-compliant retail banking earlier this year, setting aside an initial 50 million Egyptian pounds ($7.1 million) to provide financing for the purchase of durable goods, agricultural equipment and education fees.
"Such needs never cease to exist regardless of politics or macroeconomics, and hence no negative impact has been felt or is expected," he said.
Mursi's government fought a six-month battle to pass a law clearing the way for sovereign sukuk issues, overcoming a bitter controversy over the use of state-owned assets to back sukuk. Officials then talked of Egypt making a debut international issue of Islamic bonds this year, and of raising $10 billion a year by selling sukuk.
Such hopes always looked too optimistic, and because it will take time to make technical preparations and restore political stability, a sovereign sukuk sale may not be possible before late next year. But that does not mean future Egyptian governments will abandon the idea.
In the past year, governments and companies in the Gulf and Turkey have stepped up sukuk issues, tapping large pools of Islamic funds whose demand for sharia-compliant instruments has exceeded supply.
To help replenish its foreign exchange reserves and bridge its huge state budget deficit, Egypt will remain under strong pressure to follow suit - especially since the Gulf has become increasingly important to the Egyptian economy.
Saudi Arabia, the United Arab Emirates and Kuwait have become Egypt's main financial backers since Mursi was deposed, pledging $12 billion in aid. Any revival of foreign investment in Egypt is expected to depend heavily on the Gulf.
Finance Minister Ahmed Galal told reporters last month that the interim government had no problems in principle with using sukuk, but would not make them its principal instrument.
While post-Mursi governments are likely to promote Islamic finance less aggressively than the Muslim Brotherhood, they may regulate it more efficiently - most types of economic policy-making under Mursi were marred by political bickering and bureaucratic logjams. So in the long term, Islamic finance may develop in a more healthy environment.
Shahinaz Rashad, executive director of the Cairo-based Metropolitan Training Academy, which offers training to personnel at Islamic financial institutions, said customer demand had not slackened since July.
"Clients are pursuing their personal preferences, whether Islamic or conventional, regardless of who is on top in the government," she said.
(Editing by Jason Neely)