KARACHI: Over the previous more than a decade, more than 100 Sukuk (Islamic bonds) have been issued in Pakistan with the first in 2006.
These add up to around Rs1.16 trillion worth of Sukuk issued over these years. Government issuances have overwhelmed the Sukuk showcase, with Rs865 billion worth of bonds being issued by the government of Pakistan and around Rs150 billion by open area substances. Over the similar period, corporate Sukuk issues were at around Rs170 billion.
The government tapped global capital markets thrice during the period, for the first time in 2005 with a $600-million Sukuks, followed by two other issues of $1 billion each in 2014 and 2016.
According to the Organisation of Economic Cooperation and Development (OECD), by 2030 around $71 trillion will be needed for investing in and developing infrastructure including water infrastructure. This amount is 2.5% of the expected global gross domestic product (GDP) in 2030.
A large number of Sukuk have been issued to cater to infrastructure needs, mainly for projects in the Gulf Cooperation Council (GCC) and Southeast Asia. In 2012, Sukuk issuances for infrastructure projects rose 140.2% year-on-year (YoY) to $27.81 billion. In the year, 21.2% of global Sukuk were related to infrastructure.
Malaysia had the highest number of such issuances followed by Saudi Arabia. Pakistan, Indonesia, Kuwait and Brunei are some other notable countries that have floated infrastructure Sukuk.
In Malaysia, one of the notable Sukuk issues for infrastructure projects was the Musharakah Sukuk floated by Projek Lebuhraya Utara-Selatan Berhad for the construction of highways. Its size was 30.4 billion Malaysian ringgit with profit rate of 3.9% to 5.75% for tenures ranging from 5 to 25 years.
In Saudi Arabia, an Ijarah Sukuk was issued by Saudi Electricity Global Sukuk Company to finance the purchase of Ijarah assets in the power and utilities sector. The profit rate was 2.67% with tenure of five years.
In Pakistan, the Diminishing Musharakah Sukuk was issued by Neelum-Jhelum Hydropower Company (Private) Limited (NJHPC) to obtain financing for the construction of 969-megawatt Neelum-Jhelum hydroelectric power project Muzaffarabad district, Azad Jammu and Kashmir.
Keeping in view the current water crisis that Pakistan faces, one of the critical challenges that needs to be addressed is the financing of Diamer-Bhasha dam. Until now, Rs4.693 billion has been collected in the Supreme Court’s dam fund but this constitutes a very small portion of the Rs1,900 billion required to complete the project.
At this point, it seems unlikely that the funds can be collected merely through donations. We propose the financing of the dam construction through the issuance of long-term (15-year) Istisna-cum-Ijarah GDP-linked Sukuk in five tranches, which will be collected in five years with the last tranche of Sukuk maturing at the end of the 15th year from the date of its issue.
The hybrid structure allows the asset ie the dam to be constructed first from the proceeds of Sukuk under the Istisna mode of Islamic financing while Sukuk-holders will be paid after the asset is operational according to Ijarah. The rental rate to be paid to Sukuk holders is linked to the GDP of the country.
This combination not only enables the investors to enjoy periodical returns in the form of rental fee, but will also align financing costs with payment capacity, thus rendering payment default unlikely. The target is closed-end mutual funds and long-term investments by Islamic banks by using their excess liquidity.
The proposed Sukuk structure integrates the real sector of the economy with the financial sector by making the return to Sukuk-holders contingent on the economic performance. This way, parties to the Sukuk share the upsides and downsides of some real economic activities.
With the Sukuk, the main issue faced is the lack of assets. With our proposal, the asset to be used in Sukuk is being constructed first. This will solve excess liquidity problem of many Islamic banks in Pakistan.
The mechanism of the structure will be such that a Special Purpose Vehicle (SPV) will issue the Sukuk, representing ownership in the dam. As per the Istisna agreement, the SPV will periodically pay the contractor as the dam is built.
As portions of the project are completed, the SPV will enter into an Ijarah agreement to lease operational portions of the dam. This way, the Sukuk-holders will enjoy periodical rental returns.
In a research by Gharbi in 2016, the use of GDP growth rate as an alternative is recommended because of its close link to the real sector. When the GDP growth is high, there will be a rapid increase in government revenues, so the government will be able to pay higher returns to investors.
If the GDP growth is low, the government would have a lower obligation in line with its slim capacity to pay back debts because of lower revenues. This sharing of risk with the government according to the macroeconomic situation will reduce the risk of default and may even lead to higher ratings for the Sukuk.
In the recent past, outstanding Sukuk in the corporate sector includes the Rs22 billion worth of bonds issued by K-Electric in 2014-15, the Rs10.5-billion issue by Fatima Fertiliser in 2016, Rs7 billion issue by Meezan Bank in 2016 and Rs5 billion worth of Sukuk floated by Engro Fertilisers in 2016.
Banks, for example, Al Baraka, Meezan and Dubai Islamic Bank have issued Sukuk to reinforce their Tier-2 cash-flow. Attractive yields, tax exemption and greater flexibility add to the demand for Sukuk.
Pakistan’s Islamic banks hold 13% of the total deposits while Islamic mutual funds and private pensions have a higher percentage.
Using Sukuk for financing infrastructure projects has bright prospects. As estimated by the Asian Development Bank, the cost of building power plants, transportation hubs, telecom facilities, water systems and other infrastructure development is expected to cross $8 trillion in the next 10 years in Asia alone.
Islamic finance can offer solutions to emerging markets like Pakistan to finance their infrastructure development plans.
The writers are students of MS Islamic Banking and Finance at the Institute of Business Administration, Karachi
Published in The Express Tribune, November 12th, 2018.