Economic Revival: Sukuk Investments

Islamic Bonds: Sukuk and the World of Finance

Stocks and bonds are among some of the most common ways of investing and raising capital in the financial markets today. Investors in the international arena are presented with a myriad of choices in terms of bond types. One of these is a relatively recent bond market that has emerged from the Islamic community, known as "Sukuk." This term is used to describe Islamic bonds. This type of bond distinguishes itself from its Western counterpart by its adherence to Shari'ah principles, one of which is the prohibition on charging or paying interest (Islamic Development Bank, 2010). This is accomplished by granting the investor a share of the investment asset, with its cash flows and risk. The growth and success of the Sukuk market has been remarkable, in that it caters to an investor market that seeks to diversify its holdings beyond the traditional.

Thus, foreign and domestic investors who buy Sukuk must have structures approved by Shari'ah boards consisting of scholars in Islam. Issuers general include sovereigns and corporations in the Middle East and Southeast Asia, attracting many investors from some 56 IDB member countries and more than 100 non-member countries. In this way, Sukuk acts as a type of bridge between issuers and investors, where money raised can then be allocated to infrastructure initiatives in a transparent and efficient way.

In 2010, Sukuk has proven its resilience in difficult economic times, and particularly during the global economic downturn. Sukuk issuance increased, for example, from U.S.$14.9 billion to U.S.$23.3 billion between 2008 and 2009. Issuance has been particularly strong in Asia during this time. In 2010, the growth rate of the Sukuk bond global market was 10-15% (Islamic Development Bank, 2010).

Within the Shari'ah requirement, Sukuk can include various structures. Most commonly, Sukuk takes the form of partial ownership of an asset, also referred to Sukuk al-jiarah. Sukuk could also mean a partially owned debt, known as Sukuk murabaha. A partially own project is known as sukuk al-jstisna, while a business within Sukuk is known as Sukuk al-musharaka. A partially own investment is referred to as Sukuk al-jstithmar (Financial Times, 2011).

From 2010 onwards, Sukuk has made rapid strides not only in Asian markets, but also internationally, as shown in its prowess in terms of foreign currency. According to Rana (2014), Pakistan has raised $1 billion from international debt markets in 2014 with its second-largest transaction in less than a year. This was done by issuing five-year dollar-denominated Sukuk bonds. The capital raised in this way would go a long way towards Islamabad's foreign currency reserves in terms of satisfying the International Monetary Fund (IMF).

The profit rate of the transaction was 6.57%, half a percent lower than the five-year Euro bond sold in April 2014. While the Eurobond carried no collateral, Sukuk has an inherent collateral requirement. Hence, the government pledged the Islamabad-Lahore Motorway and succeeded in maintaining an interest rate that was lower than the Euro bond transaction when reaching $2 billion. This places Sukuk on par and in competition with the Euro bond in the international market. Furthermore, the 6.75% interest rate for the $1 billion Sukuk bond is 5.17% higher than the five-year U.S. treasury rate used as a bench mark (Rana, 2014).

This is a trend following the global economic downturn, also fueled by further fears of slowing economic progress (Rana, 2014). This trend is evident in the projected target rate of $500 million for the bond, whereas great investor interest resulted in $2.3 billion, almost five times higher than the projection.

On the strength of this success, Pakistan has further hopes of raising $1.2 billion from the sale of its remaining stakes in the HBL, amounting to 42.5%. In 2014, Pakistan was also asked to increase its foreign currency reserves to $13 billion by June 2015 from its $8.5 billion level in 2014.

Sukuk has been issued by various entities, including Hong Kong, the DIFC, and recently Britain has become the first Western country to issue this bond. Dubai has launched a 15-year Sukuk, the first of its kind in Dubai and an unusual length of tenor for an Islamic bond. (Reuter, 2014).

The Dubai International Financial Center has issued a U.S.$700 million sukuk in October 2014 in order to fund the growth of its megastructures and financial offerings. Essa Kaim, DIFC governor and executive chairman has made the announcement on the strength of strong growth of member firms and employees at the DIFC. The Center's 2018 target, to double its size in that year, was said to be on track.

In a first of its kind transaction in the west, Britain issued an Islamic bond, which attracted orders amounting to £2 billion in sales. Profits for the sukuk are based on rental income from three properties own by the government, since interest is forbidden under Islam. Investors were attracted from the UK, Middle East, and Asia. The order amount was 10 times higher than the amount sold.

Perhaps the best indicator of the readiness of Sukuk to enter the global market and compare with the Euro bond is the distribution of its investors. For the above-mentioned transaction, investor funding came from Europe (35%), the Middle East (32%), North America (20%), and Asia (13%). This shows a distribution of high-level investors in Sukuk. This demonstrates the confidence of the global investor market in the economic policies of Pakistan (Rana, 2014). According to the country's Finance Minister, the profit rate is also favorable in terms of comparable domestic debt cost, which is about 11% in Pakistan. According to the Minister, the Sukuk proceeds will be deposited into the State Bank, whereas the rupee proceeds will benefit the domestic debt retirement (Rana, 2014).

The global success rate of Sukuk has created a platform from which Pakistan could begin considering the issue of a dollar denominated Islamic bond. (Reuters, 2014). With Sukuk, Pakistan has become a favorite when it comes to frontier market investing. The country's peaceful 2013 elections and its Eurobond launch in two $1 billion tranches have created an excellent market for future investor confidence. For this reason, the country has projected favorable conditions for the issue of a dollar denomination for Sukuk, which has previously been issued in Pakistan rupee.