KARACHI:
In August 2023, the government of Pakistan successfully conducted the auction of the sovereign Ijarah Sukuk and issued a record Sukuk worth 371 billion rupees (equivalent to over $1.29 billion). This is a historic achievement for the Islamic capital markets and once again demonstrates the growing strength of Pakistan’s Islamic finance sector, as it is the largest issuance of Shariah-compliant instruments in a single auction since the domestic Sukuk program was launched in 2008 by the Shariah Advisory Committee of the State Bank of Pakistan (SBP) approved and Meezan Bank acted as joint financial advisor on the issue with Dubai Islamic Bank and Bank Alfalah Islamic.
The shift in government focus towards issuing Sharia-compliant Sukuk as a replacement for interest-based borrowing is a welcome step for the growth of Islamic finance in Pakistan. This strategic shift can make a positive contribution to the economy and has already resulted in significant cost savings for the government due to the lower cost of Sukuk compared to traditional instruments. In addition, it promotes financial inclusion, strengthens the Islamic banking sector and demonstrates the government’s determination to adhere to the Federal Court’s Shariah mandate to eliminate interest from the economic landscape.
Islamic finance has witnessed remarkable growth in Pakistan in recent years. According to the SBP data, as of December 2022, the market share of Islamic banking has reached 26% in funding and 22% in deposits, respectively, with Sukuk issuances playing a crucial role in this expansion and growth. The size of the Islamic mutual fund industry has also exceeded the benchmark of 40% market share and is expected to reach 50% in the next few years. Pakistan has recently become an active player in the Sukuk market and is using these instruments to meet its financing needs while adhering to Islamic principles.
Sukuk, often referred to as the Islamic alternative to bonds, are financial instruments that comply with Islamic commercial law and provide a Shariah-compliant alternative for liquidity generation, project financing and government financing needs. Unlike traditional bonds, a Sukuk is not an interest-based loan, but rather is a stock that generally represents ownership of an asset or an investment activity. With the concepts of ownership risk or risk sharing, Sukuk holders are entitled to economic returns in the form of rental income or profits.
The global Sukuk market recorded significant growth, defying economic challenges and the impact of the Covid-19 pandemic. According to the International Islamic Financial Market (IIFM) Sukuk Report 2023, 14,228 Sukuks have been issued globally to date, with a total value of over $1.79 trillion, by 36 Muslim-majority and non-Muslim countries. Active Muslim countries include Malaysia, Turkey, Saudi Arabia, Bahrain, the United Arab Emirates, Oman, Indonesia and Pakistan, while several Western countries including the US, UK, Japan, Hong Kong, Germany and France have also issued Sukuk have. Global Sukuk issuance is led by Malaysia, Indonesia, Saudi Arabia and Turkey, and recently Pakistan has begun to emerge as an emerging player in the development of Islamic capital market instruments.
Pakistan entered the global Sukuk market for the first time in 2005 and issued $600 million worth of Sukuks for the first time. Over the years, Pakistan has successfully issued Ijarah-based Sukuk worth US$4.6 billion in global markets, thereby creating a presence for Pakistan. This opportunity can be further explored to raise US dollar funds in international markets targeting ethical and Sharia-compliant investors in the Gulf Cooperation Council and Western markets. Domestically, the domestic Sukuk program was launched in 2008 and as of August 2023, the government has issued Ijarah Sukuk worth Rp 5.051 trillion.
Benefits of Sukuk for Pakistan
Sukuk has proven to be a cost-effective financing tool for government needs and is preferred by Islamic financial institutions due to the restrictions on investing in conventional options. Its Shariah-compliant nature appeals to Shariah-compliant institutions and ethical investors. Based on assets and fixed income flows, the Ijarah Sukuk structure offers a less risky investment than stocks. The issuance of Sukuk reduces dependence on conventional instruments and promotes Sharia-compliant avenues in the domestic Islamic capital market.
The domestic Sukuk market in Pakistan is expected to grow and the government plans to increase its share. The existing Ijarah Sukuk program is targeting around 1.5 trillion rupees of issuance this year. Exploring innovative concepts such as retail, asset-light, green and sustainable Sukuk will further increase the number of Sharia-compliant instruments in government securities. Focusing on Sukuk and marketing it effectively to target investor groups can also help expand the domestic and international investor base.
The asset-backed nature of Sukuk can directly contribute to real economic growth. Financing infrastructure projects such as dams, solar parks, technology parks, railway lines and hospitals ensures secure financing for important ventures. It attracts finance for infrastructure development and can be targeted at retail investors on the Pakistan Stock Exchange (PSX) to promote financial inclusion and Islamic capital market development. Initiatives such as Green and Sustainable Development Goals (SDG) connect Sukuk with global sustainability efforts and socially responsible investments. By using innovative Sukuk structures, the government can strategically address its public debt. Sukuk can be used to convert existing debt into Shariah-compliant instruments, effectively tapping into a new investor base while adhering to Islamic principles.
The impact of Sukuk extends far beyond the boundaries of the Islamic capital market. Its influence extends to related industries such as mutual funds, takaful and banking. By providing a new class of Shariah-compliant assets, Sukuk offerings expand the options for mutual funds and pension funds and improve their ability to tailor portfolios to the preferences of ethically conscious investors. This, in turn, catalyzes growth in the mutual fund sector and creates a positive domino effect throughout the economy by boosting savings rates.
A notable advantage of Sukuk lies in the alternative it offers for converting the national debt from interest-based treasury bills and PIBs into Islamic forms, in line with the government’s recent decision to convert the economy to Islamic principles in accordance with the Federal Shariat Court ruling. Issuance of Sukuks, if executed efficiently, can also provide a cost-effective route to debt conversion by drawing on large liquidity pools from Islamic financial institutions and local and international investors and can attract much-needed investments for the local economy.
The growth of Sukuk issuances in Pakistan has fundamentally transformed the field of Islamic finance. Through the government’s active participation in the global Sukuk market and the use of domestic Sukuk programs, Pakistan has successfully accessed Sharia-compliant sources of financing while meeting its financing needs. Sukuk offers low-cost financing and attracts Sharia-compliant investments. As Pakistan continues to explore new avenues and concepts in the Sukuk market, such as tokenization of Sukuks, green Sukuks, infrastructure development Sukuks and asset-light Sukuks, the potential for further growth and economic development remains significant. In addition, the strategic use of innovative Sukuk structures enables governments to manage their public debt. To achieve this goal, close collaboration and concerted efforts between the Ministry of Finance, Securities and Exchange Commission of Pakistan (SECP), State Bank of Pakistan (SBP) and financial institutions are essential.
Ahmed Ali Siddiqui is Director of the IBA Center for Excellence in Islamic Finance. Samia Tahir Jawad is a research associate at the IBA Center for Excellence in Islamic Finance
Published in The Express Tribune, October 2, 2023.
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