This is all greek to me but it seemed relevant:
Tapping the Islamic bond market
By Farhan Mahmood
According to recent news reports, Dr. Ishrat Hussain, governor of the State Bank of Pakistan stated that Pakistan plans to sell Islamic bonds overseas in the new fiscal year starting in July to help attract Islamic investors and further develop its debt market.
Tapping into the market for Islamic products is a prudent and sound tactical move of the government of Pakistan. After six years of seclusion, Pakistan is slowly getting back on the radar screen of foreign investors. There are several reasons for this: Pakistan’s role as a frontline state in the war against terrorism and the decision by the US government in March to grant Pakistan the status of a major non-NATO ally (which provided a stark illustration of the degree of strategic importance the US now attaches to its relationship with Pakistan), improving relations with India, sound implementation of macroeconomic policies and a strong improvement in the country’s external account.
The Economist Intelligence Unit expects real gross domestic product (GDP) (at factor cost) to expand by 5.30 per cent in fiscal year 2003-04 (July-June) and by 5.00 per cent in FY2004-05.
The IMF, however, remains concerned about the pace of reform of the power sector and of public-sector corporations, and about what it sees as excessive social spending. The primary goal of tapping the international capital market is to reduce reliance on the IMF and provide the administration enough fiscal room to implement discretionary development spending. Other driving forces behind the government’s intent to issue Islamic bonds are to replace higher-cost, short-term borrowing (mainly supplier credit) with longer-term debt and raise the country’s profile among Islamic investors.
Capitalising on recent success
In February this year, Pakistan raised US$500 million in its first overseas bond sale since nuclear tests led to international sanctions in 1998. The effort marked a welcome return of the country to international capital markets and last month Pakistan converted these fixed-interest bonds to floating-rate bonds to reduce costs.
Work is in progress to sort out modalities for selling Pakistan Islamic Bonds to investors conscious about shariah-compliant investments. The demand for Islamic bonds has traditionally come from the Middle East with healthy distribution into Asia and Europe. In recent months, sovereign states including Bahrain, Malaysia and Qatar have successfully utilised Islamic finance and accessed the international Islamic capital market.
A shariah-compliant investment
The basic aspect of Islamic finance is the absence of interest. In addition, there are social and ethical features such as aiding a more equitable distribution of income and wealth and avoiding undesirable areas. Islamic bonds comply with the shariah, which prohibits the payment of interest and investors share in any profit or loss.
Issuance of sukuk or Islamic bond has been one of the most useful mechanisms for raising funds in the international capital markets through structures acceptable under the shariah. Last year, Malaysia issued a US$600 million Islamic bond and reports suggest that the growing pipeline of new sovereign sukuks is likely to include Turkey, Malaysia, Indonesia and the Philippines.
Sukuk is a shariah-compliant capital market product that represents an undivided proportionate ownership interest in an asset with the corresponding right to the Islamically acceptable income streams generated by the asset. These current income streams are established and translated into tradable securities, which can be issued in the capital markets for investors’ participation.
Sukuk allows investors to lock in either medium to long-term fixed income returns or variable rates of return, which are adjusted at periodic intervals and which, by virtue of being tradable, provide investors with the flexibility to exit the investment at any time prior to completion of the investment-holding period.
Sukuk can be equated to a conventional bond except that it is always asset backed. Sovereign bodies, state corporations, multinationals and financial institutions have used sukuk issuance as an alternative to syndicated financing. It also serves as a vehicle for securitisation.
Credit quality of sukuk instruments is assessed and rated by international rating agencies, which investors use as a guideline to assess risk/return parameters of a sukuk issue. While the provisions of Islamic debt instruments may add levels of complexity to the analysis, longstanding methodologies and rating scales are sufficiently broad so far to incorporate the varied features of Islamic debt financing.
Wooing Islamic investors
An Islamic capital market is rapidly evolving and growing. Over the last 30 years, Islamic financial services have gained increased importance and greater recognition among investors. A wider product and service base is increasingly evident with 108 Islamic funds in operation globally (according to estimates, Islamic funds, which avoid investments in alcohol, gaming and tobacco companies, are worth about $3.30 billion worldwide), several global Islamic indices, innovations in Islamic product origination, retail banking and other capital market services. There is also now a greater diversity of market-players, often involving the major financial players of the developed world.
To have a wider asset base, Malaysia has been successful in making concerted efforts to develop its Islamic bond market for the last 14 years. In general, there are three broad categories of Islamic private debt securities, which can cater to various financing objectives and cash-flow needs of issuers. These are long-term Islamic debt securities of more than five years, medium term notes of two to five years and short-term commercial papers of one to twelve months. The two rating agencies in Malaysia provide long-term and short-term ratings on the likelihood of timely repayment of financial commitments of Islamic debt instruments.
Graduating from the IMF programme
Pakistan’s government is doing the correct thing by planning to issue a bond that is shariah-compliant and that has appeal to Islamic investors. An Islamic bond positions Pakistan to benefit from the growing market for shariah-compliant investments, with assets of over US$250 billion. The government has rightly focused its energies towards ensuring that Pakistan regains its ability to raise capital from international capital markets and pay off its short-term liabilities. As stated by the finance minister, Pakistan will be pre-paying another US$1.0 billion high-cost debt before the end of the current calendar year.
The IMF has been informed that once the current on going PRGF (Poverty Reduction and Growth Facility) ends in October this year, Pakistan will not be resorting to any further borrowing from the Fund. With the country returning to the radar screens of investors, the strategy to diversify Pakistan’s funding sources from primarily IFIs (International Financial Institutions) to the international capital market is a sound one. The stage is set to prepare Pakistan to graduate smoothly from the IMF programme.
— The author is a Portfolio Manager with a bank in Toronto
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