Pakistan’s regulator is pushing the development of the country’s sukuk market as part of a bid to finance the government’s growing fiscal deficit, as well as to reduce its reliance on printing money, which will help to combat inflation.
The Securities and Exchange Commission of Pakistan (SECP) also hopes the development of this market will help the country’s corporates tap Middle Eastern funding, with a long-term view to develop the sukuk market to such an extent that it overtakes Pakistan’s traditional bond market in terms of size.
The SECP launched a consultation on preliminary sukuk regulations with comments to be submitted by October 15. Under the proposed regulations, any company or corporation can issue sukuk, provided the company is not overdue on loan repayments and is rated no lower than ‘BBB-‘. In addition, the regulations provide security that the instruments issued will be compliant with shariah law.
According to commentators, the decision to bolster the country’s sukuk market is part of a bid to rectify Pakistan’s worsening fiscal position. The government’s target deficit for the fiscal year 2011-12 was 4% of the gross domestic product (GDP), or PKR850 billion (US$8.91 billion), but some commentators estimate the figure is closer to PKR1.7 trillion, or around 8.6% of GDP.
“The fiscal situation is getting progressively worse [and] the options for financing the deficit are getting constrained so the government is now forced to look at other avenues. Last year [the deficit] was financed by borrowing from commercial banks and printing money. Both are negative for growth and inflation,” said Sayem Ali, senior economist for the Middle East and Pakistan at Standard Chartered.
Over the last four years Pakistan has fought against double-digit inflation with CPI between 10% and 20% since 2008, though recently it has fallen to 9.1%. As such, the central bank, the exchange commission and the government are having to consider alternatives to financing the deficit through printing money. In the last financial year the State Bank of Pakistan printed around PKR500 billion.
“The rest of it was financed by borrowing from non-banking industries such as the national savings or other non-bank financial institutions. What that means is there’s no money left for the private sector, the credit off-take from the private sector is zero. That is why they are looking at Islamic banking as a viable alternative source of funding,” said Ali.
Islamic outperformance
The government is looking to Islamic finance in particular as it is the one sector that has shown significant growth over the past year. The sukuk regulations have been published alongside efforts to develop Pakistan’s repo market for Islamic products, and its short-term Islamic debt markets.
Islamic finance equally is a natural fit for Pakistan, due to the country’s sizable Muslim population, which is the second largest in the world. A total of PKR525 billion worth of sukuk has been issued in 68 deals since 2006 in Pakistan, with the volume growing each year.
“It is a viable option. Over the past four to five years even though the rest of the banking industry has underperformed, the Islamic banking sector has been a star. Not just inside Pakistan, regional international Islamic finance markets have also outperformed,” said one head of research at a Pakistan securities house.
As it stands, there have been no regulations issued regarding the sukuk market in Pakistan since 1984. Islamic bonds have been issued periodically in the country but Imtiaz Haider, commissioner of the securities market division at the SECP told Asiamoney PLUS that he believes the market could really take off in the future.
“By looking at the local and global trend towards shariah compliant products, it is hoped that the size of sukuk market in Pakistan will grow manifold. The Islamic system of banking is rapidly growing in Pakistan,” he said.
He quoted statistics from Dawn, a daily newspaper in Pakistan, showing that the number of Islamic banking branches in the country has multiplied fifty times over the last ten years, to exceed 900. The government and regulators will seek to continue this development, with a view to eventually seeing Islamic bond issuance outstrip issuance of plain vanilla debt.
“At this point in time we see that the sukuk market is a parallel platform besides traditional bond market, but in future it is expected that this can be a dominant primary form,” he said.
“A thriving Islamic capital market can play a vital role in the economic development of Pakistan. It can help in financing various public and private sector projects on one side and on other side can increase investor return through additional investing avenues.”
Some of the benefits he listed in developing a sukuk market over a traditional bond market were an increased investor base as well as suitability to the primary religion of Pakistan’s people.
Capital to the corporates
““Developing the local Islamic finance markets will also help to channel significant international funding to the local markets. [They could target] large foreign capital flows, primarily from the Middle East, which is one of the biggest and most liquid markets and one that Pakistan is comfortable working with,” said StanChart’s Ali.
“We have strong linkages there so they want to tap into the huge Middle East sukuk market, worth around US$100 billion.”
The SECP argued that in the short-term the sukuk market will continue to be dominated by sovereign issues, but Haider believes in the long run Pakistan’s Islamic bond market will be dominated by corporate deals, particularly in the infrastructure space.
“By seeing the inclination of investors towards shariah compliant avenues it is expected that sukuk issues for infrastructure development can emerge in future,” he said.
“The sukuk market is a liquid market for corporates that are finding it difficult to raise money through the conventional banking channels. It offers a viable alternative and the appetite is growing so it’s likely a market that will pick up in the years ahead,” agreed the head of research in Pakistan.
Two Islamic bonds are already planned for October 30, according to Haider. Engro Fertilisers hopes to issue a deal worth PKR1.5 billion, and Aisha Steel Mills is planning a bond worth PKR750 million. According to Ali, issuing Islamic bonds often allow corporates to achieve cheaper funding, due to the liquid market as well as a scarcity of suitable instruments for Islamic investors.
Once Pakistan has developed its onshore Islamic markets, Ali argues the second phrase will be to look towards developing an offshore market as well. In addition, the government is looking at developing the repo market.
“That was one part of the sector which was clearly underdeveloped so that is the key reform which we are expecting going forward. The overnight window from the central bank will become available so there will be greater appetite and more trading for sukuks,” he said.