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Jan 07 2013

Sukuk unleashed

Sukuk unleashed
Could sukuk, or Sharia-compliant bonds, be the answer to an ailing economy, asks Nesma Nowar
At the end of 2012, the Egyptian economy is in a shambles, having worsened considerably over recent months. With a budget deficit expected to reach some LE200 billion and dwindling foreign reserves of $15 billion, the government is exploring all the options available to bridge the financing gap, including a $4.8 billion IMF loan that is currently on hold.

One such option is the issuing of sukuk, or Sharia-compliant Islamic bonds, and the country's Islamist forces have been throwing their weight behind the issuing of these bonds, claiming that they offer the country a way out of its economic plight.

As a result, the Shura Council, which now holds full legislative powers, is currently looking into a draft law regulating the issuing of such bonds following its finalisation by the government in late December.

Sukuk are essentially Islamic bonds in which the creditors buy shares in an investment or project, meaning that the holder of a sukuk bond is technically a partner in the enterprise and not a creditor.

Hopes are high that sukuk bonds can help reduce the yawning budget deficit. According to Shura Council and ruling Freedom and Justice Party (FJP) member Ashraf Badreddin sukuk do not have the associated costs of regular treasury bills used by the government to borrow on the capital markets with interest rates now reaching 16 per cent and thereby increasing the government's debt bill further.

Badreddin said that the state was now paying LE140 billion in interest on the country's debt, meaning that "25-30 per cent of state expenditure goes to servicing the debt."

As a result, he said, it was urgent to look for other sources of finance and sukuk was one available option.

Badreddin said that many investors worldwide prefer to hold sukuk bonds, since then they are more involved in the investment.

The sukuk market has been expanding, "so why can't we have a share of this," Badreddin asked.

According to the accountants Ernst & Young, the global demand for sukuk bonds is expected to reach $900 billion by 2017, compared to the current level of more than $300 billion.

The forecast increase in demand for sukuk bonds stems from the growth of the Islamic banking industry and the increasing demand for financial tools that are in compliance with Islamic Sharia law.

However, for Abdallah Erfan, a researcher at the University of Notre Dame in the US, the issuing of sukuk bonds would not curb Egypt's budget deficit. Sukuk bonds, he said, were much the same as regular treasury bills, though with an Islamic slant.

"At the end of the day, the government is borrowing in order to rein in the deficit whether through sukuk or interest-bearing bills," Erfan said, pointing out that the country's problems stemmed from the gaping budget deficit.

Erfan said that what he called the unhealthy investment climate in Egypt could also drive investors away, with revenues seen as being compromised by bureaucracy and corruption. "People will not opt for buying sukuk bonds and investing in projects that only yield low revenues," he said.

Erfan said that the problem did not lie in the amount of financing available, as LE500-600 billion was sitting in the banks waiting for viable investment opportunities. Instead, the challenges lay in the government's blurred economic vision and the country's political instability.

"What we need is radical reform of the investment climate to eliminate bureaucracy and corruption," Erfan told Al-Ahram Weekly.

However, Badreddin stated that investors were ready to invest in the country. "Investors have confidence in the Egyptian economy, especially now that legislative powers have been transferred to the Shura Council and there are to be imminent parliamentary elections," he said.

Erfan said that sukuk bonds, though not effective in the short term, could be useful in the longer term, though Badreddin insisted that they could have immediate benefits.

He was hopeful that sukuk bonds could prompt the establishment of several projects in the coming period that could in turn create jobs. They could attract foreign direct investment and thus increase foreign currency reserves.

Badreddin said that a bundle of laws were set to be endorsed by the Shura Council with a view to boosting the country's economy and investment climate.

Since President Mohamed Morsi assumed office in July, there have been other predictions that the government would soon introduce Islam-friendly financial instruments.

However, the expansion of the Islamic finance market in Egypt had needed legislative support in order to regulate the use of Islamic financial tools.

In June 2011, the Egyptian Financial Supervisory Authority provisionally approved an amendment to the capital market law to allow for the introduction of sukuk and other Islamic financial instruments.

However, the dissolution of the Islamist-dominated parliament in June led to a halt in discussion over the amendment.

"In addition to legislative reforms, we need Islamic finance professionals," Erfan said. "This is a new financial culture, and many people are not familiar with Islamic finance and its instruments."

Highlights of the new sukuk law

The Draft sukuk law includes 26 articles, setting a legal framework for the issuance and transactions of sukuk in the Egyptian market.

The draft allows issuing corporate sukuk and banks are also allowed to issue them if the bank's rules permit and after the approval of the Central Bank of Egypt.

The law further allows international regional institutions to issue sukuk to finance projects in Egypt.

All issuing parties, meanwhile, should choose an Islamic supervision committee which has the jurisdiction to identify the types of sukuk which are compliant with Sharia or Islamic law. The committee consists of three experts chosen by the issuing party from a list of registered experts prepared by Dar Al-Iftaa.

The law allows nine types of sukuk in addition to any other form approved by the Islamic supervision committee of each issuer.

Regarding the type of projects which are set to be financed through sukuk, the law recommends a complete study of the project, its financial feasibility, expected revenues, credit rating, possible risks and guarantees to sukuk holders in case these risks come true.

If the sukuk issuance process for any reason is not completed, all funds should be returned to subscribers. The law allows the transaction of sukuk in Egyptian and international stock markets after the approval of the Egyptian Financial Supervisory Authority.

The law stipulates imprisonment of no more than five years and a fine of no less than LE50,000 and not more than LE20 million for whoever practises any activity stated in the law without being licensed to do so or whoever introduces false documents and information during the registration process.

© Al Ahram Weekly 2013

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