Sukuk for Infrastructure Financing and Financial Inclusion Strategy: an Alternative to SDG
Muhammed Shafeeque CM
(Student. Department of Economics, Calicut University)
(Joint director, Markaz Garden Group of Institutions)
The Sustainable Development Goals (SDGs), legitimately known as ‘transforming our world: the 2030 Agenda for Sustainable Development’ is an initiation of United Nations containing seventeen “Global Goals” with 169 targets. Its ninth goal dealt with Industry, Infrastructure and Investment which may introduce resilient infrastructure. Islamic financing has great potential to offer an alternative solution for infrastructure financing in the world. Sukuk (Islamic bonds) is a system of Islamic finance which generates return to investors without infringing Islamic laws prohibiting acts like Usury. The undivided shares in ownership of tangible assets will benefit infrastructure financing and financial inclusion. The paper will primarily explicate the need and financial sources for infrastructure development. It will further shed light on the development of Sukuk system, relying on the milestone development of Indonesian sovereign Sukuk and project financing government Sukuk. It become pivotal as it elucidates the challenges and development strategies for Sukuk system in India.
Key Words: Bond, Equity Finance, Hybrid instruments, Sukuk
Sukuk is the asset-backed Islamic bonds which provide funds for long-term investment. This tool is used in a number of developing and developed countries. India should seek to make use of these resources to effective space for infrastructure financing and development. In real, Islamic finance including Sukuk can do wonders in the nation in terms of Investment. Post 9/11, petro-dollars are actively eyeing for a safe investment space. And this is the occasion that India should aim of, given that it is not just a safe but a vibrant space for investment. It will help India to achieve the ninth objective of Sustainable development goals propounded by United Nations to be accomplished in 2030.
2. The Need for Infrastructure investments
“Expanding investment in infrastructure can play a pivotal counter cyclical role in India. The projects and programs want to be reviewed in the area of infrastructure development in India including pure public private partnerships. Also we want to ensure that their implementation is expedited and does not suffer from the fund crunch”.
-Manmohan Singh, Ex-prime minister of India-
Infrastructure development is the cornerstone of economic development in a country. In brief, it can be defined as a set of facilities used to provide goods and services to the public. The term collectively refers to roads, rail lines, bridges and similar public work that are essential for the functioning of an industrial economy. The union budget 2017-18 has allocated a record 3.96 crore to the infrastructure sector. More the financial minister Arun Jaitley said “The scale of investment will speed up the economic activities and will lead in creation of more jobs”. It is a well known fact that the GDP growth averaging 9% per year can only be achieved by overcoming the deficit in infrastructure sector. This can be achieved through a combination of public investment, PPPs (Public-private-partnership and exclusive public investments. Here the method of Sukuk will further boost the procedures of development in infrastructure development.
India has ranked 39th among 139 countries in terms of global competitiveness index(GCI), 2016-17 in the Global competitiveness report produced by World Economic Forum (WEF). India has named as the highest rising economy in terms of goods market efficiency (60), business sophistication (35) and innovation (29). The increase in GCI has mainly occurred due to the improvements in infrastructure and institutions. The GCI is measured by scrutinizing twelve areas including infrastructure. So, further improvements in infrastructure are very essential to improve the rank of India in GCI.
As per Logistics performance index (LPI), published by World Bank, India has 35th rank with an infrastructure development rating 3.34, where Germany explores with 4.44. Here we can notice a peerless development in countries, practicing Sukuk for infrastructure financing and financial inclusion like Germany.
Now the country is at an infrastructure crossroads. As India is the fastest growing economy in the world the government had set a target of investing $377 billion in infrastructure for three years in 2015. Despite the developments, the potentiality to get into international markets and bring new sources of capital and expertise, and to improve the delivery capacity, has never been well wished as greater. Thus, it makes India an attractive destination to long-term global infrastructure investors, who recognize it as a country with a healthy pipeline and several good potential partners.
There are two types of infrastructure-Economic infrastructure and social infrastructure. Economic infrastructure refers to basic facilities which may provide economic development in our country. Social infrastructure means a set of facilities which are essential for human development like hospitals and schools.
In most of the countries the development of economic infrastructure has followed a rational and harmonized path except some countries like Korea and Japan where witnessed rapid boost in economic infrastructure. It includes public utilities like power, telecommunications and public works like roads and dams. Infrastructure of a country does three things.
1. The services belonging to consumption package of residents are provided by infrastructure.
2. It increases the aggregate demand and provide short run stimulus to the economy.
3. In private sector production it acts as an input.
Therefore a better investment in economic infrastructure may promote positive output, employment and income effects in the economy. It will reduce the poverty in the country.
Education and health are the bedrocks of social development. Thus it is important to provide proper guidelines while promoting social infrastructure. As per Denison study states, even though education is a social investment, it enhances the stock of human capital, which is well referred as an economic growth1. Apart education, better investment in health sector is vital for the overall development of a country.
3. Financing sources for infrastructure investments
Debt instruments like loans and bonds enroll the major part of contribution in infrastructure finance. It can be provided through multiple instruments, either in the form of direct loans held on the balance sheets of financial institutions or may be structured for resale to investors or distribution in markets, be it private markets (such as private-placement debt) or public markets through registered corporate and government bonds. Taxation seems as a powerful tool used by governments and regulators to shape capital markets.
Hybrid instruments forms bridge between debt and equity instruments. The major hybrid instruments are subordinated Loans or Bonds and Mezzanine Finance. Equity finances are financial resources, provided in return of ownership interest. They have an important position in economy as the providers of risk capital to initiate a project or refinancing. The main categories of equity instruments are public equity concerns companies, funds, or assets that are traded in some form of vehicle listed on a stock exchange, private equity investors provide capital to unlisted companies. Also, while public equity investors are not generally involved in the management of the company (and are for the most part minority shareholders), private equity financiers can be heavily involved with or assist the owners or managers in the development and management of the asset.
In project finance, lending arrangements are solely based on the cash generation of the project. Risk sh0aring is based on the ability to control and mange the risk. Thus the liabilities will be limited to the contributed equity capital.
Corporate finance is well explicated as the traditional form of non-public infrastructure finance. Companies engaged in business to build and operate infrastructure will issue shares on the market, or borrow funds through capital markets to finance their projects.
4. Development of Sukuk
Islamic banking and finance has been one of the fastest growing industries in the last decade in terms of assets, worthy of trillions of dollars under its management. Today, more than 500 Islamic banks and financial institutions are operating in and outside the Muslim world.
The term ‘Sukuk’ is the plural form of Sak which is a Sharia oriented bond. The contribution of Sharia (Islamic law) based financing for infrastructure development can be well expounded through the Sukuk. Sukuk is a way to generate returns to investors without infringing Islamic law. It characterizes undivided shares in the ownership of tangible assets. Its main advantages are as follows;
· It provides larger market as it targets both Sharia and conventional investors.
· There will be no bubble as all Sukuk issuance are backed by a certain asset.
· The Sukuk is the most proper instrument for infrastructure financing as its underlying is the project itself.
The Government of Indonesia regularly issues Sukuk Negara in both domestic and global market as a commitment to support the development of the global Islamic financial market. The Issuance of Sukuk Negara provides an alternative Sharia compliant instrument for fast growing Islamic financial institutions in Indonesia. The Sukuk system was started in Indonesia in 2009. Now it is the biggest Sukuk issue in the world in terms of US dollars.
There are many scopes for project financing Sukuk in our country. It will generate infrastructure development, dealing energy, telecommunications, transportation et cetera. It also provides public services and empowers the local industry. It will turn as another source for the government’s strategic policy for development. Furthermore, Sukuk has wide areas of requirements.
5. Challenges of Sukuk in India
There are great challenges for Sukuk in India, as Islamic banking was looked as an alien concept.
5.1 Indian Banking laws
The prominent obstacles for establishing Islamic finance in India are the Indian Banking Regulation Act (1949), the Reserve Bank of India Act, the Negotiable Instruments Act and the Cooperative Societies Act (Majid Baba, 2013). It focuses on the requirement of payment of interest which is against Islamic banking principles. It also bans the banks to enter any profit sharing and partnership contract which is the bedrock of Islamic banking.
5.2 Issues in Project Structuring
Infrastructure projects include multiple parties and multiple contracts. Islamic finance involves complex levels of contracts. It will create uncertainty with high transaction costs involving legal and accounting fees. Also, the size of Islamic banks is small as compared to conventional banks.
5.3 Legal issues
If the enforcing of contracts gone weak, it may provide negative impacts upon the calculations of the investors. There will be problems arriving from the dispute cases, as Islamic law is not practicing in Indi. It will create great risk upon the investors due to improper legal instructions in the country.
To meet these challenges, it is important to gain the support of government. It needs a great change in legal and financial areas. Also, we need privatization in competitive markets and monopolies which can tap Islamic resources in efficient and competitive terms. They need to allow the issuance of public Sukuks in India. If large numbers of Islamic sukuks are issued, proceeds can be used to fund the infrastructure sector.
6. Why Sukuk needed in India
Despite the drawbacks of demonetization, India was the leading growing economy in South Asia in terms of gross domestic product (GDP) growth and macroeconomic management. The immediate need of Economy is to overcome the inflation levels and find an alternative source of funding for proclaimed projects in infrastructure and development. Many Middle Eastern investors are eager to capitalize the India economy. The challenges in regulatory affairs and the unfocused approach of government to Islamic finance are playing against the India’s potential to become a favorite spot of investment.
The 12th five-year plan 2012-2017 is focusing on the removal of some of these constraints and creation of space for public sector participation. Bu the success of plans will totally rely upon the potential of leaders in executing the plans. In the draft 12th five-year plan, the government is offering an investment of $1 trillion for infrastructure upgrade, which seems to be double than the earlier one.
Many of the global long-term projects globally were successfully financed by Islamic bonds (Sukuk). It can be considered as an alternative source of finance tocounter the economic deficit of our country.
Sukuks are certificates, proposing a common proportional ownership right in tangible assets. It can be denoted Shariah-compliant pool of assets. The success of Sukuk is not the hegemony of Muslim countries. Now, UK had started their plans to issue sukuk in need of attracting more funds and raising capital. Moreover, the Germany, France, UK, Ireland, Canada and Australia have introduced some new regulations in terms of Sukuk. In India, it is inevitable to amend the regulations, allowing Sukuk for enabling growth.
India offers a lot of potential for these alternate investments and needs to amend regulations to allow Shariah-based investing to enable growth. We need to focus on these areas.
· We need to develop proper legislation liberating the policies of Sukuk.
· A supportive infrastructure, including essential skills should be provided.
· We need to measure better development in Islamic banking and need to assess the impact of such moves in social areas like inequality.
· Investment should be allowed in a pilot basis by Sukuk.
7. ConclusionSukuk financing can be considered as a continuation of investment issues in non-bank alternatives in an authentic manner. As proved, Sukuks have signed their viability as an alternative financial source to mobilize medium- to long-term savings and investments from a huge investor base. In India, Sukuk will play a major role to help issuers and investors to participate in foremost projects connected with infrastructure such as power-generating facilities, airports, and bridges.
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1 Denison Edward F., “Education, Economic Growth, and Gaps in Information”, Journal of Political Economy (Supplement), Vol. 70, no, 5 part 2 pp. 124- 128, October, 1962, p.127