Pakistan Raises PKR 353 Billion in Ijarah Sukuk Auction, Misses Target

The Islamic finance sector in Pakistan continues to grow steadily, offering ethical and Shariah-compliant investment options. A testament to this growth is the latest Ijarah Sukuk Auction, held on December 3, 2024. Despite its challenges, the auction showcased the increasing role of Sukuk in diversifying government financing and attracting ethical investors.

The government aimed to raise PKR 500 billion but closed the auction with PKR 353 billion, highlighting the sector’s potential while shedding light on investor behavior. In this detailed article, we explore the auction results, the significance of Sukuk for Pakistan, and its implications in the global Islamic finance market.

What Makes Ijarah Sukuk Unique?

Ijarah Sukuk is one of the most popular forms of Islamic bonds. The word “Ijarah” refers to a leasing contract, which is central to these instruments. Instead of earning interest (which is prohibited in Islam), investors earn returns from leasing underlying assets.

1. Asset-Backed Structure: Investors hold ownership in leased assets, such as infrastructure or property.

2. Fixed and Ethical Returns: Returns are based on lease payments, ensuring compliance with Islamic laws.

3. Risk Sharing: Sukuk holders share in the risks and benefits of the leased assets, promoting fairness.

Globally, Ijarah Sukuk is instrumental in funding large-scale projects, from highways to hospitals. In Pakistan, they have become a vital tool for managing fiscal deficits while adhering to Islamic principles.

The government structured this auction with both Fixed Rental Rate (FRR) and Variable Rental Rate (VRR) Sukuk options, targeting different investor preferences.

FRR Sukuk offers a pre-determined rental rate, providing stability for risk-averse investors.

• 3-Year Tenor:

  • Rental Rate: 11.5% (unchanged from the previous auction).
  • Participation: Limited, reflecting caution among investors due to volatile economic conditions.

• 5-Year Tenor:

  • Rental Rate: 12.1%.
  • Participation: Moderate, with some interest from institutions seeking mid-term investments.

• 10-Year Tenor:

  • Rental Rate: 11.7%.
  • Participation: Minimal, as most investors opted for variable-rate instruments.

VRR Sukuk adjusts its returns to the Pakistan Market Treasury Bills (MTBs), offering flexibility and alignment with market conditions.

• 10-Year Tenor (GIS-10):
  • Target: PKR 50 billion.
  • Amount Raised: PKR 212 billion, surpassing the target by over four times.
  • Investor Sentiment: Strong, driven by the appeal of market-linked returns in a high-inflation environment.

The overwhelming success of VRR Sukuk underscores the preference for instruments that provide a hedge against inflation and interest rate volatility.

Global Context

1. Malaysia: A Global Leader

Malaysia is the world’s largest issuer of Sukuk, accounting for more than 60% of global Sukuk issuances. Its success is driven by a well-developed Islamic finance ecosystem, innovative Sukuk structures, and strong regulatory support. The country has successfully used Sukuk to fund mega projects like the MRT system and highways.

2. Saudi Arabia: Vision 2030

Saudi Arabia leverages Sukuk to support its Vision 2030 initiatives, focusing on economic diversification. The country’s Public Investment Fund (PIF) uses Sukuk to finance projects in tourism, infrastructure, and renewable energy.

3. Indonesia: Infrastructure Financing

Indonesia’s Sukuk market is known for funding infrastructure projects. It raised over $3 billion in Sukuk in 2023 alone to finance initiatives like power plants and toll roads.

4. Pakistan’s Role

While Pakistan’s Sukuk market is smaller, it holds immense potential. By learning from global leaders, Pakistan can position itself as a regional hub for Islamic finance, attracting both domestic and international investors.

The auction’s inability to meet its PKR 500 billion target stems from several factors:

• Economic Volatility: High inflation, currency devaluation, and interest rate fluctuations discourage long-term investments, especially in fixed-rate instruments.
• Investor Caution: Institutional and retail investors are cautious amid Pakistan’s economic challenges, including fiscal deficits and external debt pressures.
• Preference for VRR Sukuk: The overwhelming demand for VRR Sukuk, which raised PKR 212 billion, suggests that investors prefer market-linked returns to fixed rates.

Related: Pakistan Issues $1 Billion Sukuk Bond

Understanding investor behavior is crucial for optimizing future Sukuk issuances.

1. Institutional Investors: Banks and financial institutions dominate the Sukuk market. They favor VRR Sukuk for liquidity management and portfolio diversification.
2. Retail Investors: Retail participation in Pakistan’s Sukuk market remains limited due to low awareness and accessibility. Initiatives to engage this segment could unlock significant potential.
3. Global Investors: Sukuk appeals to ethical investors worldwide. By adhering to international standards, Pakistan can attract global funds, especially from Gulf Cooperation Council (GCC) countries.

Advantages of FRR Sukuk

•  Stability: Predictable returns appeal to conservative investors.
• Risk Mitigation: Fixed rates shield investors from market volatility.

 Advantages of VRR Sukuk

• Flexibility: Market-linked returns adapt to changing economic conditions.
• Inflation Hedge: Higher potential returns in inflationary environments.

The December auction highlights a growing preference for VRR Sukuk, reflecting current economic realities.

To strengthen its Sukuk market, Pakistan can draw lessons from global leaders:

1. Innovative Structures: Countries like Malaysia offer hybrid Sukuk combining fixed and variable rates.
2. Infrastructure Focus: Indonesia’s use of Sukuk for public projects attracts diverse investors.
3. Regulatory Support: Robust frameworks in Saudi Arabia and Malaysia build investor confidence.
4. Global Outreach: Partnerships with international Islamic finance institutions can boost foreign investment.

The role of Sukuk extends beyond fundraising; they have broader implications for Pakistan’s economy:

• Reducing Debt Costs: Sukuk offers a cost-effective alternative to conventional bonds, saving the government millions in interest payments.
• Promoting Financial Inclusion: Sukuk enables underserved segments to participate in the financial system, fostering inclusion and equity.
• Supporting Infrastructure: Funds raised through Sukuk can be channeled into critical infrastructure projects, boosting economic growth.
• Enhancing Fiscal Stability: By diversifying funding sources, Sukuk reduces reliance on volatile external financing.

Challenges

1. Economic Uncertainty: High inflation and currency risks deter long-term investment.

2. Awareness Gap: Limited knowledge of Sukuk among retail investors restricts participation.

3. Global Competition: Competing with established markets requires innovation.

Recommendations

• Investor Education: Increase awareness through campaigns targeting retail investors.
• Policy Support: Strengthen regulatory frameworks to encourage investment.
• Product Innovation: Introduce diversified Sukuk offerings to cater to different investor needs.
• International Partnerships: Collaborate with global Islamic finance institutions to attract foreign capital.

To fully capitalize on Sukuk’s potential, Pakistan must adopt a long-term strategic approach:

1. Market Research: Conduct studies to understand investor behavior and preferences.
2. Product Diversification: Offer a mix of tenors, rates, and structures to attract diverse investors.
3. Technology Integration: Use blockchain and fintech solutions to enhance transparency and efficiency.
4. Global Benchmarking: Learn from leading Sukuk markets to adopt best practices.

The December 2024 Ijarah Sukuk Auction serves as a barometer of Pakistan’s Islamic finance sector. Despite falling short of its PKR 500 billion target, the auction reflects strong demand for market-linked instruments, particularly VRR Sukuk.

Moving forward, a focus on innovation, investor engagement, and global collaboration will be key to unlocking the full potential of Pakistan’s Sukuk market. By addressing challenges and leveraging opportunities, Pakistan can solidify its position in the global Islamic finance ecosystem and drive sustainable economic growth.