Govt to test-run sukuk auction ahead of bond launch

KARACHI: Pakistan Stock Exchange (PSX) will hold a mock transaction of the upcoming one-year listed domestic Islamic bond, known as sukuk, on Friday (December 1).

The date of the actual auction of the government Ijara sukuk, which are Shariah-compliant debt instruments based on Islamic guidelines, was not disclosed by the PXS in a notice issued on Thursday, but banking industry insiders expect it to be issued by mid-December.

Sources said the finance ministry has appointed Meezan Bank Limited and three Islamic banks - BankIslami Pakistan Limited, Dubai Islamic Bank Pakistan Limited, and Bank Alfalah Islamic - as joint financial advisors for the potential issuance of local-currency sukuk.

The sukuk will be open to both local and foreign investors, as well as retail and institutional investors who prefer Islamic finance, they added.

The PSX invited all broker clearing members and non-broker clearing members of National Clearing Company of Pakistan Limited (NCCPL) to participate in a simulated session for end-to-end testing of the brokerage auction system.

The government aims to issue its debt instruments through the local exchange to strengthen and diversify the country’s capital market, and the testing of the upcoming sukuk auction is part of the plan.

In September, thecaretaker finance minister Shamshad Akhtar said that the PSX listing of government debt securities would enhance transparency in the process of issuing bonds, T-bills, and sukuk through public auctions and also facilitate retail investors’ participation.

She stressed that this move would play a vital role in developing Pakistan’s debt market. The target amount to be raised through this auction is Rs30 billion, according to the auction calendar and instrument details of the simulated session. Buyers will bid for the asset at a cut-off rate determined by the finance ministry during the auction, it said. PSX’s responsibility is to make the auction system available to eligible participants so they can submit bids during the auction. The State Bank of Pakistan issuance price and par value will be used to calculate withholding tax. Investing in sukuk in the secondary market involves paying tax for the entire tenor rather than the holding period, it added.

Surprisingly, the government is issuing sukuk first at the local bourse. Industry insiders suspect that the government is trying to convert its current debt into Shariah-compliant securities because sukuk borrowing is cheaper than conventional paper loans. The government is offering profit rates of 21 percent on T-bill investments, 16-17 percent on PIB investments, and 16 percent on five-year fixed rate sukuk investments.

Conventional banks are also criticised for making huge profits on investments in risk-free government papers, especially in the country’s high interest rate environment.

According to the SBP’s report, the government has been significantly dependent on bank credit to meet its budgetary responsibilities, and investments in government securities form roughly 48 percent of the banking sector’s assets base at the end of December 2022. The majority of this investment is made up of traditional T-bills and PIBs, which account for 87.3 percent of the Rs16.8 trillion in government securities that banks hold; sukuk makes up just 12.7 percent of this total. From 2020 to 2022, investments in government securities saw an average growth of 28.9 percent. A significant portion of this expansion has come from the recent issue of conventional government securities.

The SBP intends to convert current conventional banks into Islamic financial institutions. In line with its strategic vision for 2023–2028, it intends to do this by creating a roadmap for the switch to Islamic banking and coordinating with banks to make the conversion.

Furthermore, the Federal Shariat Court's historic ruling, which mandates that Pakistan's banking sector comply with Shariah by 2027, has set a high bar for the Islamic banking sector.

Over time, the share of Islamic banking in the banking sector as a whole has increased significantly. The percentage of Islamic banking assets and deposits in the market has reached 20 and 22 percent, respectively, and by December 2022, there will be 4,396 Islamic branches.

Conversion of existing government debt to Shariah-compliant instruments seems to be a big challenge for the government.

The SBP in one of its report stated that in order to assist in the issuing of Shariah-compliant government securities (which will replace the stock of PIBs and TBs), it will be necessary to have a sizable pool of government assets with unambiguous titles to ownership and the ability to provide income. The lack of suitable assets, however, may make it difficult to convert the current conventional stock of domestic public debt into Shariah-compliant securities. In response to the lack of a minimum deposit rate (MDR) for Islamic banks, the finance minister recently made comments and urged SBP to take its application into consideration in order to give depositors in Islamic banking a reasonable return.

Islamic banks are already on a disadvantage due to absence of investment avenues, according to analysts. They sees deposit rate can potentially be linked to a benchmark Islamic instruments (for e.g., sukuk) return.