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May 30, 2013

Who Never Talks about Money and Religion...?

Posted by Yasemin Hurcan and Gregory Horman

Sukuk[1] is an Arabic word that is used to define borrowing instruments issued in line with Islamic norms, the sharia. Sukuk are not limited to private sector borrowers. Increasingly, these instruments are being issued by governments to finance the public sector. Although there is already a sizeable body of literature on the capital market aspects of sovereign sukuk issuance, the public financial management (PFM) dimension of sukuk has not been widely discussed. The implications for areas such as budgeting, reporting, and accounting are not insignificant.

Malaysia is recognized as one of the pioneers of sovereign sukuk issuance, and these instruments make up a significant share of the total public sector debt. Qatar and Bahrain are also notable issuers of sukuk, and in recent years Pakistan has added sukuk to its borrowing mix. In October 2012, Turkey, too, joined the group of countries issuing sovereign sukuk. Although sovereign sukuk issuances have so far been made only by countries where sharia is the governing law, or the population is predominantly Muslim, other countries have investigated sukuk as an opportunity to broaden their sources of financing. In 2008, for example, the UK Debt Management Office consulted with the market to find out the possibility of issuing sukuk as an additional borrowing instrument. These developments suggest that the use of sukuk instruments for sovereign borrowing is likely to increase in the coming years.  

In sharia law, charging or paying interest on money lent is not permissible. Therefore, sukuk are often designed to conform to the principles of sharia through a direct relationship between borrowing, the use of the funds raised and special contractual techniques, and to exclude any explicit interest payments. Sovereign sukuk are linked to tangible assets and are often structured in a way to generate a similar economic effect as conventional bonds, but in a sharia-compliant manner. Indeed, the Accounting and Auditing Organization for Islamic Financial Institutions[2] (AAOIFI) has sought to classify sukuk instruments as equity investment instruments rather than as pure debt instruments.  

Sukuk come in a range of types, depending on the nature of the underlying asset, as recognized by the AAOIFI. The most commonly issued sovereign sukuk allow for partial ownership of an asset (sukuk al-ijara) and are, in effect, an Islamic leasing contract.

It can be argued that the substance of an al-ijara transaction is very similar to that of issuing conventional bonds. However, there are three important differences. First, the standards laid down by sharia law and AAOIFI require that a financial entity (special-purpose vehicle) separate from the sovereign should be formed to hold the assets and be responsible for making service payments on sukuk transactions. Moreover, these assets must be transferred in full to this independent entity. Second, all the records of sukuk-related transactions should be kept separate from those of conventional borrowing instruments. Third, remuneration on sukuk cannot be called interest and must be recorded separately.

Complying with these requirements creates several challenges for governments issuing sukuk that wish to record and consolidate fiscal and financial accounts according to accepted international standards of public sector accounting and statistical reporting. This requires action on two fronts. First, in countries issuing sukuk, PFM laws and regulations, together with accounting and reporting guidance, should be reviewed to ensure that sukuk processes and transactions are correctly defined both in themselves and in relation to other parts of the PFM cycle, and to clarify the role and responsibilities of the special purpose entity.

Second, the growth in sovereign sukuk issuance, in both domestic and international markets, together with the ongoing need for fiscal consolidation in numerous countries, and the stricter rules established by AAOIFI in 2008 all point to the need for strong international norms on the accounting and reporting of sukuk-related transactions. Sukuk are not yet adequately covered in government accounting standards such as IPSAS, in government statistical standards such as the Government Finance Statistics Manual 2001, or in standards relating to public sector debt statistics. While the Monetary and Financial Statistics Manual 2010 has an appendix on Islamic banking, covering the primary types of credit supplied by Islamic financial institutions, it is not specifically designed to cover sovereign sukuk transactions. Modification of these standards, rather than the development of entirely new standards for sukuk alone, is required: (i) to avoid ambiguities and non-transparent differential treatment of sukuk across countries; and (ii) to ensure a consistent approach to the treatment of conventional and sukuk finance within the overall framework of PFM standards.

[1] For the sake of clarity, we employ only the word sukuk, the plural form of sakk, in this posting.

[2] The AAOIFI is an Islamic international autonomous non-for-profit corporate body that prepares accounting, auditing, governance, ethics, and sharia standards for Islamic financial institutions and industry. AAOIFI was established under an agreement of association signed by Islamic financial institutions in 1990 in Algiers, and was registered in 1991 in Bahrain. As an independent international organization, AAOIFI is supported by 200 institutional members from 45 countries, including central banks, commercial financial institutions, and representatives of the international Islamic banking and finance industry. The organization has gained widespread support for the implementation of its standards, which are now adopted in Bahrain, the Dubai International Financial Center, Jordan, Lebanon, Qatar, Sudan, and Syria. The relevant authorities in Australia, Indonesia, Malaysia, Pakistan, Saudi Arabia, and South Africa have issued guidelines that are based on AAOIFI’s standards and pronouncements.

Note: The posts on the IMF PFM Blog should not be reported as representing the views of the IMF. The views expressed are those of the authors and do not necessarily represent those of the IMF or IMF policy. 


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Of timely note, Egypt is moving closer to joining the club of sovereign sukuk issuers. A law to allow the government to issue Islamic bonds was approved in May, and according to the prospectus for a new euro-medium term note program released later in the month, government aims to issue its maiden sukuk in early 2014.

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