Thursday, April 1, 2010

Think twice before investing in Sukuk

Reportedly Ministry of Finance has finalized the plan to issue Rs100 billion Sukuk before the end of the current financial year to retire inter-corporate debt ailing energy chain, from power generation to exploration and production companies.
The government is all set to issue the said Sukuk and aims at investors looking for Riba-free income generating products. Other entities, particularly Islamic banks would be able to invest in instruments, which also qualify for meeting statutory liquidity reserve requirement of the central bank.
However, the recent default of Maple Leaf Cement Sukuk and a few other players of the sector demands investors should complete due diligence rather more carefully. Maple Leaf has now asked the investors to restructure the Sukuk at its terms. This will put the financial institutions at a disadvantageous position.
Allied Bank was able to withstand the dent only because of the size of its investment but other investors got the real jolt. Investors also questioned the credibility of the Shariah Advisor. It is true that under Shariah arrangements the basis of participation is profit and loss sharing. However, as Ameen (custodian of funds) the Shariah Advisor is also required to minutely examine the business model to minimise losses.
The second point is that cement industry is highly leveraged (substantial borrowing) and it was but obvious that any reduction in gross margins could turn the profit and loss statement red. This side of the business was not taken care of.
The issue of inter-corporate debt is even trickier. In desperation the government had issued term finance certificates (TFCs) twice, amounting to Rs165 million. Some of the banks have declined government's offer as they didn't find the proposition prudent.
It seems that fearing lukewarm response from the conventional commercial banks, the government now wants to convince those who are looking for Shariah compliant investment opportunities. The only concern of the financial analysts is the fate of Sukuks issued to resolve inter-corporate debt which could be even riskier than those issued by the cement manufacturers.
Demand for energy is on the rise and top line of the players enjoyed growth potential but rising cost of power generation, mounting receivables and efforts to maximise petroleum development levy collection have only ballooned the circular debt. In such a scenario investing in Sukuks for the resolution of inter-corporate debt could prove disastrous. Islamic banks and asset management companies ought to be more careful after cement manufacturers Sukuk tragedy.

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