Islamic Finance to Reduce Fiscal Deficit in India – II

Besides evaluating fall in annual growth rate of Gross Domestic Product (GDP) from 9.0% in 2007-08 to 6.7% in 2008-09, it would also be important to analyse the growth trend for different industries during the last year. The Manufacturing Industry employing majority of non-agricultural workers observed deepest fall where annual growth rate fell to 2.4% in 2008-09 compared to 8.2% in 2007-08. Similarly the annual growth rate of agriculture, forestry and fishing fell to 1.6% in 2008-09 against 4.9% a year ago.

However the increase in annual growth rate for Community, Social and Personal services has remarkably increased to 13.1% in 2008-09 as compared to 6.8% in 2007-08 reflecting the impact of increased expenditures by the Government by financing schemes like NREGS.  But it would be important to notice that such expenses have not only increased the fiscal deficit beyond estimated budget for 2009-10, only 9% Indian workforce engaged in Community, Social, and Personal services expected to be benefited through it.

Thus the excess flow of subsidised bank credits to GoI for financing deficit budget is ultimately restraining the economic growth.

FEARING FOR EVEN HIGHER FISCAL DEFICIT?

To reduce the fiscal deficit, it is simple to either cut the expenses or increase the revenues. But under present conditions, it is not possible either to increase the revenue receipts or to cut the expenditures because any increase in taxation will be disastrous at a time when recession has hit the business community and are already demanding for more stimuli to recover. When there is mounting pressure to increase the stimuli, the expenditure is supposed to increase further. Moreover the political promises (to provide subsidised foods and increase flagship programme expenses) by the new Parliamentarians before the election would also increase the plan expenditures. It all increases the possibility of any further increase in the current fiscal deficit.

WHAT THE GOVERNMENT SHOULD DO NOW?

Considering the constraints to increase the revenue receipts and cut the plan expenditures to control fiscal deficit, the GoI needs to innovate new products for public finance. As almost 60% of total expenditures are made for debt servicing, GoI needs to substitute the debt receipts with equity funds. Since SEBI failed to protect the stock markets and NBFCs dealing in MFs and VCs are not in a position to mobilise huge long term investment funds, GoI needs to innovate Sovereign equities to mobilise adequate amount of non debt receipts for consolidation of public finance.

Considering the available options of capital sources in international market, there are chances to get Islamic funds instead of mere equity funds from the Muslim countries. The equity funds are somehow different from Islamic Funds in the manner that when equity funds are mixed with debt funds, it doesn’t remain Islamic Funds.

Islamic economist Dr. Shariq Nisar in his paper ‘Islamic Bonds (Sukuk): Its Introduction and Application’ writes that the recent innovations in Islamic Finance have changed the dynamics of the Islamic finance industry. Especially in the area of bonds and securities the use of Sukuk or Islamic securities has become increasingly popular in the last few years, both as a means of raising government finance through sovereign issues, and as a way of companies obtaining funding through the offer of corporate Sukuk. Beginning modestly in 2000 with total 3 Sukuk worth $336 millions the total number of Sukuk by the end of 2007 reached to 244 with over US$ 75 billion funds under management. Dr. Shariq summarises the growth of Sukuk in the following Table:

Recent studies about Sukuk at http://online.wsj.com/ indicates that although the Sukuk market has managed recently to come back modestly, but only for higher corporate issuers. IFIS data show that so far this year, more than $7.6 billion of Sukuk have been issued. Almost all this year’s fund-raisers have been governments or government-related, the overwhelming majority from Southeast Asian countries such as Indonesia. The Middle Eastern market that drove the pre-2007 boom has also sprung into life this month with a $500 million issue for the government of Bahrain, which was boosted to $750 million because of strong demand. Thus there is no harm if GoI study the feasibility of innovating Islamic products to consolidate public finance in India.

SCOPE OF ISLAMIC BOND IN INDIA

Since India houses second largest Muslim population of the world, it is expected that at least 20% Indian Muslims who are economically better off and desperately looking for real Islamic investments would grab it with enthusiasm. Unfortunately so far India has yet to launch any real Islamic bond or Mutual fund because somehow all the so-called ethical mutual fund have been mixing equity funds with debts.

Moreover unofficial sources indicate that considering the higher growth rate of India, some larger Islamic banks and financial institutions like Islamic Development Bank, Dubai Islamic Bank and others desire to invest in Indian infrastructure but do not find suitable opportunities. So, we find the scope to study the prospects of Islamic Bond (Sukuk) from GoI to finance infrastructures.

Sector-wise Projected Investment for the 11th Plan

(Rs crore at 2006–07 prices)

Data Source: http://planningcommission.nic.in/

Fiscal deficits can be reduced by the Sukuk funds:

Since returns to Sukuk holders comes from the actual returns from the project, there is no chance of any interest burden on the economy. In case there is any loss in the specified project that will also be duly shared by the Sukuk holders. Thus Sukuk finance negates any possibility of interest burden on the economy and removes the chances of fiscal deficit due to interest payments on borrowed debts to finance infrastructural needs of the economy.

We have higher revenue expenditures due to higher debt servicing ratio total expenditure. The problem is also that capital expenditure is much behind the target, and growth rate can’t foster if we lack infrastructure. Thus while we need to stimulate the economy, it is better to introduce Sukuk by Indian Government as it would not only help building infrastructure, increase capital expenses and stimulate the economy, but also reduce the revenue deficits, debt servicing ratio and also revenue deficits.

Financing the deficit through more of subsidised bank loans is creating problems for the banks to reduce lending rates for private sectors; as a result the private sectors are getting lower amount of credits at higher costs. Besides the recent global recession, this hardening credit supply is adversely affecting the growth rate of agriculture and manufacturing industry by witnessing negative growth rates during the last six months.  Thus deficit finance is not helping majority of Indian workforce as agriculture and manufacturing collectively provide livelihood for around 63% workers. So, to ensure foster and inclusive growth by way of providing sufficient and affordable credits for private sector, the increased flow of subsidised bank loans to GoI should be reduced otherwise private sector will continue to suffer and we may not be able to attain desirable growth rate even by increasing the fiscal deficits to stimulate the economy.

Since Sukuk is bounded with religious faith, the economic rationality is secondary aspect in decision making by the investors. The top priorities for Sukuk holders are to ensure that –

The returns are Halal (legal according to Islamic ethics) and investments will be used for building potential infrastructures for national development, thus the investments and returns may draw tax incentives as well which may stand as compensation against lower rate of returns.

The investments are meant for legal share (proportionate ownership) in the infrastructure.

There would not be any fraud or cheating by the fund managers and the investments would not be spent for promoting unethical and unlawful activities (as prohibited by Islamic ethics).

The investments will be in safe hands to carefully develop the assets and not manipulate it.

Even if the rate of returns is low as compared to market returns on other investments, the advantage of earning Halal income, tax incentives on investments upon national infrastructure would be some compensatory advantages to the Sukuk holders.

Since all sorts of returns on Sukuk are free from interest and do not exceed the actual asset value, whatever is paid as returns to Sukuk holders is to pay from the actual earnings from the asset created by that particular investment. There is no need to borrow any debt to pay Sukuk returns or repay the whole Sukuk funds because all the Sukuk holders collectively own the asset. They will thus proportionately gain or lose according to appreciation or decline in the value of that particular asset.

Indian Institute of Islamic Infrastructure Funds (IIIIF): It is desirable that the GoI set an autonomous financial corporation as ‘Indian Institute of Islamic Infrastructure Funds’ (IIIIF) to grab the national and international market of Shar’iah Funds and mobilise adequate funds for the infrastructural investments in India. If IIIIF succeeds soliciting cooperation with leading Islamic investment and development banks around the world, hopefully we may not need debt based receipts for deficit finance especially to meet the infrastructural requirements in India. The services of such banks may be solicited through GoI securities with assured lease rent after completion of particular infrastructure projects. Once India manages to mobilise project based Islamic Infrastructure funds, with such funds specific borrowed debts may be repaid to reduce the debt burdens.

Based on the projection by the Planning Commission of India, the estimated requirements of infrastructure investment is Rs. 20,56,150 crore. Considering the commercial aspects of different sectors, it is expected that IIIIF may help us arrange 93% of the total requirements amounting Rs. 19,12,420 crore for 11^th five-year plan’s infrastructural needs. Only the investment need of water supply and sanitation amounting Rs. 1,43,730 may not be sellable otherwise infrastructure projects of all other sectors seem sellable through equity based Government securities by IIIIF upon which any specific amount as % of investment could be assured as returns in terms of lease rents after completion of the projects.

IIIIF along with RBI and Ministry of Finance may design such equity based Government Securities (Sukuk). Further such securities may be traded in open market as RBI has recently framed policy for stripping and reconstitution of Government securities to enhance the trading scope of securities. However for Sukuk, there could be assured lease rent or dividend as rate of returns instead of interest.

Sukuk may help India raise required infrastructure investment funds for the Government and the corporate sector. It may solve the most threatening challenge of our economy by providing equity funds for infrastructure against Government Securities enabling GoI reduce its fiscal deficit after repaying borrowed debts for capital expenditures through equity funds; and also by arranging equities for the corporate sector. Wish the proposed IIIIF may reduce the fiscal deficit allowing India attain foster and inclusive growth as it carries following promising features –

Reduce the fiscal deficit of India even if our revenue receipts decline and we need to increase the plan capital expenditures to stimulate the economy.

Help India save amount up to 6% of our GDP we pay as interest over debt receipts.

Enable GoI to repay debt receipts borrowed for financing the infrastructure investments.

Provide desirable equity fund for the corporate sector at a time when external financial resources are dried up and the cost of domestic bank credits is not affordable.

Once GoI succeeds arranging sufficient infrastructure funds through Sukuk and repays debts borrowed for capital expenditures, it would reduce the load of public finance on domestic banks thus enabling them to reduce the cost on credits specified under PSA or for private sector enterprises.

There could be many more significances of IIIIF if we resolve it without any prejudice for the sake of national interest. (Concluded)

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