Structured properly, infrastructure projects can avail of the vast amount of wealth that nations in the Islamic world have at their disposal. Islamic finance offers a wide variety of products, including project financing products and the ability to issue sukuk (Islamic bonds) for large infrastructure projects, and is flexible enough to be utilized on a stand-alone basis or as a complement to conventional project financing for the funding of large-scale infrastructure development.
Turkey is ideally positioned to play the role of regional hub for Islamic infrastructure investing and promotion in the region. İstanbul has the potential to become an important center for gathering the financial resources of the region and redirecting them to these regions. İstanbul becoming a regional and global financial center would contribute considerably to increased employment and increased inflow of international funds into Turkey, and to economic growth.
At first glance, the term “Islamic finance” may raise eyebrows among some secular Muslims and non-Muslims alike. However, our discussion of Islamic finance at the British House of Commons last month confirmed that Islamic finance is no longer viewed as merely a faith-based financial system. To the contrary, it is becoming a global phenomenon, appealing to the broader public independently of its religious origins.
While conventional finance facilitates the flow of capital to investment opportunities that provide the highest return in the marketplace, Islamic finance governs investments with the underlying altruistic rationale of producing the optimal socio-economic outcome in line with Islamic norms. Some notable characteristics include its avoidance of “riba,” interest‐based lending or usury, and “gharar,” speculation or uncertainty.
It also has a special focus on halal, or religiously permissible activity, such as observing dietary restrictions on alcohol, tobacco and pork, as well as other ethical and religious goals. The reason for these distinctions involves Islam's preoccupation with creating a “moral economy,” where profits from commerce are generally seen as more favorable in comparison with profits from money‐lending or speculation, which are considered “sinful” or “undesirable” because of potential negative social consequences.
Indeed, the recent crises in the conventional financial world have given rise to the widespread recognition of Islamic finance, coupled with renewed demand for private sources of capital in the form of “old money” in the West, petrodollars and nouveau-riche and sovereign wealth funds in growing economies. Given the trust deficit in the conventional financial world, these private sources of capital are understandably very careful in their investment preferences.
Instead of chasing “mirages in the desert” for unrealistic returns, they are increasingly seeking viable returns through investments in revenue-generating assets, preferably real assets on the ground that cannot vanish or substantially devalue overnight. Private sources of capital are therefore increasingly looking to invest in sound and sustainable projects, especially infrastructure projects.
With its focus on social impact and long-term sustainability, and at a time when the dysfunction of the current world financial system is so deep that the classic recipes do not work, many believe that Islamic financial principles are an antidote to some of the root causes of the global financial crises, such as greed and speculation, creating an illusion of wealth far removed from real economic growth.
This has even prompted the Vatican to suggest using the Islamic finance and banking system to the Western financial world, which actually is not that surprising given the common origins of the Jewish, Christian and Islamic traditions' prohibition of interest and economic exploitation.
Making Shariah-compliant finance operate in secular societies
The challenge in making Islamic finance work in secular societies would be to create a system that would be “consistent with religious precepts” and “viable in the modern global economy” through a process of ijtihad, loosely defined as the careful reflection and effort used in interpreting Islamic texts.
The modern history of Islamic finance is often dated to the 1970s, with the launch of Islamic banks in Saudi Arabia and the United Arab Emirates. However, its roots stretch back 14 centuries. Islamic finance rests on the application of Islamic law, or Shariah, the primary sources of which are the Quran and the sayings of the Prophet Muhammad. Shariah emphasizes justice and partnership. In the world of finance, that translates into a ban on speculation (gharar) and the charging of interest (riba).
Companies that operate in unethical industries, such as gambling or pornography, are also out of bounds, as are companies that do too much borrowing (typically defined as having debt totaling more than 33 percent of the firm's stock-market value). Such criteria mean that Shariah-compliant investors steer clear of highly leveraged conventional banks, a wise choice in recent years.
There will always be a problem of how one can interpret “Shariah compliance,” particularly in a modern economy and secular society where civil code prevails. The fact that there is no ultimate authority for Shariah compliance may hold the industry back.
Malaysia has tackled this by creating a national Shariah board. Some industry bodies, notably the Accounting and Auditing Organization for Islamic Financial Institutions in Bahrain, are working towards common standards. That a few scholars dominate the boards of the big international institutions also helps create consistency. However, differences between national jurisdictions -- between Saudi Arabia and more liberal Malaysia, say -- are likely to remain.
Islamic finance as development finance
Perhaps the area where Islamic finance has the most potential to be a game-changer is the funding of infrastructure development, especially in dynamic emerging economies like Turkey that are seeking to keep up with ever increasing demand from increasing populations with affluent middle classes.
Infrastructure deficit across emerging markets is acute. The Asian Development Bank (ADB) estimates that emerging Asian economies alone will require $8 trillion over the next decade to satisfy growing demand in the areas of energy, water and transportation, and World Bank figures suggest that only about 50 percent of infrastructure demands are being met annually across emerging countries.
Each emerging economy or economic zone is grappling with this challenge in its own way. Association of Southeast Asian Nations (ASEAN) countries, while encouraging resource mobilization through pensions funds and infrastructure-backed public bonds, have set up a $4 billion fund for major infrastructure financing that is expected to grow to $13 billion with potential co-financing by the ADB.
Although the search for a “magic bullet” solution will go on, the solution may require many different components and new alternatives to conventional sources of funding in emerging and developed countries alike.
Today's investors seek to invest in sound and sustainable projects, especially revenue-generating infrastructure projects, preferably within a framework that minimizes their recent concerns regarding speculative activities, excessive leverage, a lack of transparency, unsatisfactory and corporate governance, and a lack of social responsibility. Islamic finance is viewed as one such framework and a possible alternative mechanism for resource mobilization and targeted deployment.
Indeed, we believe that the asset-backing nature of Islamic financing may make it more suitable for infrastructure projects than traditional lenders, such as banks. What is more, sukuk investors typically have an appetite for longer tenures than bank loans, and prefer stable and predictable cash flow -- traits that are typically associated with infrastructure projects. Sukuk have economic characteristics similar to conventional bonds but, in theory, are always required to be asset-backed.
Such potential for Islamic finance is not lost on many global financial institutions. The World Bank has formally recognized Islamic finance and has designated it a priority area in their financial sector program. Governments, too, are increasingly realizing the potential for Islamic finance as a key tool to bridge their development funding deficits. The Gulf States, awash with liquidity and with a roster of huge infrastructure projects to finance, are the most dynamic markets. Britain is the most developed Western center, although France, with a much larger Muslim population, wants to close the gap.
The British government has set up a high-powered, ministerial-level Islamic Finance Task Force “to re-energise the industry and raise its profile … review international markets to target Shari'ah compliant finance and investment into the UK … [and] encourage Shari'ah compliant funds to invest in sectors and areas that will support jobs and growth. For example: infrastructure investment and credit for business start-ups and SMEs [small and medium-size enterprises].”
Governments that recognize the potential for Islamic finance as a development finance mechanism have been quick to make regulatory changes, especially to help promote diverse and liquid markets for sukuk, an essential tool in the Islamic finance industry that can help with liquidity, asset management and asset price benchmarking for Islamic financial institutions.
Governments around the world have supported Islamic financial institutions in their respective countries through sovereign sukuk issuances to lend credibility to this growing industry and to harness its potential as an alternative source of raising capital. Interestingly, the sukuk mechanism was used for the first time in Europe by the federal state of Saxony-Anhalt in Germany in 2004 as a sub-sovereign bond issuance under Islamic principles that did not offer interest payments but instead provided the bond's investors a return equal to Euribor rates.
Malaysia hosts the world's biggest market for sukuk, while Saudi Arabia boasts the world's biggest share of Shariah-compliant assets. Sukuk are spreading rapidly in West Asia and parts of Africa, where the population is predominantly Muslim. Global banks, including HSBC and Standard Chartered, have set up Islamic banking units to take advantage of growing demand for financial products that comply with the religion's ban on interest.
Sukuk sales in 2012 surged to $46 billion globally, more than double the 2010 volume. Sukuk sales in 2013 are to exceed $60 billion, with sales in the six-nation Gulf Cooperation Council alone expected to increase to between $30 billion and $35 billion, a 64 percent jump from 2012.
As the 16th largest economy in the world; a member of the Organization for Economic Co-operation and Development (OECD); a member of the Organization of Islamic Cooperation (OIC); the biggest economy from eastern Europe to China to the Middle East, excluding Russia; and with its strategic location between Eurasia, the Middle East and Africa, Turkey is ideally positioned to play the role of regional hub for Islamic infrastructure investing and promotion in the region.
Islamic finance in Turkey is a more recent phenomenon. Participation banking, a moniker for financial practices structured in accordance with Islamic law, has not traditionally made up a large segment of Turkey's finance sector. The state bureaucracy and military routinely resisted Islamic influence in business and finance. Participation banking has grown in recent years because of more permissible public attitudes, decreased trust in the conventional banking sector after the financial crises in 2001 and 2008, and the desire to attract capital from the Gulf region.
Turkey is regarded as the most promising market for Islamic finance, with a young and dynamic population; qualified labor force; developed financial markets; diversity of financial products, services and practices; and a strong regulatory framework in the financial sector.
Turkey's growing economic ties with the Middle East and Pacific Rim will be an advantage. However, like Malaysia, Turkey will need a regulatory framework that allows Islamic financing to play on a level playing field alongside conventional financing. With a robust Islamic bond market, Turkey could provide the advice and technical know-how to companies embarking on infrastructure projects throughout the region, helping with resource mobilization and effective deployment for essential infrastructure development within and around Turkey.
The İstanbul Stock Exchange (İMKB) is expected to emerge as a key regional bourse for listing Islamic securities and is already developing a product to handle the liquidity needs of Islamic funds.
The Turkish government has already taken several steps towards creating a regulatory framework conducive to Islamic finance, including facilitating sukuk issuances. It received a well-deserved pat on the back recently when a study sponsored by the Qatar Financial Centre Authority in partnership with the International Tax and Investment Center, based in Washington, D.C., concluded that “Turkey and the Qatar Financial Centre (QFC) have the most Islamic Finance friendly tax systems out of eight countries in the MENA [Middle East and North Africa] region.” The study observed that “of the countries reviewed only Turkey and the QFC have a tax system that enables sukuk transactions to be carried out without excessive tax costs.”
The Turkish government also issued a $1.5 billion sovereign sukuk in October of 2012 that was 200 percent oversubscribed, raising expectations for a “sukuk wave” given the “tremendous amount of interest among issuers to look at sukuk,” as one analyst put it.
There are good reasons, free of ideological or religious concerns, to argue that the growing enthusiasm for Islamic finance could be translated into a viable business proposition in Turkey and its surrounding region to complement conventional financing vehicles.
Given the direction of the ongoing transitions in the world financial system (and in the Islamic world), it is reasonable to say that Islamic finance may gain additional footholds throughout the region. While the extent to which Islamic finance will affect policy issues in Turkey has yet to be determined, it will clearly take on greater significance for economic development -- particularly in financing its massive energy and infrastructure projects -- in a greatly more interconnected region.
*Mehmet Öğütçü is chairman of the UK-based Global Resources Corporation. An internationally recognized authority on energy, investment, finance and geopolitics over the past 30 years, Öğütçü has worked with a particular geographic focus on Europe, Central Asia, Russia, the Middle East and China for most of his career as a diplomat, International Energy Agency (IEA) and OECD executive and businessman/investor. [email protected]
**Fazl Syed is senior advisor to Global Resources Corporation.