Critical Issues and Challenges in Islamic Economics pdf

CRITICAL ISSUES AND CHALLENGES IN ISLAMIC ECONOMICS – Book Sample

How Do Sovereign Sukuk Impact on the Economic Growth of Developing Countries? An Analysis of the Infrastructure Sector

1.1 Introduction

The word “sukuk” is plural for “sakk”, which is a certificate of ownership of a given class of assets that a borrower gives to a lender as a proof of ownership (Safari et al. 2014). Being one of the most dynamic products of Islamic finance, sukuk has now become a part of the global financial system. It is used as an instrument of liquidity for financing various projects by governments and corporate entities in many Muslim and non-Muslim countries across the globe.

Iqbal and Khan (2004) contend that build–operate–transfer projects (BOTs) that are based on sukuk structures allow developing economies to meet their liquidity demands without using interest-based financing methods. Furthermore, financing government expenditure through sukuk which are based on real assets keeps public expenditure under control since availability of finance without tangible assets is limited.

Consequently, developing countries can achieve a higher degree of prudence in managing the macroeconomic and microeconomic elements that operate in the economy.

According to Diaw (2011), sukuk have numerous advantages with respect to financing government expenditure on infrastructure projects. For instance, they are expected to improve the solidity of the markets and financial institutions since they are based on tangible assets. This in turn strengthens the connection between the real sector and the financial sector of the economy. Furthermore, typical infrastructure projects require long-term financing methods.

Similarly, sukuk holders also prefer to have a steady and predictable cash flow over a long period of time. I have in this study tried to determine whether there is a difference in several economic, state financial and social well-being indicators before and after the issuance of sovereign sukuk in developing countries. This involved two regional sukuk leaders, namely Malaysia and Saudi Arabia, which served to make a comparison.

The main aim of this research is focused on identifying the impact of sovereign sukuk issuances on the economic development of Malaysia and Saudi Arabia. Additionally, I intend to discover new means for promoting a solid understanding of sovereign sukuk and their role in financing infrastructure projects. In order to achieve these research objectives, the following questions need to be addressed.

1.             Does sovereign sukuk have an impact on the economic development of Malaysia and Saudi Arabia? Objective: develop a hypothesis to test the impact of sovereign sukuk issuances on the economic development of Malaysia and Saudi Arabia.

2.            Is there any difference in the economic, state financial and social well-being indicators of Malaysia before and after the issuance of sovereign sukuk in the infrastructure sector? Objective: measure the differences in the economic, state financial and social well-being indicators of Malay-sia five years before and after the issuance of sovereign sukuk in the infrastructure sector.

3.            Is there any difference in the economic, state financial and social well-being indicators of Saudi Arabia before and after the issuance of sovereign sukuk in the infrastructure sector? Objective: measure the differences in the economic, state financial and social well-being indicators of Saudi Arabia five years before and after the issuance of sovereign sukuk in the infrastructure sector.

1.2 Literature Review

1.2.1 Defining the Concept of Islamic Banking

As the recent global economic crisis caused huge turmoil in the conventional banking and finance industry pioneered by capitalism, a more substantial role for Islamic banking has started to unfold. Islamic banking is a banking system that operates in line with the principles of Islamic law (shariah) and its practical application based on the Qur’an and the teachings of the Prophet Muhammad [peace be upon him] (El Tiby 2011).

As noted by Siddiqi (2006), Islamic banking began to develop as a new economic model in the late 1970s, while the practice of lending on interest created serious problems such as unemployment, poverty and inequality. Although some capitalist observers see contemporary Islamic banking as an application of dogmatic principles in religion, it is indeed one of the most successful models for ethical banking thus far.

Theoretical Underpinnings

The prohibition of interest (riba in Arabic) is the central principle in Islamic banking. It is a critical implication of shariah, creating a fundamental difference between Islamic and conventional banking systems. Technically, the term riba includes all kinds of undeserved income that arises solely on account of the time allowed for the use of money or any other thing of value lent (Ayub 2007).

The rationale behind it is to sustain socio-economic justice by preventing the amassing of wealth in the hands of a few individuals or financial institutions.1 Thus, a predetermined, fixed return earned by the lender without considering the results of the borrower’s endeavour is regarded as an unjust gain.

Yet, one shouldn’t imagine that Islamic banking consists solely of interest-free financing. In addition to the prohibition of interest, it stresses a number of significant factors such as gharar and haram.

As noted by Ikbal (2011), Islamic banking upholds the principles of shariah by eliminating gharar which is defined as uncertainty, hazard or danger caused by a lack of knowledge in relation to the important elements of business contracts (object, price and time of delivery).

Kamali2 states that gharar can be associated with gambling (maysir)as when one of the parties in a contract unfairly devours the property of his counterpart, thus violating the law of equivalence (Paldi 2013). Obvi-ously, any form of gambling is forbidden by shariah.

However, uncertainty or risk cannot be removed completely even from profit and loss sharing transactions. There have been many discussions amongst Islamic jurists concerning different aspects of gharar and whether it would necessarily make transactions invalid in Islamic banks. Al-Bashir (2008) argues that speculative risk-taking in business doesn’t involve the practices of gambling because the collaborators invest their assets and labour to earn profit through trading.3 Also, they use existing information to anticipate price changes that may occur in the future.

Islamic jurists have reached a consensus that gharar is divided into two types: gharar-e- kathir (excessive uncertainty) and gharar qalil (nominal uncertainty). The former makes contracts null and void since it engages in gambling activities including pure speculation which leads to excessive risk and lack of control, while the latter is allowed in certain contracts such as salam (advance purchase) and istisna’a (a manufacturing contract) because of their important need by the people.

It must be emphasized that gharar qalil can be allowed only in circumstances where the benefitof the contract is greater than its harm (Ayub 2007). Apart from the prohibition of riba and gharar, the Islamic banking system adheres to certain investment ethics which disallow Muslims from investing in

enterprises that deal with haram (unlawful) products, including pork, alcohol, pornography and illegal drugs (Elmelki 2009). Furthermore, Islamic mutual funds cannot engage in the contracts associated with indirect interest charges such as repurchase agreements (Hassan 2010).

Key Instruments of Islamic Banking

Over recent decades, Islamic banking institutions have established various interest-free financial products as alternatives to conventional modes of financing. These products are divided into two main categories of Islamic financing methods: profit and loss sharing (PLS) and mark-up transactions (Sramek 2009). The PLS method is based on two purely shariah-compliant contracts, namely mudaraba and mushararka. Mudaraba is a trust-financing contract between a fund provider (rabb al-mal) and an entrepreneur (mudarib) and represents a partnership of capital and labour (Mughal 2010). Under a mudaraba contract, the supplier of capital advances funds to an entrepreneur to be employed on a particular business plan. The profit is then shared between the two parties in a mutually pre-agreed ratio.

In case of business failure, any incurred losses are borne only by the fund provider (Islamic bank) while the entrepreneur loses his time and effort (Mirakhor 2007). Musharaka is a partnership agreement under which two or more parties contribute capital to an enterprise and share its risks and rewards together. It is considered a cornerstone of Islamic financing philosophy.

In musharaka, profits are distributed to all partners on a predetermined basis, whereas the losses are shared according to the ratio of contribution made by each investor (Arshad 2010). It is essential to note that all partners have the right to engage in the management of the project, though they are not obliged to do so. Thus, Islamic banks can supervise the investment management processes (Samad 2010).

Among the mark-up type products, murabaha (sale with profit) and ijara (leasing) are commonly used in Islamic banking. Under a murabaha agreement, the bank purchases an asset on behalf of its client and resells it to him at a mutually agreed price that includes the actual cost of the asset plus a fixed profit margin which is disclosed to the buyer (Chong 2009). The client then makes the payment either in a lump sum or through instalments. In ijara contracts, the bank buys an asset at the request of its