Sukuk Bonds

What Are Sukuk Bonds?

Sukuk bonds are a unique way for countries and companies to raise funds while adhering to Islamic principles. Think of them as the Islamic equivalent of regular bonds, but with a key difference: Sukuk avoids practices that go against Islamic law, such as charging interest (riba). Instead of earning interest, Sukuk bondholders get a share in the profits from the assets or projects they’ve invested in.

How Does Sukuk Work?

Imagine you and a group of people are investing in the construction of a shopping mall. Instead of lending money and charging interest, you pool your money to actually own part of the mall. As the mall generates income by renting out its shops, you receive a share of the rental profits. Sukuk works in a similar way. When you buy a Sukuk, you’re investing in real-world projects or assets—such as a building, a highway, or even a business—and earn profits based on how well the investment performs.

How Sukuk is Different from Regular Bonds

1. No Interest: Unlike regular bonds where investors receive interest on the money they lend, Sukuk bonds provide investors with a share of the profit, in line with Islamic principles that prohibit earning interest.
2. Linked to Real Assets: When you invest in Sukuk, your money is tied to a tangible asset like a building or infrastructure. This ensures that your investment has a specific purpose and is backed by something real.
3. Sharia-Compliant: Sukuk must follow Islamic law, meaning they avoid involvement in unethical activities such as gambling, alcohol, tobacco, or excessive risk-taking.

Types of Sukuk Bonds

1. Murabaha Sukuk: In this structure, the issuer buys an asset and sells it to the Sukuk holders at a markup. The markup represents the profit, which is then distributed to the Sukuk holders over time. This structure is often used for financing trade transactions.
2. Ijarah Sukuk: This type works like a lease. The issuer leases an asset, such as a property or equipment, to the Sukuk holders, who in turn receive rental payments. These payments are a mix of profit and repayment of the principal, much like a traditional lease arrangement.
3. Istisna Sukuk: These are used to finance the construction of a new project, such as a factory or infrastructure. The issuer agrees to build the asset for the Sukuk holders, who fund the project in stages. Once completed, the asset is transferred to the investors.

Real-Life Example: Maldives’ Sukuk Bond

In April 2021, the Maldives issued its first Sukuk bond, raising $500 million. This move helped the country tap into Islamic finance to fund major government projects, particularly in infrastructure. The bond came with semi-annual coupon payments and was set to mature in 2026.

However, by 2024, the Maldives faced the risk of defaulting on this bond due to rising external debt and declining foreign reserves. As a country heavily reliant on tourism, the global inflation and high commodity prices severely affected the Maldives’ economy, making it difficult to meet its debt obligations. A crucial payment of $25 million was due in October 2024, and missing this would have made the Maldives the first country to default on a Sukuk bond.

India’s Role in Helping Maldives

India stepped in to prevent this default by providing critical financial assistance:

1. Bond Subscription: India subscribed to $50 million worth of Maldivian bonds through the State Bank of India, giving the Maldives immediate liquidity.
2. Currency Swap Agreement: India arranged a $400 million currency swap between the Maldives Monetary Authority and the Reserve Bank of India (RBI). This allowed the Maldives to access Indian rupees, easing the pressure on its foreign exchange reserves and enabling it to meet its Sukuk payment deadlines.

Currency Swap Agreement: Key Details

1. US Dollar/Euro Swap:
   • Amount: $400 million
   • Purpose: Short-term liquidity in US dollars or euros to meet financial obligations.
   • Validity: Until June 2027.
2. INR Swap:
   • Amount: ₹30 billion (approximately $357 million)
   • Purpose: To provide Indian rupees for domestic needs.
   • Validity: Until June 2027.

How the Currency Swap Works?

1. Request: Maldives can request a swap of US dollars, euros, or Indian rupees from the RBI when needed.
2. Provision: RBI provides the required currency from its reserves.
3. Repayment: Maldives must repay the swapped amount by the validity date, along with a predetermined interest rate.