The Federal Finance Minister, Muhammad Ishaq Dar, is good at numbers. He can certainly impress the audience comprising bankers and fund managers with his pep talk about Pakistan’s economy and its future prospects. But the decisions to participate in a bond offering by investors is based on incontrovertible data; painstakingly researched but based on their risk perception about the ability of the issuer to pay back the principal along with profit to bond holders. These investors are also well aware of the commitments of the underwriters called lead managers (two in case of Pakistani Sukuk) and the participants in the book building exercise making the offer that have two portions. One portion is the serious amount they would buy and second the speculative amount, which is not a serious offer – that they know which they will not get. It is always a judgement call on the part of the offering party as well as the accepting party.
We are being told with lot of glee that the sukuk issue was five times oversubscribed. Had we indicated a higher rate it might have been ten times oversubscribed. So, what is more important in such issues is the rate of return or profit. Rate is where the pain is – everything else is illusive!
We therefore need to see the borrowed amount from a reserve management perspective. With no professional debt management manager around all cases of future debt rejection or acceptance end at the desk of the Finance minister. With five-year Pakistan Investment Bonds (PIBs) trading at 10.80 percent on the secondary market inclusive of rupee depreciation by an average amount of five percent per year or more in last five years. Similarly, the newly-placed five-year sukuk giving 6.75 percent fixed return equates to 11.75 percent per year for the issuer of bonds. So the servicing of the dollar sukuk to the country is more than an equivalent tenor rupee-based PIB, before the last discount rate cut but less than the 5-year PIB rate before the SBP policy rate cut.
However, one needs to look at the sukuk issue from other angles as well. There is indeed diversification of our total debt of Rs 15 trillion from domestic to dollar-based debt. By accepting a billion dollars, Pakistan is now closer to its Net Foreign Assets (NFA) target provided to the International Monetary Fund, ie, net Foreign Exchange reserves. With oil prices weakening along with inflation- there is further space for a significant reduction in SBP’s policy rate. Dollar rates are going to stay at close to one percent for a considerable period. CPI in December may be as low as 4 percent. The pressure on balance of payment (BoP) position may be ebbing due to a dramatic fall in oil prices. As such, targets need to be revised with the Fund staff.
The settlement date for the sukuk issue is December 3, 2014. However, it has already started trading on the secondary market at 50 basis point premium. One way to look at it is that Pakistan has paid 50 bps more and should have priced its sukuk bond at 6.25 percent. But had the investors not seen an upside, they would not be interested in an issue from a country that has been absent from the global fixed income market for nearly a decade. There will always be arguments for and against future borrowing. There is nothing wrong with borrowing if the money is spent on projects which can earn and pay back the loan from its cash flow; meeting current expenditure from borrowed money, ie, loans, needs to be avoided. Second, Pakistan needs to maintain forex reserves equivalent to three months of imports to give comfort to lenders.
There is a dearth of sovereign sukuks and the supply is larger than the demand. The five-year mid-point swap works out to 7.19 percent, ie, the benchmark for five-year Sukuk. The UK Sukuk had a 1.9 percent coupon and is trading at 150 basis points bps premium. Going for offshore sukuk was indeed a correct option; timing was right. But, what Pakistan pays is dependent on the credit rating of its paper by the rating agencies. Moody’s rated CAA1 while S&P rated Pak Sukuk as B minus – equivalent to Pakistan country rating. Business Recorder was critical of government taking two billion dollars in the Eurobonds and had advocated that the government needed to take 500 million dollars as per its target. Had it done so, it could have entered the market again and may have received the additional amount at a lower rate. We do understand that the dollar interest rate will eventually go up but not in the near term. In a bond market, the rate is more important than the amount; therefore, tighter the rate better are the country’s future repayments. Liquidity plays a very important role in determining the rate. The Sukuk market, at present, is flush with liquidity. The underlying asset, ie, the motorway between Lahore and Islamabad has been valued at Rs 200 to 250 billion equivalent 2 to 2.5 billion dollars. Pakistan could have borrowed more. But eventually it would need to service the debt along with repayment of principal. This is where all the factors need to be taken into account – when a decision is taken. A right decision has been taken. Prime Minister Nawaz Sharif’s congratulatory message from Kathmandu to Finance Minister Dar shows that government is happy with the outcome. Now we should let posterity determine the consequences. However, we do need to stress once again that the Finance minister should devote more time to his core function. That is only possible if he frees himself from all other extraneous engagements. The fact that Pakistan Sukuk is trading on the secondary market at a premium is a clear evidence of the market’s hunger for Pak Islamic paper. This is good augury for the country.