Infrastructure development plays a pivotal role in driving economic growth, enhancing prosperity, and improving living standards. However, financing these projects poses a significant challenge, particularly in developing economies.

Governments around the world are continuously searching for effective and sustainable funding mechanisms to support such large-scale initiatives. Sukuk, a Shariah-compliant financial instrument, has become an essential tool for financing infrastructure projects, providing substantial benefits to governments, investors, and society at large.

According to S&P, global Sukuk issuance is projected to reach approximately $170 billion in 2024, compared to $168.4bn in 2023 and $179.4bn in 2022.

Pakistan entered the global Sukuk market in 2005 with its first issuance totaling $600 million. Since then, the country has successfully issued Ijarah-based Sukuk worth $4.6bn in international markets, establishing a significant presence. Domestically, Pakistan launched its Sukuk program in 2008, and by August 2024, the government had issued Ijarah Sukuk valued at over Rs6.5 trillion.

As the global Sukuk market expands, governments can effectively utilise Islamic financing to sustainably fund major projects

In 2023, sovereign Sukuk saw record growth, with issuances reaching Rs1.77tr. Currently, the primary focus of sovereign Sukuk is to replace expensive interest-based borrowing as part of the financial system’s conversion and to meet the government’s budgetary needs.

Unlike conventional bonds, Sukuk does not represent an interest-based loan, but it is closer to a share in nature, and it generally represents ownership of an asset or an investment activity. With the concepts of ownership risk or risk sharing, Sukuk holders are entitled to economic returns in terms of rental income or profits derived from the underlying business activity.

The asset-backed nature of Sukuk can play a crucial role in driving real economic growth and supporting infrastructure development. By financing projects like dams, airports, solar parks, technology parks, railway tracks, and hospitals, Sukuk can offer secure funding for essential ventures.

This form of financing not only attracts investment in infrastructure development but can also be made accessible to retail investors through the Pakistan Stock Exchange, thereby promoting financial inclusion and advancing the Islamic capital market.

Initiatives such as Green Sukuk and Sustainable Development Goals align Sukuk with global sustainability efforts and socially responsible investments. By leveraging innovative Sukuk structures, the government can effectively meet its infrastructure development needs, fostering economic growth and job creation, all while adhering to Islamic principles.

Effectively utilising Sukuk as a funding tool for strategic infrastructure development unlocks numerous economic benefits for society, such as creating employment, stimulating economic activity, driving growth and prosperity, improving connectivity, making the movement of goods, services, and people more efficient, and finally, enhancing living standards by providing access to essential services like electricity, water, and transportation.

There are numerous global examples where Sukuk have been utilised to finance infrastructure projects generating significant value for the economy.

In 2018, Indonesia issued a $1.25bn Green Sukuk to fund renewable energy projects, including geothermal and solar power plants. Similarly, in 2019, Turkey issued a $300m Green Sukuk to finance the construction of a wind power plant.

In 2020, Malaysia issued a $1.3bn Green Sukuk to fund sustainable infrastructure projects, such as green buildings, energy-efficient structures, and sustainable water management systems. That same year, Saudi Arabia issued a $1.5bn environmental, social and governance Sukuk to finance the construction of a water desalination plant, advancing water conservation and sustainable development.

Domestically, in 2016, Neelum Jhelum Hydropower Company (Private) Limited issued a 10-year Sukuk valued at Rs100bn to fund the Neelum Jhelum Hydropower project.

The preference for Sukuk in infrastructure development is also driven by how it adheres to Islamic finance guidelines, prohibiting interest (riba) and requiring investments to be backed by tangible assets. This alignment appeals to a wider range of investors, particularly those seeking ethical investment opportunities.

Furthermore, Sukuk appeals to both Islamic and conventional investors, expanding the investor base and increasing the pool of available capital. This broader interest can result in lower financing costs and better funding conditions for infrastructure projects. Moreover, the global rise of Islamic finance allows Sukuk to attract international investors, further boosting capital availability.

A notable feature of Sukuk is its risk-sharing nature. Investors share both the risks and rewards of the underlying assets, fostering more prudent and responsible project management, as both the issuer and investors are invested in the project’s success. The asset-backed nature of Sukuk also ensures that funds are allocated to specific, tangible projects, enhancing transparency and reducing the risk of misallocation.

Sukuk has become an essential tool for financing infrastructure development, especially for government-funded projects. The different types of Sukuk — Ijarah, Mudarabah, Musharakah, Istisna, and Wakalah — offer flexible and effective financing options tailored to the unique needs of infrastructure projects. By utilising Sukuk, governments can foster sustainable and inclusive economic growth while ensuring transparency and accountability in fund allocation.

As the global Sukuk market expands, policymakers, governments, and investors must tap into its potential to unlock economic growth and prosperity for future generations.

The writer is Director IBA Centre of Excellence in Islamic Finance.

Email: aasiddiqui@iba.edu.pk

Published in Dawn, The Business and Finance Weekly, September 9th, 2024