Shariah Compliant Funds Could Boost Brazilian Development
Maalouf Ashford & Talbot
The sixth-largest global economy, Brazil represents a very real opportunity for Islamic finance to spread its wings in a hitherto relatively untapped region, while Shariah compliant finance offers Brazil an exciting source of funding to boost development. Alexandre Lopes discusses the opportunities and challenges involved.
Known for its profit and loss sharing principle, Islamic finance seems to be expanding the global footprint of its funds to countries outside its original market in the Middle East. As this US$1.3 trillion industry sets sail, an untapped huge market in South America is likely to cross its path.
Shariah compliant investors in particular should look to the wealth of opportunities in Brazil: the sixth largest economy in the world, the world’s second-biggest emerging market economy and a member of the BRIC group (fast-growing developing economies) and one of the top 10 countries for foreign investments. On the other side of the coin, Brazil’s development thirst may find some relief in this growing industry.
The expansion of Islamic finance
With an estimated annual growth rate between 15-20%, Islamic finance has flourished amid the political upheavals of the Arab Spring with rapid customer base enlargement and is now set to grow even more with opportunities arising in huge infrastructure projects that are taking place in the MENA region. The issuance of the recent US$2 billion sovereign sukuk in Egypt and the new tax and regulatory frameworks applicable to Islamic banks in Tunisia are signs of the Islamic finance spring.
Considering the global Muslim population, estimated to be 1.6 billion (of which around 200 thousand live in Brazil, also home to 12 million Arab-Brazilians), the future of the industry is promising. However, it is urgent that Islamic finance reconsiders its strategies to expand beyond the Muslim community. In fact I would say that it is vital that Islamic finance continues its swift expansion into non-Islamic financial hubs, as witnessed in London. It has also been claimed that an effort should be made to structure innovative products to satisfy a wide array of global consumers. As the world has changed and the business needs of people have substantially evolved, Shariah compliant products should adapt to such trends and rise to compete for a share in a market that include major infrastructure, shipping and aviation projects.
Islamic finance has been praised for showing some resilience during the credit crunch, mainly due to the fact that Shariah outlaws interest and stipulates that income should be reaped from an underlying real business risk. Being an asset-backed financing, it has proved more stable than its conventional counterparts to the point of being promoted as a safe haven by some experts. Others, who are less optimistic, would not however consider it as fully immune from potential economic risks.
Brazil’s wealth of opportunities
Known for its undisputed natural resources and for being a large democratic nation based on the principle of respect of private property, Brazil managed to survive the global financial crisis relatively unscathed primarily due to its well-diversified economy and fiscal stimulus plans. Now it seems to be ready to grow steadily based on promises made by the government of fiscal restraint, spending cuts and reduced interest rates.
It has been some years since an immense reserve of oil was discovered in the depths of the Brazilian continental shelf, below the pre-salt layer. It is estimated to contain 50 billion barrel reserves of oil, a number that would surpass its current 14 billion barrels. A recent report by state-controlled oil company Petrobras announced that it had reached approximately 300,000 barrels of oil per day in the pre-salt areas of Campos and Santos basins, just seven years after oil was first discovered in the area in 2006. The company has also stated that it aims to triple the current output by 2017.
Aware of the importance of highways, airports and sea ports for its long-term economic growth, Brazil has spent heavily on infrastructure, mainly through the Growth Acceleration Plan (PAC). The program, launched in 2007, has provided a boost to Brazil’s economy and has aimed to attract investments of US$349 billion, through a focus on improving the country’s logistics sector, power segment and its social and urban development. A second phase of this program, known as PAC II, involves investments of up to US$526 billion in areas such as energy, transport and housing from 2011-14, with investments amounting to US$346.4 billion from 2014 onward.
The government has further launched a housing program that consists of building and financing houses for the poor and middle class segment – known as the ‘My House, My Life’ program. Until now only public resources have been allocated to the scheme, yet there may be plenty of room for investments through Shariah compliant mortgages.
The international demand for agricultural commodities has been a key driver for economic growth in Brazil, given its position as the world´s largest exporter of soybeans (41% of world´s exports) and of orange juice (55% of world´s exports). Brazil accounts for 35% of global exports of raw cane and refined sugar, a product that has already attracted attention from Arab investors. Moreover, it is worth noting that Brazil is also a large exporter of Halal meat, which proves its ability to competitively adapt to the Islamic-based market requirements and, thus, its readiness to attract the ‘Halal dollar’. In addition, Brazilian trade with Arab countries reached US$26 billion in 2012, with exports that included sugar worth US$4.24 billion, meat worth US$3.93 billion and ores worth US$2.44 billion.
Another program with great potential is the so–called ‘public and private partnership’ structure (PPP), which is based on joint efforts of government and private business, and works as a financing tool to boost expanding infrastructure needs. In such a partnership, parties agree on the aimed object for at least five and up to 35 years, involving values above US$10 million. The government chooses its partner through a bidding procedure with whom it agrees to share the risks of the project. Under its concessions programs, the government plans to transfer to the private sector 7,500km of highways, 10,000km of railways and 159 ports, to be built and operated. This type of partnership, being mainly used for infrastructure projects, may well fit the Islamic finance asset-backed funding system.
With an inflow that reached US$65.3 billion in 2012, Brazil is certainly hunting for investors. As the country gets ready to host the 2014 World Cup and 2016 Olympic Games, it seems that the best is yet to come, given the perspective of a rising tide of investments.
However, Islamic finance still has a long way to go before it gains a market presence in Brazil. Lack of awareness and prevailing misconceptions regarding the industry are hurdles that still need to be overcome. Inspired by the cooperation agreement signed between the World Bank and INCEIF in 2012, the industry should be committed to educate future leaders in Brazil by collaborating with national institutions of higher learning to develop executive education programs in Islamic finance.
Just as it happened in the past with Malaysia, a legal framework still must be constructed in Brazil to conform to Shariah Islamic financial instruments, in order to guarantee the enforceability of the Shariah compliant contracts and further avoid double taxation that would prevent the industry from competing on equal footing with the conventional finance system. Investors always prefer to put their investments in markets where the jurisdiction is ready to enforce contracts and where the government enables market forces to operate freely.
Given the rise of Islamic finance in non-Muslim countries and the news that the National Bank of Abu Dhabi is opening an office in the country, Brazil must act quickly to make all necessary regulatory and tax reforms designed to facilitate the entrance of Islamic financial institutions in the market, if it wishes to become South America’s Islamic finance hub.
Alexandre Ferreira Lopes is a partner at Maalouf Ashford & Talbot. This article first appeared in Islamic Finance News (3 April 2013, Volume 10, Issue 13, Page 32 - 33). For more information, please visit www.herbertsmithfreehills.com