After many years of opposing the idea, the Reserve Bank of India (RBI) has written to the Indian government requesting that it amend laws forbidding Islamic banking in India. Central bank governor Duvvuri Subbarao told reporters at a local event on October 3 that the RBI is in talks with the government about whether or not to allow shari’ah-, or Islamic law-compliant finance.
In June, the National Commission for Minorities (NCM) spoke up in favour of introducing such financing by submitting a proposal to permit interest-free banking. Following this, the finance ministry asked the RBI to reconsider the matter. Until this point, India’s central bank had insisted that Islamic banking was not viable in the country.
Such insistences had come despite the fact that India boasts the world’s third largest Muslim population. The country is home to 180 million Muslims, equivalent to 10.9% of the global Islamic population, only behind Indonesia (with 12.7%) and Pakistan (with 11.0%).
All-told about 13.4% of Indians follow Islam and, according to some estimates, around half of them choose to keep their savings at home. If deployed, these combined savings would be large enough to provide a big boost to the financial system.
But there are still sizeable issues preventing the creation of Islamic banking in India. The country’s banking system is not entirely free from political issues, and a decision to introduce preferential facilities such as interest-free loans on the basis of religion could be politically sensitive.
That’s led many experts to conclude that implementing a nationwide grassroots Islamic banking system would be more trouble than it’s worth, particularly at such a turbulent time in India’s financial history.
However, the hype surrounding the development of Islamic finance in Asia is intensifying. And the introduction of Islamic banking could potentially give Indian lenders access to capital from regions such as the Middle East. That would only be positive for the country’s banks and corporations.
Some Indian observers believe that these arguments are beginning to resonate with the country’s authorities. One head of India research who has spoken with the finance ministry and RBI told Asiamoney PLUS that he believes the two look likely to change the legislation, allowing Indian companies to issue Islamic instruments offshore.
Allowing offshore issuance of Islamic instruments such as sukuk, or Islamic-compliant bonds, is a sensible experiment. Doing so would reduce the risk of inciting any political backlash. In addition the potential inflows into the Indian economy from doing so would likely be higher than if the central bank decided instead to implement Islamic microfinance in the country.
Equally, allowing corporations to issue sukuk offshore but not onshore would allow the RBI to avoid having to offer tax incentives, another political landmine in India. Many of India’s banks have reached their lending limits and will likely be asking for governmental support over the next few years. As such, the government is unlikely to be in any position to introduce sukuk tax incentives.
Tapping the international market
According to the head of India research, the first borrowers to take advantage of a change in offshore finance legislation would likely be the overseas subsidiaries of Indian banks, followed by the country’s airlines, which would use external commercial banks as bookrunners.
He believes the most likely destination for a debut Indian offshore sukuk would be the Middle East, due in part to its sizeable Indian diaspora as well as the region’s growing wealth. But an Indian Islamic bond could feasibly generate demand elsewhere in Asia, especially in Malaysia, which is already a thriving and well-developed Islamic finance hub.
The facilitation of offshore sukuk could also offer another route for much-needed infrastructure funding. The principles of Islamic law are a good fit with infrastructure investments, as has been well documented in the case of Indonesia and issuing a sukuk deal would naturally offer a borrower a broader investor base than with a vanilla bond issue.
In addition, the sukuk market is able to offer longer-term funding than banks can, and the fact that India has such a large Muslim population can only aid its bid for Middle Eastern capital.
It wouldn’t exactly be detrimental to India to nurture business relations with the region either, particularly given the volatility of global energy prices as well as the abundance of fuel resources in the Middle East.
The only possible downside to this is the fact that five-year tenors tend to be favoured by Islamic investors, despite a 10-year Malaysian sukuk and a seven-year Islamic deal from the Indonesian sovereign. If India is to truly help plug its infrastructure needs with sukuks, it will need to convince international investors to take longer tenors.