Download Stabilizing Economic Growth Through Risk Sharing Macro Instruments

STABILIZING
ECONOMIC
GROWTH
THROUGH
RISK
SHARING
MACRO
INSTRUMENTS
INTRODUCTION
Islamic finance assets are estimated to be $1.6 trillion, and is expected to grow at
the rate of 15% over the next few years.
Despite this impressive record, Islamic finance only accounts for 1% of the global
financial system.
A study revealed 19 from 39 Heavily Indebted Poor Countries (HIPC) are part of
the OIC.
 Heavily dependent on western financial intermediaries with high interest rates
 Liability dollarization
One way to avoid any of the above possibilities is to index their debt against real
economic variables to reduce financial distress.
 It would allow for an improved risk sharing among debtor counties and international creditors.
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KEY BENEFITS OF GDP INDEXATION
Persistent low growth phase economies:
 The GDP linked papers provide a cushion against mounting debt as in conventional
borrowing.
 Variable payment would lead to a less probability of default and allow policy makers to
expand fiscally or through tax cuts to boost the economy.
As Barro (1995) highlights, linking the liability of the country with GDP can provide ease of
maintaining smoother tax rates and provide basic infrastructure to the population in times of
crises without increasing tax rates.
Islamic and emerging economies:
 In times of high economic growth , the tendency to go into frivolous expenditure which
may lead to overheat of the economy followed by a recessionary phase to bring the
economy back to equilibrium level.
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LITERATURE REVIEW
There are three strands of literature which encompass our study, and they have been explored
accordingly.
DEBT AND GROWTH
 Krugman (1988) and others, focusing on Debt overhang, and the negative impact of debt
on investments in physical capital and growth of the system.
 Notables studies are Agenor & Montiel (1996) Greene & Villanueva (1991), Serven &
Andres (1993), Elbadawi, Ndulu, & Ndung’u (1997), Deshpande (1997) and Chowdhury
(2001) Bordo, Meissner, & Stuckler (2009) Pattillo, Poirson, & Ricci (2011) etc,
SUDDEN STOPS AND LIABILITY DOLLARIZATION
 The 1990’s and late 1980’s was a decade which witnessed financial market crises from the
Mexico Peso crisis to Asian Financial Crisis, all originating in emerging markets that
Calvo G. A. (1998) labeled these as “Sudden Stop”.
 Mendoza (2001) , Calvo & Reinhart (1999) Hutchison & Noy (2004) Durdu & Mendoza
(2005), they findi that Dollar Liabilities and its relationship with Openness which is
understood as a large supply of tradable goods reducing is highly non-linear, implying that
the interaction of high current account leverage and high dollarization may be a dangerous
combination for the economies, exposing them to sudden stops.
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LITERATURE REVIEW - CONTD
GROWTH INDEXED BONDS
 The seminal literature on indexed bonds surfaced immediately after the debt
crisis of early 1980’s.
 Bailey (1983), Krugman (1988), Froot, Keen, & Stein (1989) and Kletzer,
Newbery, & Wright (1992).
 In the literature, there is a general preference for indexation to commodity
prices, as the early crisis of 1980’s and 1990’s were determined also by
fluctuations in commodity prices.
 Shiller (1993) being the most cited work, formed the basis of later research.
Shiller conceptualized, the creation of a system of “macro markets” for GDP
linked securities, as perpetual claims on a fraction of a country’s GDP.
 Barro (1995), Obstfeld & Peri (1998) , Caballero (2002) , Dreze, (2000),
Borenzstein & Mauro (2004) Kamstra & Shiller (2008, 2009 ), further explored
different aspects of the Shiller concept and found positive results for the idea.
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INSIGHT INTO STRUCTURE AND
FIQHI ISSUES
The idea is to issue a musharakah paper by the government as the wakil of the
country, where the underlying business is the economy as a whole and the profit
is paid on actual profit (i.e. growth of the economy).
A key insight of this model is that in case the economy goes to zero growth or
negative growth in any year, the investors would share in the losses, which would
mean a reduction in their principle amount invested in the business (economy).
This sharing in risk of the economy via a musharakah paper is different from
indexation of the debt, since a debt is not created when a musharakah Sukuk is
shared, but is similar to issuance of equity shares in the business (economy) of the
country.
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STRUCTURE AND PAYOFF OPTIONS
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INVESTOR PAYOFF OFF
Since the focus of this instrument is on the long term stability we look at 5
year averages of the coupon of these instruments.
Two highlights of this analysis are:
 The coupons will tend to be higher than the interest rates actually paid in global boom
phases.
 The coupons are substantially lower in the recessionary phases, which argues well for the
viability of this instrument since our earlier findings strongly suggest the negative impact
of debt servicing costs on output during economic downturns.
• For a group wise annual analysis two major findings exist.
--- Over 20 year period the average return for investors would be higher for all groups
minus the lowest income countries.
--- Over 20 year period the volatility of payoff for investors would be generally lower or
similar to existing structure if debt for all groups minus the lowest income countries.
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ISSUER BENEFITS
Simulation of the Real GDP per capita – Case of Substitution of Debt with GDP linked
Sovereign Paper
21 year Actual Mean of GDP/Capita versus mean of simulated GDP/Capita
 The Group A, seems to be the biggest beneficiary of this instrument, as their average Real GDP per
capita over 20 year period of 1992-2012 will be significantly higher than their actual Real GDP per
capita recorded.
 For other 60 countries in sample the simulated Real GDP per capita will tend to have a similar average
for these countries The mean of simulated Real GDP per capita deviates by an error of five percent
from the Actual Real GDP per capita.
21 year Volatility of GDP/Capita versus Volatility of simulated GDP/Capita
 For Group A countries, the volatility of the simulated Real GDP per capita, is higher with proposed
instruments,
 But in the analysis for other groups of countries, the findings are very positive. It can be noticed that
volatility of simulated Real GDP per capita is relatively lower for the proposed instrument in most
cases.
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CONCLUSION
This study has tried to address a gaping hole in the literature on Islamic finance, focusing on
developing countries’ financing needs.
The empirical findings of this study, encompassed two distinct angles, as it explored the
viability of the GDP linked Sovereign Papers from an investor as well as issuer perspective.
The findings from the investor perspective are positive for all developing economies in the
sample, as it provides a higher return in terms of lowest income group economies, and
relatively more stable payoff if issued by the middle income economies.
 The risk adjusted return tends to be higher for the proposed instruments four payoff mechanism.
While analyzing the issuer perspective, the findings point towards a strong favorable
argument for this instrument to be acceptable to middle income countries.
 The average return for the investors for the proposed instrument in most cases will be higher compared to the
actual existing debt servicing returns currently used for conventional loans and financing to the economies in
sample
 Countries that range from $600- $8000 Real GDP per capita, may benefit the most from this instrument.
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