SOMETIME before New Year, the Islamic republic of Pakistan will issue Asia's second sovereign Sukuk or Islamic bond. This will be a jumbo deal, at least $500 million dollars and thus establish Islamabad in the club of Muslim sovereign Sukuk issuers that now include Bahrain, Malaysia, Qatar and Dubai.

The Pakistani Sukuk will be a welcome addition to the global Sukuk market, whose outstanding securities are still a mere $4 billion. Unlike Bahrain, Qatar or even DCA, the Pakistani paper offers a classic emerging market spread with the potential to break syndicate atleast 250 basis points over the five year US Treasury note.

This is the perfect time for Pakistan to issue an inaugural sovereign Eurosukuk. Oil prices have plunged from their highs and China's rate hike will dampen the speculative spiral in energy and commodity markets. It is no coincidence that the weighted spread on the JP Morgan EMPI index, a proxy for international investor risk aversion in emerging markets, tightens when oil falls. The fall in oil prices below $50 will also relieve pressure on the Pakistani rupee and reduce the risk of external shocks in its balance of payments.

Another compelling argument for a jumbo Eurosukuk is that Pakistan is on the verge of a sovereign ratings upgrade. Last February, after I had attended a presentation given by the Governor of the State Bank (and questioned him on the arcane subject of relative sovereign spreads that mesmerise me when trading EM debt). I wrote in this column that the Pakistan Eurobond was a pure gift.

For once, I was absolutely, gloriously right in my call on the $500 million Eurobond, even though my emerging market debt brokers in London saw better value in other B credits such as Brazil, Turkey, and Philippines. After all, in February 2004, when Pakistan returned to the global capital market after the six year black ball caused by Nawaz Sharif's 1998 technical default, Brazil traded at a 490 spread over the five year Uncle Sam (which was a mere 3.05 per cent). So Pakistan's 6.75 interest rate or 370 basis points over the five-year treasury did not look great value with one critical cavaut. Did Pervez and Shaukat really deserve to trade as a single B credit?

After all, they were not serial borrowers with no "scarcity value" in the Euro markets, unlike Lula Racip or Gloria. In short, investors were handed a BB credit at 370 overt he curve. No wonder the Pakistan Eurobond attracted $2 billion in bids. Not bad for a country whose President just survived two assassination attempts, whose military was waging a war against Al Qaeda in its tribal netherworld and whose armed forces were on the brink of war with India only two years earlier. Soon after my column was published the Pakistan Eurobond traded at 103, producing a great flip for the many investors who I recommended leverage the deal with their neighbour hood banker. The spread on the Pakistan Eurobond has of course, tightened by no less than 100 points since its issue.

Pakistan justifies a rating upgrade by Standard Poors and Moody's. Thanks to President Musharraf and Shaukat Aziz, it is no long an IMF dependent distress economy. Inflation, fiscal deficit, asset sales banking reform, a welcome mat for global investors, friendship with the West, a crackdown on extremist and sectarian terrorist, a strategic military alliance with the United States, diplomatic rapprochement with India over Kashmir, $12 billion in central bank reserves, a historic boom in the Karachi Stock Exchange all argue for an imminent rating upgrade for Islamabad. That means the Sukuk will be a winner.

The Sukuk, contrary to popular myth, need not be targeted only at Islamic investors in the Mideast. The Eurobond after all, was mainly placed in Europe and the Far East, with only $50 million with Arab investors. Since I hear Citigroup and HSBC will win the Pakistan sukuk lead manager mandate, it is obvious that the government wishes for a global investor profile - after all, the entire point of creating a benchmark sovereign borrowing program is to gain the Euro markets vote of confidence in Pakistan's remarkable economic and political turnaround. So, like the Malaysian Sukuk in 2002, I estimate Pakistan new issue will be placed mainly with non-Islamic investors. This is a pity because Islamic banks desperately needs five to seven year sovereign, liquid assets where they can earn an attractive spread over LIBOR. Besides, Islamic investors in the Middle East have a unique political, cultural and human tie to Pakistan that lets face it, Goldman Sachs or Templeton really do not. So, Excellency Aziz please designs a preferential tranche in the Sukuk for retail Islamic investors. This is a immense pool of capital and goodwill across the Arab world who will never be fair weather friends for Pakistan.

My sources in the London capital markets tell me that the sukuk will probably be priced at 250 basis points above the five-year T-note. As a Sharia compliant instrument, it should trade tighter than the conventional Eurobond, particularly if the Prime Minister listens to my advise and allocates a tranche for retail Islamic investors in the Arab world, who are not as price sensitive as Wall Street or Hong Kong fund managers.

This is also the ideal opportunity for an innovative Islamic investment bank to design a Global Sukuk Index, a Sharia compliant version of JP Morgan's EMPI - why lose yet another opportunity to make money and build a global brand to Dow Jones or Morgan Stanley as has already happened with equities or commodity? Pakistan does not really need to borrow with $12 billion in reserves (neither does Malaysia with $40 billion in reserves or China with $400 billion!). The rationale to create a Eurobond or Sukuk is to interest global investors in Pakistan's emergence from the abyss of political chaos and macroeconomic Armageddon. The Sukuk will be over subscribed. It will trade at a premium. Liquidity will be a constraint even if Islamabad issues a 500 million jumbo deal.

Bankers in UAE who designed an attractive leveraged note on the Eurobond may wish to take a long close look at designing a moneymaking product on Pakistan Sukuk. The deal is a month or six weeks away. However, just as I had a table-banging buy on the Pakistan Eurobond, I predict my country's inaugural sukuk will be another gift to global investors.

MATEIN KHALID
STRATEGIST, CAPITAL MARKETS & RESEARCH

The opinions expressed by the writer are his own and not endorsed by Press Release Network.

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