Maldives seeks bailout to avoid first Islamic sovereign debt

The Maldives will test the global Islamic finance market in the coming weeks as the debt-ridden archipelago nation seeks a bailout to prevent it from becoming the first country to default on a key form of sharia debt.

The price of a $500 million bond-like sukuk issued by the government has fallen to about 70 cents on the dollar in the past month ahead of a payment due in October as its foreign reserves run low.

A default on the bond, which matures in 2026, would be the first by a sovereign for sukuk debt, of which about $860 billion was issued at the start of the year, according to Fitch Ratings.

“The questions everyone is asking: Will the Maldives be the first sukuk (sovereign) to default,” said Joshua Loud, senior portfolio manager for emerging markets at Danske Bank. “Given that this has never happened, I don’t think the market fully understands the impact.”

The country has struggled to repay its two main bilateral creditors, India and China, from which it has borrowed heavily to finance growing budget deficits. Debt repayments now threaten to deplete their reserves.

But the Maldives, known as much for its idyllic honeymoons as for its exposure to rising sea levels, has been caught up in the increasingly bitter competition for regional influence between its two giant Asian neighbors.

Global observers and investors worry that neither power will extend support to the Muslim-majority nation of half a million people, risking a complicated process of default and restructuring.

Sukuk follows the Islamic principle of avoiding traditional interest payments, instead giving lenders a share of the profit from an underlying financial instrument.

Sharia-compliant bonds have been sold by governments around the world, including Britain, Malaysia and Nigeria, although they are usually associated with cash-strapped Gulf governments and banks. S&P Global forecasts up to $170 billion in sukuk issuance this year, and Moody’s expects more than $200 billion.

But the Maldives’ struggles threaten to upset the outlook. Tourism has rebounded after the pandemic, but the country is heavily dependent on imports, and global inflation and high spending on strategic infrastructure projects have caused its debt to grow.

Mohamed Shafeeq, the Maldives’ finance minister, said last week that the government could make the payment in October of about $25 million. But net foreign reserves fell below $50 million in July as the government also sought to maintain the rufiyaa’s peg to the US dollar. Gross reserves fell below $400 million, down from about $500 million in May.

“Reserves have fallen to an extremely low level,” said George Xu, director at Fitch Ratings in Hong Kong. “The risk of default seems more likely.” Fitch last month downgraded the country’s debt for the second time in two months, deepening concerns among global investors.

In addition to global asset managers such as BlackRock and Franklin Templeton, Emirates NBD, a government-owned bank in Dubai, owns a small portion of Maldivian sukuk, according to ownership data.

A spokesman for the Maldives president’s office told the Financial Times that the country was working to increase its foreign exchange reserves “including exploring green bonds and potential foreign exchange agreements”.

The government is “engaging with bilateral and multilateral partners to meet both immediate and medium-term financing needs.”

But economists and restructuring specialists say a default will test legal limits. In theory, sovereign sukuk are based on assets that an issuer typically sells to a special purpose vehicle and then leases back, with the lease filtering through to investors as payments.

The Maldives sukuk uses a Cayman Islands vehicle and the government has in the past referred to using the country’s largest hospital, which was built for $140 million, as an underlying asset.

In practice, investors cannot easily seize or sell these assets to collect payment in case of default.

The sovereign advisory arm of consultancy Alvarez & Marsal said this year that while “the restructuring process for sovereign sukuk is an opaque and poorly understood area of ​​law”, the terms limiting access to the assets meant it would likely work at just like the typical non-guaranteed ones. sovereign bonds.

Some analysts wondered whether one of the country’s bilateral partners — India, China or the Gulf Cooperation Council countries — might step in to help it avoid default.

“Because they have this history of not having sovereign bonds, a country like Egypt has been able to issue sukuk (at better rates). Nobody wants to see that reputation hit,” Loud said of Danske Bank.

The Gulf monarchies, themselves large sukuk issuers, have stepped in in the past to preserve the reputation of sukuk without blemish. In 2018, Bahrain was bailed out by its Gulf neighbors.

“Total external debt service will increase to $557 million in 2025 and exceed $1 billion in 2026. The amount is huge for this economy, but the Maldives has strategic partners including India, China and the GCC,” Xu said from Fitch. “Because of this, the government can continue to rely on external financial support from bilateral and multilateral lenders.”

The Maldives Monetary Authority, the central bank, said after Fitch’s downgrade in August that it was seeking a $400 million foreign exchange swap through a South Asian regional body, effectively a bailout from India.

But others are less sure the money will come. Last year, Mohamed Muizzu won the presidency on an “India out” program and called for the country’s small military contingent to leave before the two sides mend relations.

One emerging market investor, who asked not to be identified, said he saw “no sign” of India or China stepping in to help, adding that bonds still looked expensive relative to default risk.

“The complexity of a default is exacerbated by the fact that it is a sukuk and the uncertainty of how a sukuk restructuring will be handled, and so you could argue that the bonds do not fully reflect the default risk despite the steep (fall) .”