The Maldives will test the global market for Islamic finance in the coming weeks, as the debt-burdened archipelago nation hunts for a bailout that will prevent it becoming the first country to default on a key form of sharia-compliant debt.
The price of a $500mn bond-like sukuk issued by the government has collapsed to about 70 cents on the dollar over 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 $860bn were in issue at the start of the year, according to Fitch Ratings.
“The questions everyone is asking: will the Maldives be the first [sovereign] sukuk to default,” said Joshua Loud, senior emerging markets portfolio manager at Danske Bank. “Given this has never happened, I don’t think the market fully understands the impact.”
The country has struggled to pay back its two main bilateral creditors, India and China, from which it borrowed heavily to finance growing budget deficits. Debt repayments now threaten to drain its reserves.
But the Maldives, known for both idyllic honeymoons and its exposure to rising sea levels, has been caught in the increasingly fraught competition for regional influence between its two huge Asian neighbours.
Global observers and investors worry that neither power will extend support to the Muslim-majority nation of half a million people, risking a complicated default and restructuring process.
Sukuk follow the Islamic principle of shunning traditional interest payments, instead offering creditors a share of profit from an underlying financial instrument.
The sharia-compliant bonds have been sold by governments around the world including the UK, Malaysia and Nigeria although they are usually associated with cash-flush Gulf governments and banks. S&P Global is forecasting up to $170bn in sukuk issuance this year, and Moody’s expects more than $200bn.
But the Maldives’ struggles threaten to upset the outlook. Tourism has bounced back after the pandemic, but the country depends heavily on imports, and global inflation and high spending on strategic infrastructure projects have caused its debt to balloon.
Mohamed Shafeeq, the Maldivian finance minister, said last week that the government could make the October payment of about $25mn. But net foreign exchange reserves fell below $50mn in July as the government also tried to hold the rufiyaa currency’s peg to the US dollar. Gross reserves dropped under $400mn, down from about $500mn in May.
“Reserves are down to a critically low level,” said George Xu, a director with Fitch Ratings in Hong Kong. “The risk of default seems more probable.” Fitch last month downgraded the country’s debt for the second time in two months, deepening global investor concern.
As well as global asset managers such as BlackRock and Franklin Templeton, Emirates NBD, a Dubai government-owned bank, owns a small slice of the Maldivian sukuk, according to ownership data.
A spokesperson for the Maldivian president’s office told the Financial Times that the country was working to increase its foreign currency reserves “including exploring green bonds and potential currency swap agreements”.
The government was “engaging with bilateral and multilateral partners to address both immediate and medium-term financing needs”.
But economists and restructuring specialists say a default will test legal boundaries. In theory, sovereign sukuk are based on assets which an issuer typically sells to a special-purpose vehicle and then leases back, with the lease being filtered to investors as payments.
The Maldivian sukuk uses a Cayman Islands-based vehicle, and the government has referred in the past to using the country’s largest hospital, which was built for $140mn, as an underlying asset.
In practice, investors cannot easily seize or sell these assets to collect payment in a default.
The sovereign advisory arm of Alvarez & Marsal, the consulting firm, said this year that although “the restructuring process for sovereign sukuk is an opaque and poorly understood area of law”, terms limiting access to assets mean it would probably work much like typical unsecured sovereign bonds.
Some analysts have wondered whether one of the country’s bilateral partners — India, China or the countries of the Gulf Cooperation Council — might step in to help it avert default.
“Because they have this track record of no sovereign defaults, a country like Egypt has been able to issue sukuk [at better rates]. No one wants to see that reputation hit,” said Loud of Danske Bank.
Gulf monarchies, themselves big issuers of sukuk, have in the past stepped in to keep the reputation of sukuk unblemished. In 2018 Bahrain was bailed out by its Gulf neighbours.
“Total external debt service will increase to $557mn in 2025 and exceed $1bn in 2026. The amount is huge for this economy, but the Maldives does have strategic partners, including India, China and the GCC,” Fitch’s Xu said. “For that reason, the government may still continue to be able to rely on external financing support from bilateral and multilateral creditors.”
The Maldives Monetary Authority, the central bank, said after Fitch’s downgrade in August that it was seeking a $400mn currency swap through a south Asian regional body, in effect a bailout from India.
But others are less certain the money will be forthcoming. Last year Mohamed Muizzu won the presidency on an “India out” programme and asked the country’s small military contingent to leave before the two sides patched up relations.
One emerging market investor, who asked not to be identified, said they had seen “no sign” of India or China stepping in to help, adding that the bonds still seemed expensive relative to the risk of default.
“The complexity of a default is exacerbated by it being a sukuk and uncertainty with how a sukuk restructuring will be handled and thus you could argue that bonds aren’t fully reflecting the default risk despite [the] precipitous drop.”
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