Green Sukuk

The Ministry of Finance recently issued Pakistan’s first Green Sukuk, valued at Rs30 billion, under the Sustainable Investment Sukuk Framework, marking a turning point in Pakistan’s sustainable finance journey.

Announced on May 8, 2025, these Islamic bonds aim to finance environmentally sustainable projects (hence the term “green”) specifically three hydropower initiatives—the Garuk Dam in Balochistan, the Nai Gaj Dam in Sindh, and the Shagarthang in Gilgit-Baltistan.

This provides great reason to be zealous, until we’re posed with a fundamental question that continues to ideologically divide Islamic bankers and scholars alike: Is this Sukuk genuinely asset-backed and truly Islamic, or a conventional bond repackaged as Islamic?

The Green Sukuk’s issuance was followed by tremendous investor enthusiasm; bids totaled Rs161 billion against an initial target of Rs30 billion, leading the government to increase the final issuance to Rs31.98 billion. This clearly emphasizes investors’ growing appetite for ethical and sustainable debt instruments — though it also places greater responsibility on ensuring genuine Shariah-compliance. The instrument is fully tradable on the Pakistan Stock Exchange (PSX), enhancing liquidity, though this feature does not resolve questions around how variable rent is sourced pre-project completion.

Islamic finance expert Harris Irfan, in his book “Heaven’s Bankers”, points out an important distinction: Sukuk should ideally be asset-backed, directly linking the debt instrument’s returns to the performance and revenue of the leased assets. In reality, most Sukuk—likely this Green Sukuk—end up being “asset-based,” where returns are pre-agreed and guaranteed via buy-back clauses at maturity, effectively mirroring conventional bonds. This eventually makes the originator of the Sukuk — in other words — the country that is issuing the bond as the guarantor of the bond and not directly the performance of the project.

This minor distinction has major implications. Asset-backed Sukuk incorporate genuine risk-sharing, a fundamental Islamic finance principle, while asset-based Sukuk simply replicates a conventional bond by guaranteeing fixed returns irrespective of project outcomes, diluting the ethical and Islamic essence behind the concept of Sukuk. The Finance Ministry’s May 16th announcement confirmed this issuance is structured as a three-year Ijarah Sukuk, offering semi-annual rental payments to investors. However, key details remain unclear, particularly whether returns would be through project-specific cash flows or through guaranteed buybacks.

This particular point becomes extremely relevant in light of Pakistan’s Vision 2028, which aims for a complete interest-free economy. Yet, policy makers’ and investors’ infatuation with guaranteed returns presents practical and ethical contradictions. According to the Ministry of Finance’s latest Semi-Annual Public Debt Bulletin (H1-FY2025), Pakistan’s external debt totals Rs24.13 trillion, with significant maturities between now and 2028. Interest payments on external debt remain a major fiscal burden, pointing out the difficulty in genuinely shifting away from interest-based obligations unless structural adjustments occur.

Sukuk currently comprises about 14% (Rs5 trillion) of Pakistan’s Rs37 trillion domestic debt mix; demonstrating a growing, yet still modest, role in the debt landscape. This, however, does not necessarily indicate a genuine progress towards ethical Islamic financing; instead, it reinforces a broader trend of repackaging existing borrowing practices with Islamic labels. The true potential of Islamic finance lies beyond conventional debt; embracing transparent, risk-sharing instruments firmly rooted in Shariah principles.

Encouragingly, the Ministry of Finance has committed to publishing an annual Green Sukuk Report, detailing allocated proceeds, project-specific performance indicators, environmental impacts, and unutilized funds. This transparency initiative is commendable, but it must also disclose clearly whether returns are derived directly from project revenues or rely on buy-back guarantees.

One viable model I think would be suitable in achieving authentic Islamic financing is temporary asset leasing. Pakistan could explore Ijara-based Sukuk genuinely tied to revenue-generating public assets, such as toll roads or operational power plants. This technique indexes the returns directly to actual project performance, which are transparently shared between investors and the government, eliminating the need for fixed coupon guarantees. More importantly, it presents a practical, Halal solution for financing the legacy interest payments on external debt through project-specific cash flows.

A Sukuk that is backed by an asset would temporarily lease income-producing public assets to investors. Returns would thus authentically reflect the project’s revenue rather than pre-fixed interest rates. This would both uphold Shariah compliance, and bolster Pakistan’s international credibility in ethical and sustainable finance.

Since investors’ interests would be tied to the project’s profitability, a true asset backed Sukuk would create an auto-accountability mechanism, similar to the IMF’s conditionalities, but market driven in this scenario. If the project underperforms, the cost is shared. If it outperforms, the revenues are also shared. Thus for an asset-backed Sukuk to gain foreign investor confidence, the underlying project (hydro-electric dam, motorway, schools, etc) would really need transparent pricing, operational efficiency and world class management.

Practical implementation of an asset-backed project is not free from challenges. Since real project cash flows may arrive years after issuance, investors may grow anxious about interim coupon payments. Here, Islamic finance principles allow for collateralization—another Halal alternative. Investors could be provided interim returns through revenues from already operational comparable public assets held as collateral, maintaining compliance and financial stability.

Recently, the Finance ministry’s indication of future “innovative funding products,” including Panda Bonds (renminbi-denominated debt issued in China), fits well within this category. Panda Bonds offer lower yields and strategic diversification from dollar-denominated borrowing with a small limitation; repayment must occur in Yuan, creating the need for reliable Yuan-denominated inflows to avoid exchange rate risk. Thus, while Panda Bonds do offer debt diversification, their inclusion in the portfolio does not eliminate the need for revenue-generating, risk-sharing instruments that underpin debt handling tactics.

The holy Quran explicitly forbids riba (interest) while permitting trade (Surah Al-Baqarah). The reasons why genuine Sukuk should be adopted go well beyond just compliance; they offer a path to ethical capital formation, reduce speculative excess, promote real asset pricing, and ensure that financing serves both economic growth and social justice. Harris Irfan warns against Sukuk that merely “Shariah-wrap” conventional products, noting these compromise credibility, diluting Islamic finance’s ethical foundations.

For Pakistan, the path to an interest-free economy by 2028 requires substantive reform rather than mere ambition. The Green Sukuk’s introduction is promising, yet if future issuances remain asset-based with guaranteed returns, Pakistan risks undermining investor trust and the deeper ethical purpose of Islamic finance.

Ultimately, genuine Islamic finance must focus on transparent, performance-based risk-sharing models. The current Green Sukuk can indeed become a blueprint, provided it positions returns with actual project revenues, incorporates true asset-backed structures, and transparently involves investors in project risks and rewards.

Pakistan ranks among the most climate-vulnerable nations globally, facing increasing environmental stress. Instruments like Green Sukuk help align financing with ethical Islamic principles, directly supporting climate-resilient growth; transforming finance into a powerful tool for socioeconomic justice and sustainable development.

As Pakistan moves forward, the challenge is clear: to evolve Sukuk into credible instruments backed by real assets capable of ethically refinancing external debts, managing fiscal pressures, and facilitating sustainable economic growth. Only then will Pakistan genuinely realize Vision 2028 as a policy that representsa credible path to economic justice and resilience.

Copyright Business Recorder, 2025