Islamic finance expanding in Brazil

Author: | Published: 24 Apr 2013
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With the global economy still recovering and financial markets struggling to overcome the liquidity crunch, the Brazilian economy has shown its resilience with sustained economic growth averaging 4.5% over the past five years. In 2010, Brazil's real GDP growth of 7.5% was the fifth best among the G20 countries, and the highest since 1986. This economic environment is ideal for the fast-growing and capital-intense Islamic financial sector, which is projected to grow to $1.8 trillion in 2013 at an annual rate of 17%. It is, however, a new growth sector for Brazil.

Largely asset-backed and equity-based, one of the challenges facing this dynamic sector is the limited availability of financial products that comply with Islamic or Shariah principles. Islamic funds are therefore expanding beyond Muslim to non-Muslim countries with resilient economies, such as Brazil, to diversify their portfolios. And by tailoring Brazilian financial products to Islamic principles, with the support of Brazilian regulatory authorities, these two systems are providing untapped opportunities for investors looking for rewarding but Shariah-compliant investments.

Making Islamic finance work in Brazil

Not completely unscathed from the global financial crisis, many sectors in Brazil face two main obstacles: a liquidity shortage and limited credit availability. In this environment of high growth but capital shortages, many sectors have welcomed more transparent, equity-based financing, which provides an atmosphere conducive to financing by Shariah-compliant instruments.

"Islamic funds are expanding to non-Muslim countries with resilient economies"

Before the crisis in 2000, Chase Securities and the Saudi National Commercial Bank (SNCB) arranged a one year Islamic credit facility of $50 million in favour of Brazil's state-owned oil company Petróleo Brasileiro (Petrobras). The facility was structured using murabaha contracts for financing the purchase of petroleum products from the Saudi Arabian national oil company (Saudi Aramco) and other Gulf-based oil exporters. Several banks, including the Arab American Bank, Arab Investment Company, Chase, and SNBC-Bahrain acted as the lenders under the facility.

Earlier this year, Brazil witnessed its first Shariah-compliant transaction in the agriculture sector. The deal was brokered by Abu Dhabi Equity Partners, a boutique Islamic investment bank, to finance a leading sugar and ethanol producer in the state of Mato Grosso do Sul. Using the principles of agency (wakalah) and murabaha, the transaction was structured enabling the lender to buy ethanol, which is then sold after a three month period by the producer at a principal plus pre-agreed profit rate. This transaction sets a new trend with many similar deals expected to follow, especially in agribusiness and project finance.


Brazil has one of the world's largest and fastest-growing agricultural economies and is projected to grow over 40% by 2019. It provides the optimum investment opportunities for Islamic investors. Between 2006 and 2011, Brazil increased its agricultural exports by 123%, from $3.36 billion in 2006 to $81.7 billion in 2011. Despite this unprecedented performance and growth potential, financing remains a critical obstacle in the expansion of the sector. For instance, total credit granted by the financial system to the agriculture sector was less than 30% of Brazil's GDP in 2009 – the lowest level of credit availability worldwide.

Even when financing is available from many sources (government credit programmes, the national development bank (Banco Nacional do Desenvolvimento Econômico e Social – BNDES), and commercial banks) interest rates remain very high and credit availability is limited. Brazilian farmers, particularly the medium-scale farmers, overcome these constraints by securing capital through other modes of financing such as rural partnerships, credit sales, forwards, and profit and loss agreements – making agribusiness one of the many sectors in Brazil that is suitable for financing through Shariah-compliant instruments.

For instance, Salam contracts (future delivery prefinancing contracts) can be utilised for structuring Brazilian instruments such as Cédula de Produto Rural (CPRs) that are widely used by Brazilian farmers. The Brazilian Ministry of Agriculture, supporting the use of such instruments and welcoming new investments from the Islamic sector, sets out the basic characteristics of Salam contracts that may be met by Brazilian instruments :

  • Agreed goods purchase price of the asset must be paid fully in advance;
  • The goods must have commodity-like characteristics and be fungible;
  • The delivery of the goods must be deferred;
  • The payment at maturity is through the delivery of the goods only;
  • The goods purchased must be freely available in the market;
  • The goods must be of a specified quality and quantity without ambiguity;
  • The contract cannot be used for either spot delivery or cross sales (a minimum of 30 days for delivery is recommended); and
  • The buyer may secure the seller's delivery commitment with a mortgage, guarantee or letter of credit;

In addition to Salam contracts, mudaraba (partnership between capital and work) contracts may be used for structuring rural partnerships whereby a landowner assigns the use of a rural property for agricultural activity in exchange for a payment. This is a viable tool especially in the wake of recent interpretations of Law No 5709/71 that limits foreign ownership of rural lands in Brazil.

The federal government in Brazil has always encouraged trade finance loans by reducing the withholding income tax due on interest payments to zero on such loans. Specifically, the federal government has created a product line called Pagamento Antecipado de Exportação (prepayment of exports) whereby a foreign party may send money to a Brazilian producer to finance the producer's crop and production. The producer repays the foreign party with goods plus interest on the original loan (this may be paid in cash or with additional goods). An added advantage of this structure is that there is no income tax due on the interest payment (paid in either cash or goods). The structure may thus be Islamised using salam contracts for receiving capital investments from the Gulf region.

Project finance

In this post-crisis environment, as the eurozone instability still looms, financing capital-intensive projects continues to be challenging. Investors have raised the bar by demanding more conservative risk analysis and risk allocation, stricter covenants, and more collateral. Brazil in particular feels this crunch with the 2014 FIFA World Cup and 2016 Olympic Games coming up. In addition, it has undertaken large-scale infrastructure projects in two federally sponsored growth-acceleration programmes (Programa de Aceleração do Crescimento – PAC I and PAC II). BNDES reports in O BNDES em Um Brasil em Transicao (June 2010) that Brazil will invest approximately R$1.3 trillion ($646 million) in projects from 2010 to 2013. The infrastructure sector alone is projected to require R$310 billion in investments.

The Brazilian government is undertaking several measures to attract investments from the private sector as BNDES (the main source of financing for long-term investments in Brazil) reaches its limit. Among such measures is the enactment of federal Law No 12, 431 that provides a mechanism for issuing infrastructure bonds (debentures de infraestrutura).

As the Brazilian government engineers and encourages new mechanisms for raising funds, regulators and the private sector would welcome investments from the Islamic sector. Usually in infrastructure projects, Shariah-compliant financing is secured for a single tranche, with conventional financing providing the remainder of the funds. To date, very few financings have been structured entirely on a Shariah-compliant basis making the Islamic investor an ideal strategic partner for BNDES and other financial institutions and developers in Brazil.

Contrary to common perception, Islamic finance is not confined only to the Muslim world. In recent years with the support of local regulatory authorities, the sector has flourished in many non-traditional countries, such as China, Singapore, Germany, France, Japan, Hong Kong, and Russsia. The German state of Saxony-Anhalt issued a €100 million ($130 million) Islamic bond (sukuk) in 2004 – the first sovereign Islamic bond in Europe. Singapore-listed Golden-Agri, the world's second largest palm oil company, issued its first sukuk, worth $488 million, in Malaysia in 2012. To support and promote Islamic financing, the regulatory authorities in these countries, especially in the UK and Singapore, continue to improve their tax and regulatory frameworks.

Follwing this trend, the vast Arabian desserts and Amazonian greens can be bridged for providing uncharted investment opportunities by: (i) Islamising Brazilian financial products, and (ii) providing the requisite regulatory framework for this new investor.

By Bruno Balduccini, Tiago AD Themudo Lessa and Amina Akram of Pinheiro Neto Advogados in Brazil