Islamic finance in agriculture
Agriculture has always been a paramount industry is the lands of Islam. According to the Holy Quran, it was archangel Gabriel who taught Adam and Hawa to plough the earth and to grow wheat. Thus, agricultural products have long been the basis of commercial trade. The very first Waqf was composed of a grove of 600 date palms to feed Medina’s poor, and most of Zakat’s calculations are based on reallocation of fruits of “land and labor”.
The roots of Islamic farming and especially its reliance on sustainable agriculture are more relevant today than ever. We are finally coming back to the principles developed in the 8th century — no overgrazing and deforestation, no monocropping, and great respect for those who till the earth for living.
Still, the financial support for farmers in many cases is grossly inadequate, especially in the developing countries. Many factors for that are cited, but among the most common ones are — high risks attributed to small-scale farming; high transaction costs involved in working with rural customers; lack of industry specific financial skills; and of course, the lack of support from the government and regulators.
Islamic finance offers a great deal of instruments for the industry. Some of these tools are better known, and the others hold mainly historical value. Among the most popular financing modes are:
1. Working capital financing of seeds, fertilizers, and fuel — done via Murabahah or Musawamah, where an Islamic finance institution buys the inputs from the market and resells them to farmers on the “cost + profit” basis.
2. Term financing of fixed assets (machinery, equipment, tractors) — done via Murabahah for short-term financing, or Ijarah, or Islamic leasing, where an Islamic finance institution purchases an item and rents it out to the farmer. The Diminishing Musharakah, or partnership between an Islamic finance institution and a farmer is rarely used due to the complexity of implementation and monitoring.
3. For the development of agricultural facilities (farm buildings, silos, or others that require construction or modification), Istisnah could be used, where an Islamic finance institution becomes the seller or manufacturer of an asset, and appoints a contractor to build or renovate it.
Among the rarely used are the agriculture specific modes of Islamic financing:
- Musaqat (irrigation partnership) for plants and trees;
- Muzara’a (partnership in crops) where one party provides the land, and the other provides other factors of production;
- Mugharasa (a partneship for tree growing) where the land, trees and the labor are put together for the benefit of the partnership.
It is generally accepted that the key to successful agricultural development within the framework of Islamic economy is the availability of Bay Salam, or Islamic forward contract, which was specifically permitted by Prophet Muhammad (peace be upon him) under the following conditions:
· The buyer must pay the full payment at the time of making the contract;
· The commodity must not be in the nature of money;
· The buyer must clearly define the quality and the quantity of the commodity before a contract is made;
· The time of delivery of the commodity must be specified
· And, the commodity must be readily available at the time of delivery
Despite its widely recognized universality, Bay Salam is still used sporadically, as it creates additional hurdles for Islamic finance institutions, since the contract is settled in-kind. So, as a part of a proper risk management, the institution must look to enter into a Parallel Salam contract to assure the speedy resale of the received crops. How nice it would be to have an Islamic equivalent of Bunge or Cargill to act as a clearing house for Salam operators.
Still, the changes are in the air. The year 2021 will likely to see the issuance a rare breed — Sukuk al-Salam by a large Russian grain trader. Who are the lucky buyers? We believe that this high margin product will attract interest from the GCC grain importers and the Islamic banks that serve them. Between the top-5 Russian grain exporters the total issue of Sukuk al-Salam may reach US$700–800 million per year by 2025.
Another interesting example (based on the author’s experience) is Islamic contract farming model that is now being tested in the Philippines. It involves bundling of various Islamic finance products and offering them as a part of a single contract farming package by organizers. The included products are services are:
· Salam harvest pre-payment contracts supported by the GCC buyers within the framework of their Food Security programs;
· Ijarah leasing of machinery on as-needed basis;
· Takaful harvest insurance;
· Financial inclusion of farm laborers by offering banking services to the underbanked;
· And/or Mubarabah agreement with farmers to operate the farm with a determined profit margin.
Is it too good to be true? Perhaps, but “he who never tries never wins”.
