By Jack Kimball and Mirwais Harooni
KABUL (Reuters) - Afghanistan, which has only a semblance of a capital market, intends to sell Islamic bonds as it braces for a possible sharp fall in Western financial support as the war against the Taliban winds down, a senior central bank official said this week.
The official said the sale of short-term Islamic bonds, also known as sukuk, is still in the planning stage, but could be a new way of raising money for the government.
"The purpose is so that the ministry of finance can have tools for their financing to cover their expenses," Khan Afzal Hadawal, first deputy governor at the Afghan central bank, told Reuters in an interview.
"We have to develop the financial markets of Afghanistan. We have to offer those instruments not only for the banks, (but) so that the government has an alternative to finance their projects and the central bank can control money growth."
Billions of dollars in Western aid have propped up the economy since the Taliban government was toppled in 2001. Now Afghanistan faces the prospect of Western cash evaporating after most foreign combat troops withdraw by the end of 2014.
One of the world's most unstable, corrupt countries hopes financial creativity based on Islamic sharia law will help soften the blow, and ultimately deepen its nascent financial markets.
The sukuk are expected initially to be issued in the Afghani currency and offered to local banks within the next year. They may gradually be expanded to medium- and long-term bonds.
A draft law on the bonds must be approved by the justice ministry, and possibly parliament, and should be completed by the end of September, Hadawal said.
Afghanistan may need around $7.8 billion a year in foreign funding to help pay its security and other bills after most U.S.-led NATO combat troops leave, according to the World Bank. It is likely to receive about $4.1 billion in aid for its security forces per year after 2014, but that number could fall.
In the runup to a NATO summit this weekend, the U.S. government has been pressing reluctant European allies to offer around one third of the estimated $4 billion annual cost of financing Afghan forces after 2014.
If international backers slash funds severely, Afghanistan's government may be forced to reduce spending on security and development, making it even more unpopular, and its control of the country even more fragile.
The reputation of Afghan financial institutions was badly damaged in 2010 by a scandal involving Kabulbank, which gave hundreds of millions of dollars in unsecured and undocumented loans to the country's elite, including sitting ministers.
SOMETHING NEW, SOMETHING SECURE
The government hopes the Islamic bonds will give Afghans a sense of stability, and expand financial activities beyond the primary and secondary markets for central bank paper.
"(Sukuk) are something new and people have access to financing, something compliant with sharia ... and the most important thing is, something very secure, guaranteed and people are not worried that they will lose it," Hadawal said.
Islamic bonds will gradually replace capital notes that used to manage liquidity and have weekly auctions of around $40-$80 million depending on market conditions, central bank officials said. Total investment in capital notes stands at around $714 million with yields of about 2.13 percent for 28-day paper.
Unlike mainstream bonds, sukuk do not involve interest payments, which are forbidden in Islamic finance. Instead, holders receive returns from underlying assets.
Details of the assets, amount, maturities and issuance time-frame would be determined after Afghanistan gets technical assistance from the International Monetary Fund, Hadawal said.
"We do not have the people ... who are familiar with the products, with the terms and then with the maturities," he said.
The Afghan finance ministry declined to comment.
Afghanistan is one of the poorest countries in the world, with annual per capita income of just $528. Its fast-growing population means that to provide jobs, the economy must expand far more rapidly than in other countries.
The central bank forecasts economic growth of 7.3 percent this year versus 3.7 percent in 2011, driven by agriculture and agri-business, but future expansion is likely to depend on major mining projects coming online.
(Editing by Michael Georgy and Daniel Magnowski)