Slow But Steady Growth Of Sukuk In Africa

Africas three largest economies - Nigeria, South Africa and Egypt all raised sizeable public debt funding through three sukuk issuances in 2023/24, totalling an aggregate equivalent of $3.045bn.

Sukuk is an Islamic debt instrument wherein the finance provider has ownership of real assets and earns a return sourced from those assets. This contrasts with conventional bonds where the investor has a debt instrument earning the return predominately via the payment of interest (riba). Riba or excess is not allowed under sharia law.

At a time when the IMF has warned that high sovereign debt servicing costs are a growing challenge for low-and-medium-income-countries (LMICs), preventing them from spending more funds on essential services and critical investment needed to boost growth, sukuk is emerging as a viable and potentially less costly public fundraising alternative.

According to the IMF, public debt servicing costs are increasing rapidly while annual refinancing needs have tripled to over $60bn in 2023 due to high interest rates, cost of finance and the pace at which LMICs must repay debt, which in turn is impacting national budgets. Following Ghanas debt default last year, fears of more LMICs unable to service their debt have not materialised so far.

Instead, countries such as Sierra Leone and Kenya are resorting to the risky strategy of more costly borrowing through issuing conventional US dollar and Eurobonds to refinance existing expensive debt. The reality is that debt forgiveness notwithstanding, public debt sustainability is now an even more urgent priority for LMICs and the stability of the global financial system.

The foray of Egypt, Nigeria and South Africa into the alternative sovereign sukuk market underpins a reset in their fund-raising strategy to include sukuk and murabaha (cost-plus financing) commodity finance syndications.

This complements the issuance of conventional bonds, the use of IMF standby facilities, concessionary multilateral financing and often more expensive bank credit facilities. All three countries have stated that sukuk is now an integral part of their public debt mix. According to Fitch Ratings, global outstanding sukuk volumes expanded by 10% y-o-y and for the first time crossed $800bn in Q3 2023, with sovereigns being the key issuers. Both outstanding and issued sukuk continued to hold 30% of the total funding mix in core markets.

However, the reality is that overall African sovereign sukuk issuance remains low. Egypt, Nigeria and South Africa were the only three public sukuk issuers in 2023, contributing a mere 2% of global sukuk volumes.

In money terms, the three countries accounted for 70% of Africas total sukuk issuance since 2014, with South Africa and Egypt the only two to issue US-dollar sukuk in the international market through well-subscribed $500m and $1.5bn transactions.

The main reason for this, says Samira Mensah, Primary Credit Analyst at S P in Johannesburg, is that the complexities and evolving Islamic legal requirements related to sukuk issuance, hamper the success of the instrument and make African sovereigns hesitant to use sukuk to fund large infrastructure projects.

The African Development Bank estimated that Africas infrastructure deficits, which are compounded by climate change and energy transition risks, lead to investment needs of $130bn-$170bn per year.

While the sukuk issuance of some African sovereigns benefited from the support of multilateral financial institutions, other sovereigns turned their backs on sukuk as related complexities did not justify the endeavour, in their view.

International credit rating agencies however can have a highly selective, skewed and exaggerated perception of African credit risk, which has serious implications for project-related credit and investment insurance premiums and the cost of finance.

Oulimata Sarr, Senegals erstwhile Minister of Economy, Planning and Cooperation, often lamented that despite their vital importance in infrastructure financing, insurance often contributes to the increase in the cost of a project, especially in Africa where we suffer from an unfavourable and biased credit rating.

The pricing of insurance premiums is partly based on a countrys credit rating and as rating agencies overstate risk on the continent, African countries find themselves paying very high premiums.

The African sukuk issuance momentum is further tempered by global economic conditions. Egypts debut $1.5bn sukuk in 2023 under its $5bn Trust Certificate Issuance Programme was driven partly by its substantial infrastructure funding needs, especially in climate action, energy transition to renewables and building food security and resilience in the wake of the supply chain disruptions due to the Ukraine conflict.

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