S&P: Sub-Saharan Africa Remains Out Of Step With Islamic Finance

JOHANNESBURG (Capital Markers in Africa) -Islamic finance is an unlikely showstopper across Sub-Saharan Africa. Despite the region’s pronounced financing needs, particularly for infrastructure projects and to repay COVID-19-related debt, S&P Global Ratings believes that Sub-Saharan countries will access the market via multilateral institutions (MLIs) instead of through sukuk issuances.

Sukuks’ Run May Be Short-Lived
We foresee limited market issuance–of both sukuk and conventional debt–across Sub-Saharan Africa (SSA) over the remainder of the year. Senegal was the first Sub-Saharan sovereign to issue sukuk in 2014, followed by South Africa’s international sukuk debut with a $500 million issuance that same year. Between 2014 and 2016, three West African countries issued the equivalent of $billion in local currency in their domestic capital markets. Since then, only Nigeria has sporadically issued naira-denominated sukuk to fund infrastructure projects.

The infrastructure gap in SSA and technical support provided by MLIs could have ushered more sukuk issuances into the region. However, issuers have remained skeptical about the added value of sukuk versus conventional bonds, particularly given the higher complexity related to Islamic finance. At the same time, SSA sovereigns’ debt levels have soared amid the scramble to provide fiscal stimuli during the pandemic. Subsequently, as the creditworthiness of some SSA sovereigns deteriorated and global liquidity became scarcer, investors’ appetite for their debt instruments reduced. We do not anticipate a change that would accelerate sukuk issuances across SSA in the near term.

Islamic Finance Has Underutilized Potential Appeal
Over the past decade, we estimate that SSA sovereigns have issued approximately $2.5 billion worth of sukuk, compared with about $600 billion worldwide in just 2021. These issuances have largely originated from countries with strong growth prospects back in 2014, like Senegal, or large economies, such as South Africa.

Since then, only Nigeria–which boasts the largest economy in Africa with a nominal GDP of $432 billion in 2021–has incorporated sukuk in its budget funding plan. The Nigerian government issued moderate amounts at a time, ranging from Nigerian naira (NGN)150 billion to NGN250 billion (or $350 million to $600 million), in the domestic market to fund specific development projects. South Africa has yet to return to the sukuk market after its first issuance in 2014, while Kenya didn’t follow through with any sukuk issuance after undergoing a full regulatory and legal overhaul to accommodate Islamic finance.

In our view, the asset-backing principle of sukuk transactions could help countries with less-efficient debt-fueled investment strategies, as we believe is the case in SSA. Reportedly, sukuk issuance allows investors to diversify and tends to appeal to a class of investors that would not invest in conventional instruments. Additionally, SSA’s chronic infrastructure shortage theoretically presents an opportunity for issuers to explore sukuk options. The African Development Bank estimated Africa’s infrastructure financing needs would reach $170 billion a year by 2025 and an annual financing gap of up to some $100 billion. So far, conventional borrowing through Eurobonds has not systematically contributed to meaningful infrastructure development in SSA.

We note, however, that the sukuk market is only one small asset class of the global capital market and is as vulnerable as any other to global liquidity dynamics. What’s more, the lack of fixed capital in SSA to be used as tangible assets could also prove to be challenging despite the hybrid nature of sukuk transactions. Overall, inherent weaknesses of SSA economies and the complexity related to sukuk issuances aggravate the instrument’s bleak prospects of catching on.

Eurobonds Have Trumped Sukuks
By providing technical assistance, MLIs have supported sukuk issuance in Africa, particularly in the West Africa Economic And Monetary Union (WAEMU). The International Corporation for the Development of the Private Sector (ICD) helped several West African countries enter the sukuk market. Chief among them were Senegal and Cote d’Ivoire, both having accessed the market multiple times in 2014-2016. The ICD also created a holding company to create Islamic banks in member countries to address the supply constraints in majority Muslim member countries.

Despite support from MLIs and from domestic institutions such as central banks, the rise of Islamic finance in 2014-2016 was subtle since major WAEMU sovereigns turned to the Eurobond market instead.

Additionally, the complexity of issuing sukuk, lack of standardization, and comparatively longer time to market have not convinced African policymakers to regularly issue sukuk over accessing the Eurobond market. According to the IMF, the stock of African Eurobonds reached $140 billion in 2021, and almost 60% of the stock is held by four African countries, two of which are in SSA (South Africa and Nigeria). In 2021 alone, SSA sovereigns issued about $8 billion worth of Eurobonds.

We do not expect all SSA sovereigns will use Islamic finance as a financing tool to attract a new category of investors. Even though large SSA economies that already attract portfolio investment were seen as good candidates to issue sukuk as a way to diversify funding sources for their large infrastructure projects, this has not been the trend.

Economic Uncertainty Further Challenges Sukuk Issuances
We do not anticipate that SSA sovereigns will issue sukuk to tackle the fast-approaching wall of maturities in 2024. Institutional and political instability (including conflicts and international sanctions), as well as a lack of visibility in the international capital markets, have undermined SSA countries’ ability to play a leading role in the development of Islamic finance in the region. Market accessibility for many SSA countries is closed because debt vulnerability is exacerbated by higher debt service costs. Also, domestic capital markets for most SSA countries are largely undeveloped and do not provide sufficient liquidity to cover large financing needs. Domestic debt financing has become more expensive as high policy rates, designed to tame inflationary expectations, are passed through into yields of treasury bills and government bonds. We’ve observed that SSA countries are mitigating these risks by either curtailing their investment plans or turning to concessional funding.

In our view, SSA sovereign issuers do not see the sukuk market as the panacea to fund their budget deficits and will likely continue to prioritize Eurobonds and other conventional instruments. Moreover, the complexities and the significant amount of time and energy necessary to put together a sukuk issuance accentuate the need for a greater simplification and clarification of risks for investors.

Source: S&P Global Ratings [This report does not constitute a rating action].