How the African Landscape could Benefit from Islamic Finance
Infrastructure is one of the most important drivers of economic growth and reaps numerous socioeconomic benefits. In 2018, a report published by the Boston Consulting Group and Africa Finance Corporation estimated an annual infrastructure investment gap of US$100 billion in sub-Saharan Africa that is expected to increase. Infrastructure impacts a number of the UN’s Sustainable Development Goals (SDGs) directly such as SDG 9 - “build resilient infrastructure, promote inclusive and sustainable industrialization, and foster innovation” as well as indirectly such as SDG 7 “affordable and clean energy” and SDG 11 “sustainable cities and communities”. Achievement of the goals requires a large amount of investment and governments alone cannot foot the bill.
In Africa, a substantial level of investment is needed for both hard infrastructure (such as bridges, roads and transportation links) as well as soft infrastructure (building of institutions such as schools and hospitals) moreover, two important challenges remain.
Firstly, rapid urbanization that is taking place throughout Africa as more citizens are moving into the cities increasing the demand for infrastructure and in particular housing. Secondly, the continent has a high number of landlocked countries making some countries increasingly dependent on the infrastructure of their neighbors.
Although commodity prices are rising, now is the time for African policymakers to prioritize attracting foreign direct investment and diversify their sources of financing. One way the continent can do that is by tapping and leveraging the use of Islamic Finance, a market valued to reach $3trillion in total assets by 2020.
Islamic Finance in Africa
The continent is home to a quarter of the world’s Muslims, and there are a number of Islamic banks operating throughout Africa. However, the development of Islamic finance in sub-Saharan Africa is low in comparison to other regions.
African countries such as Morocco, Senegal and South Africa have in the past funded infrastructure projects using Islamic finance through the issuance of Sukuk, a Shari’ah compliant debt capital market instrument. If mobilized well, Sukuk financing has great potential to fund much-needed infrastructure projects throughout Africa. In 2017 alone, Sukuk issuance volume reached $97.9 billion, a 45.3% increase from the year before; the continent is well positioned to attract further investment through increasing the number of Sukuk issued by Sovereigns and corporates alike.
South Africa’s Sovereign Sukuk
In September 2014, the Republic of South Africa successfully issued its inaugural USD$500 million 5.75-year Sukuk with a coupon rate of 3.90%. The Sukuk was listed on the Luxembourg Stock Exchange and the proceeds raised were used to fund infrastructure development as according to the South African National Treasury, “The decision to issue an Islamic bond has been informed by a drive to broaden the investor base and to set a benchmark for state-owned companies seeking diversified sources of funding for infrastructure development.”
However, in order to issue the Sukuk, the Government had to make amendments to its legislation and tax laws signifying how crucial political will is to removing obstacles and facilitating the diversification of funding sources. The debut Sukuk was more than 4 times oversubscribed demonstrating strong appetite and investor confidence in South Africa with an overwhelming 84% of investors being from the Middle East and Asia.
Three key lessons can be learnt from the South African Sukuk issue.
Firstly, the government was able to diversify its funding sources and tap a new investor base. Prior to issuing the Sukuk, the government issued a dual-tranche conventional bond in July earlier that year, the majority of the investors, 81% to be precise, were from the US and Europe unlike the Sukuk investors who were predominately from the Middle East and Asia. The government was able to tap a new pool of investors and diversify their investor base.
Secondly, the importance of creating a conducive regulatory environment. With the changes being made to domestic legislation, the government was able to issue a Sukuk in-line with the Shari’ah (Islamic law) on the international capital markets.
Lastly, showing that Sukuk are a viable funding tool for infrastructure financing. As stated by the National Treasury, one of the driving factors to issue a Sukuk was to set a benchmark for state-owned enterprises looking for infrastructure funding. As South Africa’s infrastructure needs increase with its growing population, the Government needs to consider alterative financial instruments to fund the country’s infrastructure needs of which Sukuk are well suited for.
Sound and stable infrastructure is an important component of economic development as it helps facilitate trade, improves well-being and creates jobs.
With the tightening of government budgets, African governments cannot finance infrastructure development alone and need to explore alternative sources of financing and one way is through leveraging the use of Islamic finance, in particular Sukuk financing.
Having said that, Islamic finance is in no way a panacea but rather an underutilized tool and there is vast potential in mobilizing the industry to help develop the continents skyline. However, the nuances of the continent need to be taken into consideration given the differing financial and legal systems therefore there is no uniform approach.
The challenge remains to attract foreign investors so policymakers need to prioritize creating an environment that both attracts and protects investors. South Africa being an example of how a Government can overcome these obstacles.
About the Author
Maram Ahmed is an advisor, educator and researcher with a focus on emerging markets. Maram is currently a Visiting Fellow at SOAS, University of London, a leading institution for the study of the Asia, Africa and the Middle East. At SOAS, Maram teaches Corporate Governance, Finance in the Middle East & North Africa and Islamic Banking & Finance. Maram’s current research interests include sustainable development, governance, humanitarian financing and women’s empowerment. She has authored numerous articles in top academic journals and has spoken at major conferences in Europe and the Middle East.