‘Big Three’ Rating Agencies See Noticeable Increase in Islamic Finance Assets and Uptake in Africa in 2021 as South Africa Confirms Intention to Issue Debut Rand Sukuk

“Following a successful issuance in global capital markets in 2014, the National Treasury will issue a domestic rand-denominated Islamic Sukuk in 2021/22 to diversify funding sources and reach new investors,” confirmed South African Finance Minister Tito Mboweni in his National Budget 2021 presentation to parliament in Cape Town in February.

That South Africa’s public finances are under severe strain is not in doubt. Gross national debt, according to the Treasury is projected to rise from 80.3% of GDP in 2020/21 to 87.3% of GDP by 2023/24, with debt-service costs reaching R338.6 billion in that year. “Our borrowing requirement,” he conceded, “will remain well above R500 billion a year over the medium term. Gross loan debt will increase from R3.95 trillion this year to R5.2 trillion in 2023/24.” The budget deficit is projected to contract from R689.8 billion in 2020/21 to R377.9 billion in 2023/34.

As the largest economy on the continent, the Treasury is looking for cost-effective solutions to raise funds. Treasury sources have confirmed that Sukuk will play a growing role going forward as the Debt Management Office seeks to widen the funding universe, tenors and investor profile. Both the planned sovereign domestic Sukuk and the proposed R1 billion debut Sukuk of electricity utility ESKOM with two RFPs already tendered are expected to come to the market in 2021.

Finance Minister Tito Mboweni in his Budget Review in 2020 confirmed that the aim is also to develop the rand sukuk market and a yield curve. He wants South Africa to capitalise on issuing Africa’s first sovereign benchmark international US$500 million Sukuk in 2014, and to emulate that in the domestic bond/Sukuk market.

In fact, 2021 has seen a resurgent interest in Islamic finance in Africa. International rating agencies Moody’s, Fitch and S&P and various multilaterals have all published reports recently highlighting this potential albeit with the usual caveats.

The Islamic finance industry in general has shown remarkable resilience in the wake of the COVID-19 pandemic. They like most other banks received generous financial support from Treasuries and regulators. Globally no Islamic bank collapsed over the last year. On the contrary there been creative consolidations through mergers in Saudi Arabia (National Commercial Bank and SAMBA Financial Group), Indonesia (BNI Syariah and Bank Syariah Mandiri) and UAE (Dubai Islamic Bank (DIB) and Noor Bank) creating mega challenger banks to the global majors.

DIB already has a gateway footprint in Africa through its subsidiary headquartered in Nairobi. Mboweni too in his budget speech stressed that the government is working towards promoting South Africa as a financial gateway to continental Africa especially in the wake of the starting of operations of the Accra-headquartered African Continental Free Trade Area (AfCTA), the world’s newest and largest free trade area, on 1 January 2021.

Sukuk is one asset class that has maintained its poise during the 2020 pandemic paralysis with an estimated US$155 billion in 2020 slightly down on the US$167.3 billion in 2019. S&P forecast global Sukuk issuance to increase to over US$155 billion in 2021 while others project even higher volumes closer to US$200 billion.

Africa has been left behind in Sukuk issuance. According to the Islamic Financial Services Industry Stability Report 2020, global sukuk outstanding totalled US$543.4 billion at end 2019, of which South East Asia and the Middle East accounted for US$520 billion. Africa accounted for a mere US$1.8 billion.

“Islamic banking,” says Moody’s “has made little headway in Africa despite the continent’s large Muslim populations. Sub-Saharan Africa (SSA) has around 18% of the world’s Muslim population but its Islamic finance assets make up only 1% of such global assets. The reasons include low levels of banking inclusion, low public awareness, limited domestic savings, and – until recently – scant government attention.”

But these are changing times. “We expect Islamic banking assets in Africa to increase noticeably,” maintains Sean Marion, MD-Financial Institutions at Moody’s. “Africa has huge potential for growth in Islamic banking due to large Muslim populations, a low starting base and growing government interest in the sector. For governments, sector expansion would diversify the funding sources of their economies and reduce financing shortfalls exacerbated by the pandemic.”

To him, Egypt, Morocco, Sudan, South Africa, Nigeria and Senegal will lead this growth trajectory in Africa. They (except South Africa) have large Muslim populations and existing and/or rapidly evolving regulatory and supervisory structures in place for rapid growth. They (except Egypt) also have a history of Sukuk issuance. South Africa, Morocco, Egypt and Nigeria have the largest banking systems in Africa. South Africa also has the most developed capital market and bond issuance infrastructure on the continent.

According to Marion, “African governments have increased their presence in Islamic capital markets in recent years with numerous debut sukuk in 10 countries.” This follows the adoption of the requisite regulatory and legal frameworks. “We expect the continent’s vast financing needs, which were exacerbated by the pandemic, to encourage governments and – to a lesser extent – banks, to step up their issuance of sukuk,” he added.

Islamic finance in Africa can be classified in general into three categories – countries in which there is proactive policy and regulatory support such as Sudan, Senegal and Djibouti; countries which are indifferent but prepared to develop it as a niche industry including Kenya and South Africa, and countries which ought to be major players but are held back due to political sensitivities such as Nigeria.

The effectiveness of sukuk as an infrastructure financing instrument, lauded by the G20, IMF and World Bank, is best illustrated by the Nigerian experience. Abuja raised N362.557bn in three sovereign sukuk between 2017-2020 to finance the construction or rehabilitation of 25 arterial roads in Nigeria. This brought tangible real economy, capital market and financial inclusion benefits for individuals and companies.

And yet President Muhammadu Buhari had to justify to his Presidential Economic Advisory Council (PEAC) why his Debt Management Office at the Finance Ministry had to borrow through Sukuk to finance the road projects. “We have so many challenges with infrastructure. We just have to take loans to do roads, rail and power, so that investors will find us attractive and come here to put their money,’’ he emphasised.

The barriers to entry for Islamic finance are both structural and behavioural, and not due to religious sentiments. Here market penetration was driven by proactive government support through equity holdings, requisite legal and regulatory frameworks, tax incentives and market education, or initially stifled by secular considerations but is now seeing traction due to its growing maturity and contribution to consumer finance and GDP. 

African countries, says Moody’s, are starting to put the enabling laws and regulations in place to facilitate Islamic finance. However, constraints remain – legislative complexity and lengthy processes associated with sukuk issuance; the need to identify physical collateral; complex documentation required for Islamic financial products; limited product offerings; and new tax laws that would allow equal fiscal treatment of Islamic finance products with conventional banking products.

The challenge for market penetration should not be underestimated. In North Africa, with its 90% plus Muslim population, there are only 13 Islamic banks out of a total of 107 banks. Islamic assets, according to Moody’s, have a paltry market share of total banking asset of only 0.5% in Morocco, 5.5% in Tunisia, 2.8% in Algeria and 5% in Egypt.

Some observers feel that the post-COVID recovery is increasingly being driven by resurgent trade and investment relations, and Islamic finance – especially trade and infrastructure finance – can play a vital role, especially in emerging markets in Africa and Asia.

The UAE and Kenya are leading from the front in boosting Afro-Arab trade and investment, judging by the high level turn out of the 4-day Dubai Week in Africa 21 virtual trade summit in mid-February 2021. Africa has a market of 1.2 billion people and a combined GDP of US$2.5 trillion.

GCC countries are particularly keen to leverage opportunities resulting from the launch of the AfCTA, whose estimated potential could unleash a free trade zone projected at US$2.5 trillion by 2030, and the Halal economy including Islamic finance. Already Abu Dhabi’s wealth fund, ADIA with assets totalling $610bn, is targeting long-term investments in Africa.

A major driver of Afro-Arab trade and investment is the Islamic Development Bank (IsDB) Group through its various multilateral funding and credit insurance programmes. The 57-member IsDB, of which 28 members are from continental Africa, is a strong promoter of the compelling ‘Made-in-Africa’ story. Its trade fund, ITFC in December 2020, launched a new standalone Letter of Credit (LC) Confirmation instrument as part of its strategy to expand its private sector interventions, now open to SMEs in 28 African economies. The aim is to boost exports in line with the IsDB Group’s ambition of boosting intra-Islamic trade which current stands around 25% to total trade.

“With this LC Confirmation instrument, ITFC is demonstrating the important role that Islamic trade finance products and solutions have in levelling the playing field for developing markets that seek to participate in the global economy. This provides much-needed support for exporters, the issuing banks and as a consequence, serves to provide strategic trade finance support where and when it is needed most during the COVID-19 pandemic and beyond,” explained Hani Sonbol, CEO of ITFC.

ITFC in collaboration with Afreximbank and the Arab Bank for Economic Development in Africa (BADEA) have also recently launched a $1.5bn Collaborative COVID-19 Pandemic Response Facility (COPREFA) to support African economies with rapid financial assistance to reduce the impact of the pandemic.

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