Can the Middle East Play a Larger Role in Financing Africa’s Infrastructure Gaps?
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an the Middle East Play a Larger Role in Financing Africa’s Infrastructure Gaps?
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By Bathsheba Asati, Research Associate Botho Emerging Markets Group
June 10, 2021
Africa’s infrastructure financing gap now stands at over $170 billion per year, with the continent falling behind other regions in electricity and internet connectivity, transport and energy infrastructure. By the end of 2019, more than 270 million Africans lived in areas lacking internet and mobile network coverage. By 2030, nine out of every ten people without access to electricity will be in Sub-Saharan Africa. To fill these connectivity and infrastructure gaps, many of the region’s governments have returned to debt financing—creating a cycle of chronic over-indebtedness. There is a growing need for sustainable financing models to avoid further deepening this debt crisis. Sovereign Sukuks may be just the solution to sustainably finance infrastructure projects on the continent. As Middle East-based investors expand their African footprint, Middle Eastern and African countries should collaborate to create Sharia-compliant structures like Sukuk bonds to facilitate investments into the continent.
Sukuk bonds are Sharia-compliant instruments that represent a direct asset ownership instrument and are better suited for infrastructure financing when compared to conventional bonds. Sukuks represent proprietary rights to an asset from which investors can receive profits while conventional bonds create a debt obligation on which the borrower pays back interest in addition to the principal amount. The pricing of Sukuks is predominantly based on the value of the underlying asset, which gives the issuer more negotiating power when structuring these bonds. Contrarily, the pricing of conventional bonds is heavily dependent on credit ratings, which have been criticised to be harsher towards African borrowers. Sukuk bonds also have more risk-sharing provisions between the issuer and investors. For instance, the principal amount repaid to investors is dependent on the market value of the asset and not the initial amount invested—meaning that investors may receive less or more than their initial investment if the value of the asset changes. Because of their asset-based nature, Sukuks are a suitable financing option for African countries looking to boost their infrastructure without accumulating overwhelming debt burdens.
The Sukuk market outside Muslim countries is still young, but evidence from recent issuances indicates significant interest from investors, especially those from the Middle East. In 2014, the UK became the first country to issue a Sukuk bond outside the Muslim world. The £200 million bond was more than ten times oversubscribed; investors placed orders of over £2.3 billion. On the continent, Senegal also issued its first Sukuk in 2014 to raise $168 million in an attempt to become Africa’s Islamic finance hub. Senegal’s maiden Sukuk bond was advantageous to the country in many ways. Firstly, it was denominated in local currency, which eliminated foreign exchange risks that often inflate repayment costs. Secondly, the bond had a positive signalling effect on Gulf investors, indicating that Senegal was keen to create Sharia-compliant opportunities to secure their investment. Similar to Senegal, South Africa’s first Sukuk bond issued in 2014 to raise $500 million allowed the country to tap into funding pools from the Middle East. Fifty-nine percent of the investors were from the Middle East and Asia region, twenty-five percent from Europe, and only eight percent were from the United States. Nigeria has also turned to the Sukuk market to raise investment to fund road infrastructure projects and has raised close to $1 billion through three Sukuk bond issuances. One of its issuances was four times oversubscribed, demonstrating the popularity of African-issued Sukuk bonds.
The shift toward Sukuk bonds is very opportune since there is growing interest from Middle Eastern countries to invest in Africa. In 2016, the UAE was one of the largest investors in Africa by capital investment, second only to China. Since then the UAE has remained among the top 10 sources of FDI for African countries. Turkey’s FDI into Africa grew from just $100 million in 2003 to over $6.5 billion in 2021. State-backed agencies have led this charge. For example, the Abu Dhabi Fund for Development has invested over $16.6 billion in diverse projects across 28 African countries. Similarly, the Saudi Fund for Development has also funded multiple projects across Africa, including the rehabilitation of roads and electricity projects in Rwanda as well as Kenya’s Big Four projects. In 2019, Qatar Airways entered into a partnership with the Rwanda Development Board to take up a 60% stake in a new $1.3 billion international airport in Rwanda. Investing in sovereign Sukuks presents an opportunity for the Middle East’s oil-dependent countries to further diversify their economies by investing in infrastructure projects on the continent.
Several African countries are reportedly working towards issuing follow-up or maiden Sukuk bonds to leverage the proven interest from Middle Eastern investors. Egypt’s Cabinet approved a Bill in late 2020, which, if endorsed by the House of Representatives and the President, will enable the country to issue Sukuk bonds. Kenya is also designing policy frameworks to guide its Islamic finance sector as the government prepares to issue its first Sukuk bond. As African governments expand their Islamic financing opportunities, they must pay attention to and resolve existing criticisms that surround Sukuk bonds. One of the key concerns raised is that some Sukuks do not reflect all the precepts of Sharia law, an issue that can weaken the confidence and interest of Middle East investors. To ensure that all bonds issued are Sharia-compliant, African countries with nascent Islamic finance sectors should collaborate with Middle Eastern governments and organizations in structuring Sukuk bonds. This collaborative approach will bolster the credibility of the Sukuk bond among Arab investors and also allow the issuing country to forge strong relationships with potential investors.
There are many advantages for African borrowers seeking to access Sharia-compliant financing, one of which is the openness to issuing bonds in local currencies, which is uncommon in conventional bonds. Moreover, Sukuk bonds not only benefit the public sector but also have positive spillover effects on the private sector. Enhanced relationships between African and Middle Eastern governments create pathways for African private-sector organisations to use Sharia-compliant structures to raise financing from Middle Eastern investors. Reports have shown that the current supply of Sukuk bonds does not meet existing demand. This presents an opportunity for African countries to leverage the deepening ties with Middle East investors and expand their Islamic finance sectors to create more Sharia-compliant opportunities.
By Bathsheba Asati - Research Associate, Botho Emerging Markets Group