We expect the top three sukuk issuers in Africa--South Africa, Egypt, and Nigeria--will continue to play a role in Islamic finance. Rated African sovereigns' sukuk issuance amounts to almost $4.3 billion and has accounted for more than two-thirds of Africa's total issuance of $6.6 billion since 2014. The increase in local-currency sukuk issuance, which results from tighter external financing conditions, will help the pricing of sukuk that are issued by the private sector. Private sukuk issuance is still nascent and accounts for about 5% of total sukuk issuance in Africa. Some companies have also issued sustainable sukuk.

Sukuk Are No Panacea

The complexities and evolving Sharia 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 Africa's infrastructure deficits, which are compounded by climate change and energy transition risks, lead to investment needs of $130 billion-$170 billion 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 the related complexities did not justify the endeavour, in their view.

Sukuk issuance remains low.   African sovereigns turned to domestic capital markets after high global interest rates and geopolitical risks hampered access to international eurobond markets. As a result, total sukuk issuance in Africa increased to $3.0 billion or less than 2% of global volumes in 2023, from $950 million and 0.5%, respectively, in 2022, while global sukuk issuance decreased to $168.4 billion, from $179.4 billion in 2022. Egypt, South Africa, and Nigeria were the only African sovereigns that issued sukuk in 2023.

African sovereigns are willing to leverage Islamic finance to broaden their investor base and attract foreign investors.   We estimate African sovereigns have issued $6.6 billion in sukuk since 2014 (see chart 1), two-thirds of which were local-currency sukuk. We believe African sovereigns, which contributed less than 1% to total global sukuk issuance since early 2000, have not reached their full potential yet, especially considering their infrastructure investment needs. South Africa, Egypt, and Nigeria have accounted for more than two-thirds of Africa's sukuk issuance since 2014.

Chart 1

African sovereigns kept it simple by issuing mainly ijara sukuk and shying away from more complex hybrid structures.   Ijara sukuk, which are based on a sale and leaseback structure, have been priced in line with similar government bonds. African sovereigns aim also to capture investors' interest by increasingly issuing sustainable sukuk, with a focus on affordable housing, energy, and water supply, among others.

Country Spotlight

Egypt: Home of Africa's largest sovereign sukuk issuance

In February 2023, Egypt's debut sukuk, which is part of the country's $5 billion sukuk program, raised $1.5 billion. The transaction was three times larger than South Africa's debut sukuk in 2014 and, just like South Africa's inaugural sukuk, four times oversubscribed. This means global investors', especially Gulf-based investors', appetite for foreign-currency denominated sukuk is large. The Egyptian government aimed to bridge budget financing gaps with the sukuk proceeds. Although the three-year instrument has a high yield of 10.88%, its pricing is similar to Egypt's three-year government bonds. Egypt, which could return to the sukuk market in 2024, aims to simplify access to sukuk by making the approval process for corporate sukuk easier. That said, a sovereign sukuk yield curve, which is necessary to price corporate sukuk, does not exist yet.

South Africa: Back on the market

After a long absence, South Africa returned to the sukuk market by issuing a local-currency sukuk in November 2023. Its debut five-year sukuk of $500 million dates back to 2014. The latest sukuk issuance comprises a South African rand (ZAR) 20.4 billion ($1.1 billion) four-tranche transaction that was 1.7 times oversubscribed. Various tranches were priced at 9.87%-11.9%, compared with 8.60%-9.78% for five-year and 10-year South African government bond yields. Foreign investors' involvement in South Africa's latest sukuk issuance was limited. We note that the South African government's sukuk are eligible for the South African Reserve Bank's open market operations, which supports their liquidity. Yet, limited supply hints at a passive investment strategy, at least for now. South Africa's most recent sukuk issuance also has a social element that requires mandated banks to abide by the broad-based black economic empowerment program. We expect to see more social and sustainability-driven sukuk as authorities incentivize investors to support decarbonisation and sustainability goals. South Africa could use sukuk to partly finance its 20-year energy transition plan, which will likely require investments of almost $100 billion over the next five years.

Nigeria: Promising and frequent issuer

We expect Nigeria will continue its funding strategy of moderate local-currency sukuk issuances. Nigeria has issued sukuk frequently since the debt management office (DMO) incorporated the instrument in its funding strategy in 2016 (see chart 2). The oversubscription rate tends to be high, which underpins domestic investors' appetite for sukuk. Nigeria's DMO started issuing sukuk in 2017 to diversify its funding sources, improve financial inclusion, and increase domestic liquidity, with the objective to build a sovereign sukuk yield curve. The size of the DMO's sukuk issuances depends on the magnitude and development stage of the projects Nigeria aims to fund. Ijara sukuk have been earmarked exclusively for the construction and reparation of roads and bridges. We believe Nigeria has not tapped into the full potential of sukuk yet, especially in light of its large infrastructure funding gaps--70% of roads in the country are unpaved--and the interest from a diversified domestic investor base, including retail investors.

Chart 2

Nigeria's initial issuance target of NGN100 billion-NGN250 billion ($120 million-$300 million) to finance specific road infrastructure projects was moderate.   Yet, the government managed to raise a total of NGN1.23 trillion over 2017-2023. Nigeria's first two sukuk issuances were only slightly oversubscribed but the subsequent ones attracted an oversubscription rate of 4x, leading the government to upsize its funding targets and allocations. To date, total sukuk issuance amounts to the equivalent of $1.37 billion (NGN900/$1). Nigeria issued a NGN150 billion sukuk in October 2023 and allocated an additional NGN200 billion for road and bridge projects, considering the NGN653 billion subscription. Investors' strong appetite for sukuk leads to better pricing and listings on the Nigeria Stock Exchange and the FMDQ securities exchange.

Nigerian local governments' sukuk issuance was modest.   Osun State was the first local government to issue sukuk in 2013, raising NGN10 billion (equivalent to $60 million at the time and fully repaid). A decade later, Lagos State, the country's economic and financial hub and home to Nigeria's largest local government, completed a NGN20 billion ($22.2 million) sukuk issuance, which was part of a large debt and hybrid instrument program. Both local governments' issuances were oversubscribed. The government-related entity Family Homes Funds also issued a NGN20 billion ($22.2 million) sukuk to finance affordable social housing.

Corporate sukuk are on the rise.  Since 2019, corporate pension funds in Nigeria broaden their investment scope to include sukuk, which help increase fund diversification. Corporate sukuk issuance remains low but benefits from the need to channel long-term funding to the private sector, especially the manufacturing and energy sectors, to support the economic recovery. As part of a NGN100 billion program, TajBank Ltd. listed its NGN10 billion AT1 sukuk on the Nigerian stock exchange in 2023, after raising NGN11.4 billion. This paves the way for additional sukuk issuances. Nigeria-based clean energy start-up OneWattSolar issued the first green sukuk for NGN1 billion in 2021. The largest industrial conglomerate Dangote Group also explored sukuk prior to 2020 but paused its plans because of the COVID-19 pandemic.

Kenya: Sovereign sukuk issuance still pending

In September 2023, a property developer issued Kenya's first sukuk for Kenyan shilling (KES) 3 billion ($20 million) at a return of 11.13% to fund social housing. Kenya has not yet issued its debut sovereign sukuk, which was expected in 2017-2018, after the country had finalised its regulatory framework in 2016. We believe this could change in 2024 since Kenya's $2 billion eurobond will mature in June 2024. Sukuk could help Kenya to access hitherto untapped liquidity pools and attract foreign investors, including from the East African Community and Gulf countries. Sovereign sukuk could also help Kenya mobilize savings (17% of GDP), diversify investment opportunities, and, ultimately, establish a sovereign benchmark for corporate sukuk prices.

Sukuk Didn't Live Up To Africa's Investment Needs

Most African countries lack basic infrastructure, such as electricity and water supply, to support their sustainable long-term economic and social development goals.   The African Development Bank estimated infrastructure investment needs of $130 billion-$170 billion per year, with the financing gap representing two-thirds of that amount. Yet, sukuk issuance on the continent is low. African countries use sukuk to upgrade existing power plants, water stations, and dams (South Africa), or build roads (Nigeria).

In our view, not all African sovereigns will prioritize sukuk to finance their investment needs.   Instead, we believe they will turn to conventional debt markets or concessional financing. Egypt has been the largest eurobond issuer in Africa, with outstanding issuances amounting to approximately $27 billion, while Kenya, which entered the eurobond market in 2014, had a total of $7 billion outstanding eurobonds in 2023. Sukuk did not attract significant interest because of their complexity and evolving Sharia requirements.

The lack of standardization remains a problem.   Key countries with the potential for active sukuk markets have addressed and clarified the legal framework and tax implications of sukuk by enlisting the help of multilateral financial institutions, including the Islamic development bank and the Islamic corporation for the development of the private sector. Central banks have recognised sukuk as eligible instruments for their open market operations, which means banks can use them as collateral for central bank refinancing. The central banks of Nigeria and Mauritius are the only African central banks part of the international Islamic liquidity management corporation, which was established in 2010 and issues short-term sukuk to help Islamic finance institutions manage their liquidity.

Sukuk are more complex and require longer time to market than conventional bonds.   The potential adoption of the accounting and auditing organization for Islamic financial institutions' (AAOIFI's) Sharia standard 62 could have additional implications on a market that is already fragmented. We understand that Nigeria and Mauritius are among the jurisdictions that adopted the AAOIFI standards. Sukuk require three things above all to become more mainstream and less opportunistic: simplification, the clarification of risks, and long-term visibility on Sharia standards.