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Friday, September 23, 2011


Abstract: The paper looks at the feasibility and benefits of introduction of Sukuk into the Nigerian capital market. The paper argue that Nigeria will gain a lot of economic and financial advantages by using Sukuk as an alternative source of funding, that is to run concurrently with the conventional bond instruments. A brief overview of the global Sukuk market was provided as well as a look at the Nigerian debt market. 

    The recent trends around the world that led to increase in sophistication and diversification of global debt market in the face of global economic turmoil and political uncertainties especially the revert to revolution in Middle east, failed democracy and poverty in sub Saharan Africa, and moves toward democratic dictatorship elsewhere warrant the writing of this piece. In order to relate all these to the presence Nigerian predicaments. Debt market, especially sovereign debt market that Nigerian government debt falls into, is a market that always shows the full characterization of a global institution. For example, despite the not so distance cancellation of Nigeria’s foreign debts in 2005 by the Paris club, foreign debt still account for some 30 to 40 % of Nigeria’s total debt. Global financial centers such London, Luxemburg, New York, and Hong Kong have continued, unabated, to process trillion of Dollars of financial debt that help in oiling the wheels of world economic growth. The world capitalist financial set up come under it heaviest toll since the great depression of the 1930s in the last three to four years, this has left a far reaching foot print on the world debt market, attracting hundreds of down grading from rating agencies. Despite the last global financial crisis, the global debt market continues to grow in various directions and remains the most innovative segment of the world financial industry. 
     Unlike most oil rich countries, Nigeria has big population majority of which are poor and deprived. According to some estimates about 70% of Nigeria’s populations are poor, with high infant mortality rate, and high rural-urban migration rate. Nigeria has the lowest GDP per head among the member countries of Organization of Petroleum Exporting Countries (OPEC) of about $2,500, in 2010 estimate. About 70% of Nigeria labour force is employed in agriculture which is in decade long decline; couple with high rate of infrastructural decay. Total gross fixed investment as at 2010 stands at 11.6% of the GDP, constrained by big obstacles like fluctuating inflation and interest rates. In term of electricity supply Nigeria is ravaged by one of the worst electricity supply problems in the Sub Saharan Africa, with total supply fluctuating between 2,000 to 4,000 mega watts since the return to democracy in 1999. On it decade long return to democracy, Nigerian performance is no better than what is obtained in other Sub Saharan African countries. All the past three general elections were characterized by large scale election rigging and manipulation in order to maintain the superiority of one political party against those in the opposition. Thus, the political terrain is still highly risky and full of uncertainties. Nigeria is perceived among it neighbors as a big power, due to its large population and oil wealth. It is against these back grounds that this piece is going to explore the workability of Sukuk as an alternative source of debt for the Nigerian government. The article is divided into introduction, defining what is Sukuk, a look at Sukuk issuance around the world, the Nigeria bond market, why Nigeria should enter the Sukuk market, and conclusion.  

        Sukuk is an Arabic word that has it root from the word Sakk that means financial instrument or check (in fact the modern cheque originated from this Arabic term, for example see, the article ‘Muslim Scholars and the History of Economics: A Need for Consideration’ in American Journal of Islamic social sciences, vol 4; written by Abbas Mirakhor). In modern financial terminology, Sukuk is commonly refers to as Islamic Bond, meaning a financial certificate that comply with Islamic law. This means that unlike conventional bond, Sukuk does not give room for the charging of interest rate. One clear distinction on the structures of a Sukuk instrument is whether it is Asset based or Asset backed. Majority of the Sukuk issued to date are asset based. Conventional bond, in contrast to Sukuk, represents the issuer’s pure debt, while Sukuk represent ownership stake in an underlying asset (Cakir and Raei, 2007). 

Some common feature of Sukuk according to Professor Wilson include,
         • Transparency and clarity of rights and obligations;
         • That income from securities must be related to the purpose for which the
            funding is used, and not simply comprise interest; and
         • That securities should be backed by real underlying assets, rather than
            being simply paper derivatives.
   According Accounting and Audit Organisation for Islamic Financial Institutions (AAOIFI) there are 14 different types of Sukuk allowed by Shariah. Some important types of Sukuk include, Salam Sukuk, Ijara Sukuk, Istisna’a Sukuk, Hybrid Sukuk, as well as Mudarabah and Musharakah Sukuk. Ijara Sukuk still remains the most popular type of Sukuk issued so far, accounting for some 44% of the total issue. Next in importance to Ijara are Sukuk Musharakah and Mudarabah. The market for Sukuk is rapidly expanding making it one of the fastest segments of Islamic finance. Like it conventional counterpart Bond, Sukuk have both primary and secondary markets, though the secondary market is still in infancy stage. The first Sukuk issue was done by Pakistan under Mudaraba companies’ ordinance act of 1981(Wilson, 2009). 


The history of Sukuk issuance has remained very interesting from 1980s when government such as that of Pakistan (during the move toward the Islamization of the economy) and Malaysia (when the government moved to support the nascent Islamic finance industry) were searching for Shariah compliant alternatives to conventional bond market, to date when the Sukuk market is increasingly been recognized around the world as really revolutionary and innovative contribution coming from the Islamic world. This is not to leave aside the contributions of the Islamic Development Bank (IDB) base in Jeddah Saudi Arabia in all these. IDB is a pioneer in the development of Sukuk market globally, from the role of issuer to that of being an incubating ground from where most of the researches and ideas that give rise to the Islamic capital market originated.  For example, the IDB’s Islamic Investment Portfolio (IBP) and the Unit Investment Fund (UIF) have played an important role in providing Shariah compliant channels of investment to the Islamic finance industry during the late eighties and early nineties. The Sukuk certificates so far issued by IDB have remained the most rated Islamic bond in the market with AAA ratings and always oversubscribed when issued. The current ones issued by IDB trust services Ltd and IDB Tadamun services Berhad remained the darling of Islamic bond market investors.
There is no way you will talk about the evolution of Sukuk market without touching on the significant role Malaysia played in it development. The Malaysian case is unique in that of all the countries in the world that aspire to become a force to be reckoned with in the area, Malaysia then and now provided the nascent market with all the support it needed to develop. The first attempt to overcome the liquidity problem facing Islamic banks, argues Wilson (2005) was undertaken by Bank Negara Malaysia (the Central Bank) in July 1983, after the first Islamic bank in Malaysia began operations. Thereafter in 1994 the first Islamic inter bank market was lunched in Kuala Lumpur in 1994. According to some estimates from Bank Negara Malaysia (Malaysian Central Bank), Malaysian Sukuk Issuance account for about 39% of the global issuance as at 2009. This put Malaysia in number one position, followed by United Arab Emirate (UAE) with 28%. In Malaysia itself Islamic bond account for about 40% of the total bond market as at 2010 with conventional bond accounting for the rest, another pointer to the increasing manner in which Sukuk is encroaching into the conventional bond space. Next door to Malaysia, Indonesia has entered the Sukuk market with issuance of Sukuk instruments in order to raise capital needed for the development of the Indonesian economy. According to estimates, Indonesia, despite it recent entry into the Sukuk market, account for some 2% of the total Sukuk issuance.
    United Arab Emirates is next to Malaysia in term of the total Sukuk issued worldwide, accounting for about 28% of the total as at 2009. UAE remain the biggest US Dollar dominated issuer of Sukuk. Dubai International financial Exchange (DIFX) account for some substantial number of the total Sukuk issuance in UAE. A lot of these Sukuks from the UAE are from corporate bodies with a state guarantee in the back ground. Saudi Arabia and Bahrain are other very active players in Sukuk market who have between them, so far issued Billion of Dollars worth of Sukuk. Currently Saudi Arabia stands as number three in the world Sukuk total issuance with Bahrain coming as fourth. In 2001 Bahrain offered the first government bills that were developed in line with Islamic laws in the Middle East (Wilson, 2005). In 2004 Saudi Arabia introduced a new capital market authority to help incorporate Islamic issues into the mainstream. Bahrain wants to be the capital of Islamic finance in the Middle East as Malaysia is in South East Asia. With AAOIFI suited in Bahrain while Islamic Development is based in Jeddah Saudi Arabia the two have important role to play in shaping the future of Islamic finance. Other Gulf countries such as Qatar and Kuwait have also been very active in the Sukuk market, as at 2009 each of them have contributed 3% of the total Sukuk issue globally. In October 2003, Qatar issue $700 million Dollars worth of Sukuk the largest of such type of issue at that time.
     Pakistan is a historic player in the development of Islamic finance worldwide. It has at one time or the other issue various type of Islamic financial instruments in the last two decades. Not very long ago the Pakistan International Sukuk company issued a Sukuk of $600 million in 2005. The Pakistan Water and Power Development Authority (WAPDA), a government agency, have in the recent past issued a Sukuk of $134 million to help finance Mangla Dam project with maturity of 7 years. In 1980 Pakistan issued the first Mudarabah certificate successfully (Al-Omar and Abdel-Haq). Germany is the first non-Muslim country to issue Sukuk, when the state of Saxony-Anhalt issued Euro dominated Sukuk of 100 million in the year 2004. Since that German issuance other countries have been rushing to tap into the Islamic Bond market. The list includes United King Dom, Japan, China, Singapore, Hong Kong, Australia, Russia and others. Despite the global economic slow down the double digit rate of growth of the Islamic Sukuk market continue unabated. According to Moody, a rating agency, the global market for Islamic finance in the near future is going to be in the range of $4 trillion making it a very significant player in the global finance industry. 
       The importance of public debt sustainability in maintaining economic growth and development can not be over estimated, especially in a developing economy like that of Nigeria. The debate about the right or sustainable level of debt Nigeria should maintain has been on and off. It was brought to the spotlight once again last year when Jonathan administration tried to secure a foreign debt facility of about $500 million Dollars to implement some developmental programs, according image makers of the regime. The argument then was looking at how Nigeria narrowly escaped debt burden with its debt cancellation arrangement with Paris club in 2005, why should Nigeria rushed again to accumulate another foreign debt. The public pressure then force the government to consider other alternatives like short term foreign liquidity facility, long term debt, as well as domestic borrowing. The general feeling among the Nigerian public is of distaste against foreign debt, because of the believe that it was responsible for the hardships Nigerians undergone during the 1980s and 1990s. But, government officials still believe that looking at the current level of debt there is still more room for government borrowing in order to implement desire projects. But the question we are asking, too, is how innovative is Nigerian government in securing its debts? What is the cost of foreign debt facility visa vi that of domestic borrowing especially one arranged through issuing domestic bonds? What is the portfolio balance of Nigeria’s foreign to domestic debts stock?
     The global bond market is right now tense with Euro zone and US some of the hardest hit by the crisis. This has compounded Nigeria situation especially when it comes to Eurobond borrowings as it has implication on the cost of borrowing. Currently, the federal government ten year Eurobond of $500 million attract coupon rate of about 6.75%, as at September 2, 2011 according to data from the debt management office. Naira dominated bond issued for the domestic market attract interest of between 11 to 12%. Nigeria’s total domestic debt stood at N 5,210,437,263,000.00 with federal government bond contributing about 62.88% of the whole. At around 20% of the GDP Nigeria’s debt is still below the limit set for its debt to enter the zone of non sustainability. All along Nigeria has two major sources of Debt, domestic Naira dominated and Eurobond. But this may not be enough, Nigeria has to be very innovative by looking at other alternative sources of fund. In a period when investors are increasingly concerned about the safety of their investments, thus, the present concern with diversification of their portfolios, Nigerian authorities should follow their inner thinking and tap the markets where they are rushing to put their money. As Mirakhor and Zaidi (2004) persuasively argued in the case of Pakistan, “external borrowing permits a country to maintain domestic investment at levels beyond those that could be financed through domestic saving alone. If these resources have been channeled into productive capital accumulation, these investments could be expected to generate the stream of returns required to repay the original loans”.
But the fear for Nigeria as it was for Pakistan is that the authorities may not have the foresight to restrict the use of the money to only the most accountable investments.


    There are many reasons why Nigeria shall embrace the Islamic bond, Sukuk. The fact that the global debt market is facing some kind of supply hiccups, forcing countries around the world to look for alternatives is enough justification for Nigerian government to look in the way of Sukuk as alternative source of funding. But there are many other reasons why Nigeria shall tap into the Sukuk market among which is the need for reliable and cheaper alternative source of fund, in which case Sukuk is the answer. The large reserve of Surplus cash available in the Middle East should be tapped by Nigeria as others are doing. Like Nigerian economy itself, the market for Sukuk is young and growing at double digit making it one of the fastest segments of international finance. With interest bearing bond becoming increasingly costlier and difficult to arrange, Sukuk with its elimination of interest and substituting it with rent or profit sharing is cheaper and tailored to benefit both sides. As aspiring regional hub for financial transactions Nigeria can not allow this historic opportunity to pass her and go to another country, probably Senegal, Ivory Coast, or Ghana. Other global financial centres like London, Hong Kong, Dubai, Singapore and Luxemburg have been on the rush to get their cut of this promising market. Coming to the issue of negative effects of interest rate on our economy, Interest rate was the major factor responsible for the accumulation of Billions of Dollars of Nigeria debt during the 1990s; that is enough a reason for Nigeria to embrace a system that do not allow that. Past high interest charges are at the heart of Greece present predicament. Under Sukuk both the issuer and issuee share in the underlying risks and it does not allow for the kind of deadly derivatives that caused the last global financial crisis of which are interest rate swaps and securitization of toxic assets.
      As Nigeria is preparing to lunch it own Islamic non interest banking system, Sukuk market will provide the needed instruments to manage liquidity in the banking system. It will act as a channel through which Islamic bank can invest their money for both short and longer term and generate good returns that comply with Shariah. This, too, will increase the amount of fund government can generate to finance it projects. As we well know that because of religious justifications there are many rich Nigerian Muslims that cannot invest in interest bearing bond. Thus, with the introduction of the Sukuk instruments federal government will be able to tap this vast amount of cash and use it to finance it projects. These Sukuk instrument, as with conventional bond, can be subscribed to by both corporate institutions like banks and private individuals. Unlike conventional bond, argued Tariq (2004), “Investing in Sukuk issuances involves the funding of trade or production of tangible assets. Sukuk are directly linked with real sector activities. Hence these will not create short-term speculative movement of funds and potential financial crises”, which is not uncommon in the conventional financial arrangement.  In addition to this Sukuk has the advantage, which is unique to it, of linking the investor directly with holding in the asset thereby making him a shareholder in the underlying assets, unlike in the case of bond where the bondholder is some kind of an outsider. Looking at the different range of debt instruments available in the Nigerian capital market, it is a kind of logical progression for Nigeria to introduce Islamic capital market instruments.
    In a 2007 IMF paper by Cakir and Raei (Working paper, wp07237) that measured the viability of Sukuk as an alternative source of ‘investment/financing instruments’, the study try to find out the portfolio diversification benefits of investing in Sukuk by comparing the Sukuk market to that of Eurobond in some selected countries. The study finding is that there are real and significant gains to investing in Sukuk. World wide, the recent issuance of different kinds of Sukuk instruments and their subsequent over subscription is another pointer to the increasing global demands for Sukuk. The fact that countries in the developed and emerging parts of the world are in hurry to issue their own sovereign Sukuk is additional indication of the future prospect of the market. The resilience of the Islamic finance industry during the last global financial crisis has helped in winning a lot of convert to the System. Conventional capitalist institutions, that before the crisis had no plan of entering the market, have now entered or are planning to enter. With continue innovation that churns out new products into the market, Islamic finance contribution to the development of capital market in developing and emerging economy will continue unabated.

     As an emerging African economy with potential to be among the 20 largest economies in the world in the foreseeable future, Nigeria cannot afford to play with an opportunity that will help her in the realization of that aim. Like Malaysia is currently using Islamic finance to help her in realizing it vision 2020:20 and is in the course of achieving it, Nigeria should use the same to achieve it own 2020:20. In order to make these possible the central bank shall liaise with both the ministry of finance and debt management office to develop the needed infrastructures for the development of Sukuk market in the country. And, Nigeria should welcome partnership with other countries that are in advanced stage of the development of Sukuk market in their respective financial centres. But in order to avoid what happened in the case of the introduction of Islamic banking in Nigeria, the general public need to be well enlighten about positive benefits of the introduction of Sukuk.

Al-Omar, F. and Abdel-Haq M. (1996), “Islamic Banking: theory, practice  and challenges”, Zed Books, London
Alvi, I. (2006), “Review on Several Sukuk Products Issued Worldwide”, KLIFF Malaysia
Cakir, S. and Raei, F. (2007), “Sukuk vs. Eurobonds: Is there a difference in Value-at-Risk? IMF working paper, WP/07/237
Mirakhor, A. and Zaidi, I. (2004), “Foreign Currency Deposits and International Liquidity Shortages in Pakistan”, IMF working paper, WP/04/167
Sukuk Market by Bank Negara Malaysia: Academic visit by INCEIF’s CIFP Student, 30 October 2009
Tariq, A. (2004), “Managing financial Risks of Sukuk Structures”, Unpublished Thesis Loughborough University, UK
Wilson, R. (2004), “Islamic Bonds: Your Guide to Issuing, Structuring and Investing in Sukuk”, Euromoney Books

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