SUKUK AS AN ALTERNATIVE SOURCE OF FUNDS FOR THE

NIGERIAN GOVERNMENT

BY

SHAFIU IBRAHIM ABDULLAHI

KANO, NIGERIA
afgafaga@yahoo.com
 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
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.

INTRODUCTION
The recent trends around the world that saw the increasing 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, lame duck
democracy and poverty in sub Saharan Africa, and moves toward democratic
dictatorship elsewhere warrant the writing of this piece; to relate all this to
Nigerian present predicaments. Debt market, especially sovereign debt market
that Nigerian government debt falls into, is a market that always shows the
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 continue, 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 a 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’s 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, been constraint 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
obtain in other sub Saharan African countries. All the past three general elections
were characterized by large scale election riggings and manipulation in order to
maintain the superiority of one political party against the others in the opposition.
Thus, the political train 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, what is Sukuk, a look at Sukuk issuance
around the world, the Nigeria bond market, why Nigeria should enter the Sukuk
market, and conclusion.

WHAT IS SUKUK?
Sukuk is an Arabic word that has it root from the word Sakk that means
financial instrument or check (in fact the modern check 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).

A LOOK AT SOVEREIGN ISSUANCE OF SUKUK BY COUNTRIES

AROUND THE WORLD
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 in itself, 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 so far issued by IDB has remained the most
highly rated Islamic bond in the market with AAA ratings and always
oversubscribed. The current ones issued by IDB trust services Ltd and IDB
Tadamun services Berhad still remained the darling of Islamic bond market
investors.

There is no way you will talk about the evolution of Sukuk market without
touching the significant role Malaysia played in it development. The Malaysian
case is unique in that of all the present 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 issue
worldwide, accounting for about 28% of the total as at 2009. UAE still 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 kind
of 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
issues a Sukuk of $600 million in 2005; and Pakistan Water and Power
Development Authority (WAPDA), a government agency, have in the recent past
issue 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 some few 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 NIGERIAN BOND MARKET

The importance of public debt sustainability in maintaining economic growth
and sustainability 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 limelight once again
last year when Jonathan administration try 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
recent Nigeria narrowly escaped debt burden with the 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 many alternatives, short term foreign liquidity facility, long term debt,
as well as domestic borrowing. The general opinions among the Nigerian public is
that of distaste against foreign debt, because of the belief that it was responsible
for all the hardships Nigerians under go during the 1980s and 1990s. Government
officials still belief that looking at the current level of debt in the country 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 and 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 will have 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, 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 concern about the
safety of their investment, thus, the present concern about diversification of their
portfolios, Nigerian authorities should follow their thinking and tap these other
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 needed
investments.

WHY NIGERIA SHOULD ENTER THE SUKUK MARKET

There are many reasons why Nigeria should embrace the Islamic bond, Sukuk.
The fact that the global debt market is facing some 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 should tap into the Sukuk market
among which is the need for reliable and cheaper alternative source of fund, in
which case Sukuk is all this. 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 it 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. 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 that
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 know because of religious justifications
there are many rich Nigerian Muslims that cannot invest in interest bearing bond;
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, argue
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) to measure
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 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 help 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 churn out new products into the market, Islamic
finance contribution to the development of capital market in developing and
emerging economy will continue unabated.
 CONCLUSION
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 any opportunity that will help her in the realization of that. 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 should 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 more advance stage
of the development of Sukuk market in their respective financial centres. But in
order to avoid what happen in the case of the introduction of Islamic banking in
the country, the general public need to be well enlighten about many positive
benefits of introduction of Sukuk.

Bibliography

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”,
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Wilson, R. (2004), “Islamic Bonds: Your Guide to Issuing, Structuring and

Investing in Sukuk”, Euromoney Books

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http://www.economist.com

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http://www.sukuk.me

http://www.saudigazette.com.sa

http://www.dubaichronicle.com

http://knowledge.wharton.upenn.edu/arabic

https://www.cia.gov/library/publications/the-world-
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