Editor’s Note: For this article, North Africa includes Algeria, Egypt, Libya, Mauritania, Morocco, and Tunisia.
It is time to invest in North Africa. Or that is the vibe emanating from Islamic finance circles. Speculative western investors generally fail in comparison to their sharia-compliant counterparts. Or, better put, North Africans better appreciate the emphasis placed on virtue and risk sharing. Yet current risk-sharing may come at a high price.
Economic news out of North Africa is dismal. Tunisia reportedly has a $3.2 billion gap in this year’s budget. Egypt’s projected budget gap is nearly nine times that number at $28.75 billion. The numbers out of Libya are more positive in that its budget deficit is planned at only 4 percent of GDP with a conservative oil price of $90 per barrel. Price per barrel of oil is projected to hover around $100 for next couple years. But such optimism in Libya, bolstered by strong GDP growth, is moderated by the 41.8 percent GDP contraction in 2011.
Since the end of the Arab Spring in North Africa, victorious leaders, specifically in Tunisia and Egypt, have worked anxiously to Islamic-fy their country. Sukuk offerings in both countries are an effort to further that process. Yet postponement inside both governments raises concerns about the potential success of sukuk issues for both countries. Legislation authorizing sukuk issuances in Tunisia has been delayed by parliament as it drafts a new constitution. Similar legislation stalled in the Egyptian parliament as leaders argued over which individual state assets would provide streams of income necessary to back the Islamic bonds. Tunisia has not debated what assets will back their sovereign issue, leaving many investors to assume further delays.
Supporters of Islamic finance argue that sukuk issuances are the correct conservative add-on to a relatively strong region. Growth in North Africa is projected at 3.9 percent for 2013. Political officials bank on this growth as they approach investors. But the growth in the region does not compare to Sub-Saharan Africa. Only Libya is expected to grow north of 4 percent compared to several sub-Saharan African countries. Great success with issuances have been seen in Mauritania, Nigeria, Senegal and South Africa. Yet, according to the International Monetary Fund (IMF) reports, it is not growth that worries investors but rather the country’s internal politics.
Complex political transitions continue to weaken public confidence. Not long ago, it was Sub-Saharan Africa’s constant flirtation with conflict and economic turmoil that stirred investors. Then the Arab Spring happened. Already losing ground to the more rapidly growing Sub-Saharan Africa, North Africa vastly conceded more ground in the race for foreign capital into the continent.
A projected GDP growth of 9.5 percent, for example, in Libya in 2013, following 20.1 percent in 2012, eclipses the low GDP growth rates in Europe and America. But ongoing political battles and violence scares many investors, especially Western investors. The prospect of losses beyond the control and volatility of more familiar Western markets weakens investors’ abilities to properly account and price for risk. The occasional bombings, threats to security or political turmoil do not speak to lower downside risk.
Sukuk issuances provide immense upside. Sukuk offerings automatically open North Africa to markets still largely untapped in the Gulf. Saudi Arabian investors have generally been the most interested group in potential offerings across the region. But an abundance of cash in other Gulf countries, including Qatar and UAE, should make future sukuk issuances oversubscribed, granted nowhere near the level seen in recent Rwandan and Zambian Eurobond offers.
Backing bonds by specific assets guarantees greater security for investors and should requires minimal regulatory reform. Yet calls from investors for clearer and tighter rules means that investors imagine the downside risk to be greater than regional leaders recognize. Officials have already tired with the elongated processes to approve their IMF loans. Sukuk issuances historically have been a more expensive alternative o IMF funding. But it is less intrusiveness and does not focus on structural adjustments to the economy, making it the more politically viable option for officials.
Unfamiliarity in the world of Islamic finance may create the greatest challenges. The process of choosing which assets to back bonds muddies the political waters and challenges alliances. Most sukuk issuances have not been rated. But, as the field grows particularly with Western voters, this will have to change. Legal precedent – beyond regulatory rules – is still in its development stage, despite past issuances in other countries. Sukuk issuances’ contribution to the development of markets is also unclear. Little trading is seen in secondary markets. Still the liquidity could help boost investment in the countries.
The sukuk must also battle the more attractive stock markets in the region. Undervalued stocks offer unlimited returns hidden from the higher scrutiny of publicly discussed and touted sukuk issuances. Regional stock markets are undervalued by an estimated 15 to 20 percent, the greatest incidence of undervaluation seen in Libya and Egypt.
Delays in sukuk issuances by countries, specifically Tunisia, could be beneficial. More stability and a longer track record post-Arab Spring will boost investor confidence. But budget gaps may be too wide for leaders to wait. Yet, yields in Islamic finance should not fluctuate like they do in Western markets. Appetites however never stay consistent.