Viable Option for Financing Nigeria’s Budget Deficit

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As the 2017 appropriation bill has been signed by the Acting President Yemi Osinbajo and implementation has commenced, there had been suggestions on the alternative funding for the expansionary budget. While the quest for solution to Nigeria’s burgeoning fiscal deficit has led the federal government to exploring some options of financing, floating Islamic bonds has been identified as one of the most credible. Kunle Aderinokun writes

The 2017 budget, tagged Budget of Recovery and Growth, is estimated at N7.44 trillion, an increase of 22.8 per cent from the N6.06 trillion of 2016. The federal government proposed, in the budget, a revenue projection of N5.08trillion and an aggregate expenditure of N7.44trillion, translating to fiscal deficit of N2.36trillion, which is planned to be financed largely by borrowing. The fiscal deficit is about 2.18 percent of the Gross Domestic Product

While N1.985 trillion is expected from oil proceeds as revenue, additional N1.373 trillion would come from the non-oil sector.

In the revised budget passed by the National Assembly, N2.987 trillion has been allocated for non-debt recurrent expenditure of the MDAs that are not under statutory transfers club while capital expenditure is estimated at N2.177 trillion. For debt service, the federal government voted N1.488 trillion to service domestic debts; N175.883 billion for foreign debts; and N177.460 billion for sinking fund to retire maturing loans, totalling N1.841 trillion for debt service.

Financing the deficit, according to the Minister of Budget and National Planning, Senator Udoma Udo Udoma, will be through borrowing from external and domestic sources. “The budget deficit is to be financed mainly through borrowings, which have been projected at N2.32 trillion. Of this amount, N1.067 trillion (46 per cent of this borrowing) is intended to be sourced externally, while N1.254 trillion will be sourced domestically,” Udoma had disclosed during the budget breakdown in December last year.

Economic activities have remained sluggish, despite a slight increase in oil price and the launch of the Economic Recovery and Growth Plan by the Federal Government. For the citizenry, the prevailing recession is yet to ease, a situation that has sustained the debate on how to effectively pull the country out of recession. Borrowing, which is an option, has been met with persistent opposition in some quarters.

Late last year, the Federal Government presented a $29.960 billion borrowing plan to the National Assembly for approval. The proposed facility, Nigeria’s single biggest loan request, including $575 million from the World Bank, would be used to finance key infrastructure projects across different sectors of the economy. But the plan was rejected by the legislature. The rationale from those opposed to Nigeria borrowing its way out of the recession was that such a loan would only heighten the risk of mortgaging future generations and there is no guarantee that the targeted projects would be assiduously executed.

Therefore, the search for options continues. Among many being vigorously advocated is Sukuk or Islamic Bond. Sukuk, unlike conventional bonds, are issued in compliance with Sharia/Islamic commercial principles. Unlike conventional bonds, which attract interest, Islamic finance forbids the payment of interest. Instead, it permits payment to investors, profits and fees generated by underlying assets. In essence, the sale of Sukuk is the sale of a unit share of an asset. Also, Islamic finance encourages the sharing of profit and loss on any investment at pre-agreed ratios (mudaraba, musharaka), while prohibiting investment in certain businesses deemed haram, such as gambling, alcohol, tobacco, arms and pornography.

Sukuk originated in the Middle East and quickly spread to other Islamic countries in Asia, and subsequently to other parts of the world, including Europe and Africa. Malaysia, which still dominates the global sukuk market, issued the first Sukuk in 1990, followed by Bahrain in 2001. Overall, the Middle East and South-east Asia remain the main hubs of Islamic financial institutions with Malaysia, UAE and Bahrain as the principal centres.

The Islamic finance market, offering a wide range of financial products, has grown at an outstanding pace. According to Head, Non-Interest Banking at Stanbic IBTC Bank, Iretiola Lawal, Islamic finance is the fastest-growing ethical finance market with an annual average growth of between 10 and 20 per cent. Global Islamic financial assets under management are currently estimated at about US$2 trillion, according to The Economist, with annual growth between 2009 and 2013 at 17.6 per cent and a projection of 19.7 per cent by 2018. There are also over 300 banks and 250 mutual funds providing Shariah-compliant services across the globe, according to KPMG.

Islamic bonds guarantee access to a larger investor base and provide potential lower pricing to bond issuers. As a result, it has emerged as vital instrument for raising funds and asset management as the world recognises the huge potential the market embodies. Among a broad range of investors that the Sukuk market provides investment opportunities are central banks, pension fund managers and reserve managers.

The cutting edge of Islamic finance lies in the numerous benefits it offers, including attractive returns, better risk management, diversification of investments, reduction of financing costs, enhancing financial inclusion and prohibition of speculation. Also, by making people direct holders of assets in the real sector, Islamic bond reduces their aversion to risk.

From the early 90s, Sukuk has evolved and become an integral constituent of the mainstream global financial system. A forecast by Thomson Reuters projects that the global Sukuk market will reach US$250 billion by 2020, from a new issuance peak of US$139.2 billion in 2012, from US$92.7 billion in 2011. On its part, Ernst & Young foresees the global demand for Sukuk reaching US$900 billion this year.

Due to adoption of various means, notably Ijarah, Islamic project financing has emerged as an effective alternative to the conventional direct financing. Some projects that are unable to take off due to failure to meet conventional financing requirements are executable through Islamic project finance with hybrid financing modes. Also, Islamic finance is pivotal in executing projects that even though have immense economic impact, are unappealing to conventional investors. Such projects as independent power projects and waste treatment plants will likely attract Islamic finance. The Kuala Lumpur International Airport, which gulped a massive RM8.8 billion (US$2.84 billion), was built through Islamic project finance.

Islamic project finance, nonetheless, faces significant liquidity challenges, possibly its biggest constraint yet, due to a “disconnect between the short-term nature of deposits of most Islamic financial institutions and the long-term nature of investments in projects,” according to BSA Ahmed Bin Hezeem & Associates.

The African market, according to experts, has a huge potential for Islamic bonds or Sukuk to meet the continent’s funding requirements for infrastructure development. S&P, in its article, Africa’s Small Sukuk Market Shows Significant Promise, outlined the benefits of growing the Islamic bond market on the continent. A major highlight, the firm said, is that these Islamic bonds could be structured in a way to yield returns without infringing on Islamic principles. “We believe African sukuk can provide diversification benefits for Islamic investors as well as additional financing opportunities,” said Samira Mensa, S&P Global Ratings credit analyst.

Nigeria, Africa’s second biggest oil producer and home to about 78 million Muslims, will contend with Senegal, Egypt and South Africa in seeking to explore the Islamic finance industry.

Chief Executive, Personal and Business Banking at Standard Bank Africa, Terry Moodley, stated: “There is a substantial untapped market among Muslims, who make up a large portion of the population in Africa.”

“Islamic finance has emerged as an effective tool for financing development worldwide, including in non-Muslim countries. Major financial markets are discovering solid evidence that Islamic finance has already been mainstreamed within the global financial system – and that it has the potential to help address the challenges of ending extreme poverty and boosting shared prosperity,” the Global Islamic Finance Development Centre stated, in reiterating the importance of Islamic finance to economic development.

Non-interest banking or financing is not targeted at Muslims alone as the diversification of Nigeria’s economy will naturally entail development of financial services of all strands. Stanbic IBTC Bank’s Lawal indicated that the institution is ready to partner with the Nigerian government to harness the Islamic finance market. “We are also working on leveraging our Standard Bank expertise to work with the Nigerian government on Sukuk to finance this year’s budget deficit,” she stated, noting that the group was committed to making sure that Islamic Banking actually succeeds in Nigeria. “The bond market plays a central role in the deepening of financial markets not only for the diversity of products it offers but essentially its role in improving diversification of funding sources and increasing access to credit markets,” she added.

Lawal noted that Stanbic IBTC Stockbrokers Limited was appointed stockbroker to the Federal Government on FGN Bonds as well as primary market maker by The Nigerian Stock Exchange, in a clear affirmation of the company’s ability to deliver on its mandates as well as the Stanbic IBTC Group’s overall leadership in the various market segments. Stanbic IBTC Capital Limited was also the issuing house and sponsor of the FGN bond listing on the FMDQ platform as well as financial adviser on the US$1 billion FGN Eurobond programme.

There is a widely held view, and rightly too, that Nigeria’s potential is severely subdued by infrastructural difficulties. Many roads, constructed decades ago, have in the light of frequent use and irregular maintenance gone into disrepair, while power remains an ever-pressing challenge. The road network could benefit from complementary rail networks, aiding in the efficient haulage of men and goods.

Perhaps, an International Monetary Fund staff discussion note, which highlighted the contributions of Islamic finance to economic development, would be helpful as Nigeria explores options on financing its budget deficit. The discussion examines Islamic finance in three dimensions: Islamic finance fosters greater financial inclusion; it places emphasis on asset-backed financing and its risk-sharing features as well as prohibition of speculation imply less systemic risk than conventional finance. Sukuk, in particular, is seen as well-matched for infrastructure financing as its risk-sharing feature could help in bridging funding gaps. Sukuk bonds could be listed on international exchanges and provide alternative financing for countries, regional governments and corporations, who are able to issue either sovereign or corporate sukuks to finance projects.

While the Debt Management Office plans to make debut with federal government’s N100 billion Sovereign Sukuk bond in the local market on June 28 to finance some road projects, it is imperative for the government to consider it a major veritable source of funding the budget and raise more sukuks locally and internationally.