Identified as the financial hub of East Africa, Djibouti is a strategic country located in the Horn of Africa and close to the Middle East. The constitution of Djibouti declares Islam to be the state religion and its official languages are Arabic and French.
Djibouti has little natural resources and a limited industry; its economy depends on foreign direct investments and port services. The country’s strategic location at the southern entrance of the Red Sea and close to the Ethiopian market has allowed Djibouti to develop its banking activity and encouraged it to pursue Islamic finance.
Review of 2020
Djibouti’s national strategy is to enable infrastructure improvement and economic diversification in order to become an emerging country by 2035.
Like the rest of the world in 2020, Djibouti’s economy was affected by the COVID-19 pandemic. It is, however, expected to recover once the sanitary crisis subsides.
Since 2011, Djibouti had started to adjust its legal framework to allow the establishment of Islamic banks (law dated the 22nd January 2011) and introduce the Islamic insurance instrument of Takaful (law dated the 9th June 2012). The government established, by the Order of the 30th October 2016, a National Shariah Council to oversee the sector.
However, there have been few legislative developments in Islamic finance in 2020 and some challenges remain for 2021, particularly pursuant to the pandemic.
Preview of 2021
In the context of a pandemic-stricken global economy, Djibouti should consider addressing the issues pending in its Islamic banking market and the framework surrounding Sukuk issuance as detailed in the following.
The Islamic banking sector had previously been on track for strong growth in 2020, but COVID-19 is having an impact. Relative to conventional institutions, Islamic banks are more exposed to SMEs, microfinance and retail lending. The performance of such banks is likely to remain subdued in the coming months.
These specific issues add up to the need for further harmonization in Islamic finance practices to ensure the stability of the sector. Furthermore, Islamic banks in Djibouti mostly offer Musharakah (partnership) and Murabahah (sale with markup) as financial products. To realize their complete potential, the banks should also offer other products such as Salam (sale of fungible goods) and Ijarah (leasing).
The Sukuk market is more concentrated and less liquid than its conventional counterpart. The process for issuance is costlier and more complex. As such, it is expected in the context of COVID-19 that the overall volume of issuance will be muted this year. Nevertheless, there have been signs that the pandemic could prompt an expansion in the role of Sukuk with respect to promoting sustainability and social Sukuk.
In order to benefit from this increased awareness of the potential of Sukuk issuance in exploring new sectors such as health and environmental sustainability, Djibouti must bring improvements to its national Sukuk issuance framework.
Investors will consider several domestic law issues, among which, specifically regarding Sukuk, is the nature of the underlying assets, as the transferability of title would require, among others, formalities necessary for the transfer of title to be effective under Djiboutian law, such as registration by the local authorities and the payment of any related fees.
Djibouti will also have to ensure that its tax regime does not penalize Sukuk issuances (notably due to taxes, rights or stamp duties applicable to the transfer to the SPV of the assets underlying the Sukuk) in comparison with conventional bond issuances.
Finally, the Sukuk structure should comply with Djiboutian civil law, in particular when usufruct (right ‘in rem’ to use and derive profit or benefit from property belonging to another) is used as the asset underpinning an Ijarah-based Sukuk.
Similar to the French Civil Code, Djiboutian civil law provides that a usufruct which is not granted to individuals may only last for 30 years. The Sukuk documentation will therefore have to comply with, and reflect, the said requirement.
In practical terms, there has been no Sukuk issuance in Djibouti to date. The country does not have access to international or regional capital markets and has no market for domestic government debt (treasury bills and bonds). It is crucial for Djibouti, through the central bank or a stock regulator to be created, to develop a domestic Sukuk market.
More globally, putting in place a framework which facilitates trading, price transparency, a diversified investor base and efficient clearing and settlement of Islamic finance transactions would help Djibouti overcome certain challenges.
Djibouti, due to its culture, geographic location as the connection between Africa and the Middle East and its heavy investment in infrastructure, is a perfect country to centralize Islamic investments in the East African region. The country’s pursuit of Islamic finance has so far been remarkable, despite a difficult economic context with the COVID-19 pandemic. It should complete its path by putting in place a set of rules to promote Islamic financial solutions through banking products and Sukuk issuance.
Jean-Baptiste Santelli is the partner at De Gaulle Fleurance & Associés. He can be contacted at [email protected] Racha Wylde is the associate at De Gaulle Fleurance & Associés. She can be contacted at [email protected]