Should Afghanistan issue a sovereign sukuk?

An article in Bloomberg discussed the prospects for Afghanistan to issue a sukuk to fund its budget deficit when international troops in the country leave (along with a lot of aid that accompanies them) in 2014.  I have offered a skeptical comment to an earlier Bloomberg article that reported about a proposal to allow Islamic banking in Afghanistan.

A sukuk provides a different set of opportunities and challenges from Islamic banking.  It is easier in many ways to issue a sovereign sukuk than it would be to develop a prudently regulated Islamic banking system, because the investors would demand a higher return (whether sukuk or conventional bond) based on the ability to get recourse in case the government defaults in the future.  These types of challenges are going to be common to either type of financial instrument. There are also questions about whether the country will be able to repay its debt, which again, will be priced into the yield the government pays. 

Biggest challenge unique to issuing a sukuk rather than a conventional bond, is whether the additional costs will be more beneficial to the government in terms of making a statement (and perhaps attracting some buyers who would avoid a conventional bond).  To a large degree, the cost-benefit analysis will depend on whether the sukuk is sold mostly to domestic buyers (e.g. banks) or to international investors.  The benefits may be higher and the costs lower in the former situation, compared to the latter situation, which may push the balance over the hump in favor of sukuk. 

There could also be a benefit if subscribing to the the sukuk were viewed as a politically favorable for the government-owned and government-related Islamic banks in the region (e.g. across the Gulf in the GCC).  At the end of the day, if that makes the cost of a sukuk competitive or advantageous compared with a conventional bond, then by all means the Afghan government should do it.  However, the government has higher priorities than getting into the sukuk markets, so the trade-off should be weighed carefully, so that it is not paying a nice extra bonus to an Islamic financial institution with funds that could be better used elsewhere.