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The global sukuk (Islamic bond) market experienced a significant slowdown in issuance in the first half of 2018, with new sukuk issuance expected remain lacklustre in the second half, according to credit rating agency Standard & Poor’s.
Total sukuk issuance dropped by 15.3 per cent in the first half of 2018 compared with the same period last year, reaching $44.2 billion (Dh162.34 billion) compared with $52.2 billion first half of 2017. This drop was even more pronounced for foreign currency sukuk issuance at 45 per cent.
“We believe that this is due to the absence of major issuances from the GCC countries seen in 2017. In the second half of 2018, we expect sukuk issuance volumes will continue to be slowed by the global tightening of liquidity conditions as well as by lower financing needs of some GCC countries as a result of oil prices stabilising at higher levels,” said S&P Global Ratings head of Islamic Finance, Mohammad Damak.
Sukuk issuance in 2017 increased by 45.3 per cent, reaching $97.9 billion, up from $67.4 billion in 2016, underpinned primarily by the jumbo issuances of some GCC countries and supported by strong liquidity conditions in the GCC and initiatives by some countries to develop Islamic financial services industry.
GCC countries, with Saudi Arabia in particular — having raised the lion’s share of sukuk ($27 billion), drove last year’s higher issuances. The region’s gross financing requirements increased with the oil price shock, and as such, could fall this year if the recent recovery in oil prices persists. However, analysts said, GCC sovereigns are diversifying their funding towards a combination of conventional and Islamic instruments, reflecting a cultural affinity to the sector and in order to support their governments’ respective Islamic finance agendas.
Corporate and asset-backed sukuk activity was muted in 2017, according to Moody’s, because of more attractive conventional market opportunities and analysts expect the same in 2018. In the long term, issuances in these sectors could be a source of growth underpinning the industry’s potential. The sharp increase in geopolitical risks in the Middle East will also likely weigh on investors’ appetite. Meanwhile, inherent challenges related to the sukuk market continue to drag on the expansion of this market.
Analysts expect Malaysia will continue to support market growth, owing to its strong market foundations and government support for Islamic finance. Overall, S&P expects the total volume of issuance to be in the range of $70 billion to $80 billion this year, compared to $97.9 billion last year A slowdown in demand for funds from GCC governments and corporates has resulted in the absence of jumbo local and foreign currency issuance from the region. On a positive note, analysts said it was understandable as some of these countries are on the starting blocks with potential issuances in the second half of 2018.
Analysts expect that further tightening of global liquidity, which started in the first half of 2018, will continue. Specifically, the US Federal Reserve is expected to hike its federal funds rate by another 50 basis points (bps) in the second half of 2018 after the two increases of the first half, while GCC central banks will probably mirror such an increase due to the fact that their currencies are pegged to the US dollar.
In the same vein, after reducing the pace of asset purchasing, the European Central Bank (ECB) is likely to wind down its assets purchase programme in December 2018 and start to raise interest rates in the third quarter of 2019.
“Overall, we think that the liquidity channelled to the sukuk market from developed markets will reduce and become more expensive. Currently, European and US-based investors account generally for about one-quarter of sukuk investment in terms of volume. At the same time, muted economic growth and declining lending activity in the GCC has shifted banks’ focus to capital market activities in hopes of achieving higher yields than with cash and money market instruments,” said Damak.
Geopolitical risks seem to have adversely affected investor demand for sukuk. A range of issues such as the boycott of Qatar by a group of Arab states, the recent reinstatement of US sanctions on Iran and continued animosity between Iran and some of its GCC neighbours are not helping investors’ perceptions.
“We consider that GCC countries’ need for financing is reducing as liquidity conditions improve. This is thanks to higher oil prices, which we now expect to remain at about $65 per barrel in 2018, and continued expenditure reduction by GCC countries since 2015. Overall, we think that the gross commercial long-term debt issuance of GCC countries will decline by 15 per cent in 2018 from 2017,” said Damak.
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