JEDDAH – The new issuance of sukuk worldwide could top well above $100 billion again this year, Standard & Poor's said its recent report “Investor Appetite Is Pushing Sukuk Into The Mainstream”, amid current investment spending and economic growth, along with its forecast of continued high oil prices and low bond yields. In addition, jumbo issuance may pick up further, mainly on the back of huge infrastructure projects from sovereigns. Turkey, Qatar, and Malaysia issued more than $1 billion over the past two years. Sustained investment spending and ample domestic liquidity are likely to support sukuk issuance, especially in Malaysia, Saudi Arabia, Qatar, and the UAE. Investment spending could see high-single-digit growth for 2013, estimating that the real investment growth rate was 6 percent in Malaysia and 7.4 percent in Saudi Arabia in 2012. This contributed to real GDP growth that reached 5.2 percent in Malaysia, and exceeded 5 percent in some GCC countries. The economic slowdown in China and elevated political tensions in the Middle East could be impediments though, the report said. The sukuk market, centered in Malaysia, is not only vulnerable to weaker economic conditions in the Asia-Pacific, especially lower growth in China, but also to the troubles in the eurozone and the feeble US recovery. S&P lowered its forecasts for real GDP growth for most Asian countries in 2012 and 2013. If Malaysia faces a severe drop in external demand, foreign investment and liquidity could suffer. In the GCC, a potential recurrence in geopolitical tensions could affect investments in Saudi Arabia and Qatar, two leading issuing countries. For example, political and social unrest in Bahrain, engendered by the Arab Spring, resulted in an almost one-third decline in sukuk issuance in 2012 – which investors nevertheless continued to snap up. Less likely, if oil prices were to drop significantly for an extended period, the GCC would feel the effects, the report further said. The concomitant drop in oil revenues, which account for the overwhelming share of external and fiscal revenues, could lead to a broad-based tightening in liquidity. “We believe that sovereign and sovereign-related issuance will continue to dominate, shape, and underpin the sukuk market, as it has in the past several years. Sovereign sukuk are generally the first inroad into Shariah-compliant funding in any given country, enabling the gradual creation of reference prices over time, to which private-sector entities can benchmark themselves,” it said. From a sovereign perspective, Islamic bonds can give governments access to a new investor class by diversifying sources of fiscal funding. They can also help to cover external financing needs and support reserve building. This is important for countries with sizable fiscal funding needs, such as Malaysia or those in North Africa, but less so for GCC countries, which generally enjoy healthy fiscal and external accounts. Sovereign-related issuance reached a record $115 billion globally in 2012, comprising about 80 percent of total issuance for the fourth year in a row. The segment also represents about 70 percent of the sukuk that Standard & Poor's rate. The report noted that the Saudi-based Islamic Development Bank (IDB) and the Malaysia-based International Islamic Liquidity Management Corp. are actively and increasingly helping in the development of sovereign sukuk. “The IDB is the only sukuk issuer that we rate AAA, through, notably, two programs for the finance of infrastructure projects: an $8 billion IDB Trust Services Ltd. global sukuk and a MYR1 billion Tadamun Services Bhd. sukuk geared to the Malaysian market. The IILM, founded in 2010 by central banks, monetary authorities, and multilateral organizations, seeks to play a vital role in developing much-needed short-term Sharia-compliant liquidity solutions for Islamic financial institutions.” Moreover, the report said the GCC and Asia will remain the key engines for growth of the sukuk market in the coming 18-24 months. It expects new issuers, most probably sovereigns, though with modestly sized issues to test the waters and investors' risk appetite. “And we may see the debut of issuers outside these two regions, like the Development Bank of Kazakhstan with its MYR1.5 billion sukuk program in 2012. The pace and frequency of issuance in those frontier markets, in our view, will depend greatly on their capacity to develop Islamic finance infrastructure.” The report also did note rule out the possibility that more African sovereigns will enter the market. Some African countries have been growing strongly over the past few years, and most have huge infrastructure investment needs. So far, only two African sovereigns have come to the domestic market with sukuk –Gambia and Sudan – but we understand that a number of them are considering either domestic or global issuance. GCC sovereigns, government-related entities (GREs), and banks, especially, will take advantage of these favorable market conditions to issue sukuk in the next few years. “We believe that GCC banks that are sukuk issuers – those in Saudi Arabia, Qatar, and the UAE –will increasingly turn to the market for funding sources, and perhaps in more innovative ways, not only because of the attractive market conditions but also to meet funding needs and increasingly stiff regulatory capital requirements. Gulf banks issued $7.2 billion of sukuk in 2012, of which $4 billion was issued by banks that S&P rated, up 55 percent from 2011. Banks in Saudi Arabia and Qatar are set to increasingly issue debt in 2013 and 2014, including sukuk, because of strong growth in lending that is outstripping deposit taking. In the UAE, where credit growth is stagnant, banks may continue to tap the debt markets to issue long-tenor paper to improve their long-term funding profiles. “We believe the project finance sector will increasingly rely on sukuk to fund transactions, taking advantage of the good market conditions. Infrastructure-related sukuk, especially for transportation projects, increased to $6 billion in 2012 after two years of barely any issuance. Transportation represented 67 percent of all GCC issuance within the infrastructure segment in 2012.” Countries in the region, especially Saudi Arabia, will continue to favor issuing through their GREs rather than through the sovereign. For example, the Kingdom's General Authority for Civil issued SR15 billion (about $4.1 billion) to help fund the expansion of the Jeddah airport, and Saudi Aramco Total Refining Petrochemical Co. issued $1 billion of sukuk to finance the development of the Jubail refinery. The rebound in sukuk issuance from the GCC since 2011 is set to intensify, following muted years after the global financial crisis. Total sukuk issuance in the Gulf increased to $24 billion in 2012. “We further believe that the region's economic resilience, strong project pipeline, and regional refinancing needs could boost its issuance to match Malaysia's over the long run. Although sovereign or sovereign-related entities are the main issuers, we believe private-sector entities may be able to ride the wave.” Yields on GCC sukuk appear to be consolidating at historic lows. Low interest rates worldwide and investors' preference for the bond markets – over still-depressed equity markets – largely explain the trend. The tight yields also indicate continued strong investor demand for all manner of fixed-income products in the GCC, despite the financial woes in Dubai and political troubles in Bahrain from 2008 to 2011. Although not specific to the GCC, demand is also coming from international investors and sukuk funds in the region. Not only have yields plunged on GCC sukuk, they've turned convincingly lower than yields on conventional bonds. As a result, the debt market may continue to see more sukuk than conventional fixed-income issuance, as it did for the first time in 2012. — SG
