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23 February 2024

Sukuks to face challenging year ahead, say analysts


By Shuchita Kapur

Sukuk market has witnessed a dramatic decline during 2008, especially during the fourth quarter and this year is not expected to be much better, says the Islamic Finance Information Service (Ifis).

According to figures provided by Ifis, Islamic bond issuance grew enormously between 2004 and 2007, with total issuance growing year-on-year by 49 per cent in 2005, 153 per cent in 2006 and 79 per cent in 2007. In 2007 sukuk issuance hit a record of $46.65 billion (Dh171bn).

"These results, though impressive, came at a time of easy access to credit and benefited from oil prices that were at historical highs and rising. This led to ever increasing issuance, especially from the GCC. As the GCC bond market flourished even after the initial impact of the sub-prime mortgage crisis in 2007, there were those who thought that Islamic finance can withstand this downturn intact due to the nature and features of Islamic banking and finance, and therefore of the sukuk market," said analysts at Ifis.

However, this was not the case and it simply led to some unreasonable expectations for the industry. Ifis experts say over-expectations and people believing that the sukuk market was decoupled from the conventional banking systems are untrue.

"Some industry observers thought that Islamic finance had successfully separated from global conventional credit markets, which was an Islamic variation on the now debunked decoupling theory. Others claimed that Islamic markets were now mature, independent markets, not related to the price of oil.

"A third view that was sometimes expressed was that lower leverage and emphasis on holding and selling real, tangible assets will save the industry from the full impact of the sub-prime crisis and subsequent credit crunch. Essentially, all of the above emphasises the fundamentally different natures of Islamic finance and conventional finance. But the evidence counters this. Sukuk have not done well in the past year," they say.

The data proves their point. Total issuance in 2008 dropped by 66 per cent compared to 2007, showing no immunity from the global downturn. The impact was felt across the board, with GCC issuance dropping by 50 per cent and South East Asian issuance dropping by 75 per cent.

According to Ifis, financial institutions in the Gulf have been suffering a great deal, and both Islamic and non-Islamic institutions have run into trouble. Most of Asia, including Malaysia, has been hard hit by the global economic downturn, and financial institutions have and will continue to suffer as a result. This will continue to affect the sukuk market until the financial sector recovers.

And, the increase in Islamic syndicated lending will not make-up for the losses that the sukuk market will suffer. Recovery in the conventional sector is vital. According to figures provided by Ifis, last year, Islamic syndicated lending did better than the sukuk market, with borrowing expanding from $19.6bn in 2007 to $27.2bn in 2008, registering a 32 per cent expansion.

"In the GCC, Islamic syndicated lending provided the debt market with some buffer against the drop in sukuk issuance. Lending in the GCC rose from $17bn in 2007 to $22bn in 2008. This rise, while significant, is not enough to compensate for the drop in sukuk issuance, however, which had dropped by $9bn in 2008 compared to 2007. And as with credit markets worldwide, Islamic syndicated lending froze almost completely in Q4 2008.

"It would be too early to express optimism based on the increase in syndicated lending in 2008, however. The most likely explanation for this increase is that as sukuk markets contracted, investors turned to syndications as a better alternative for two reasons. First, the rise in Libor rates that accompanied the first stages of the credit crunch made sukuk borrowing more expensive. Second, as the sukuk market dried up, relationship-lending filled in some of the gap," says Ifis.

"Thus, the increase in relationship lending that we saw in the syndicated loans market will not be sufficient to reverse this. Our opinion is that syndicated lending simply lagged the sukuk market, and will probably not behave too differently from the sukuk market in 2009. For both, Ifis does not expect a recovery before the recovery in conventional markets," they say.

Ifis also points out that the crisis in the West is different from that in GCC and Asia. In the former, it was first limited to the banking sector and then spread to the real economy, whereas, the GCC is suffering because the price of oil, the main source of revenue for the region, collapsed.

This combination of declining oil prices and global financial crisis lead to liquidity shortages in the GCC. "This lack of liquidity has severely constrained the credit hungry construction sector, which had fuelled the GCC growth story in recent years and towards which much of the proceeds of sukuk and syndicated lending have been directed.

"With world real estate prices generally on the decline, investors are questioning the soundness of real estate investments, especially in markets perceived to be overheated. This impression certainly exists in the GCC, and there is significant anecdotal evidence that indicates a rapid fall in real estate prices in Dubai and other places. It is not clear exactly how much exposure do banks have to the sector, and until it is clear, we do not expect confidence to be restored. As such, we expect banks to hoard cash and restrict lending in the GCC as they have in other markets."

"Moreover, the lack of disclosure in the region makes events such as the sudden collapse of Khaleej Bank, the troubles of Investment Dar and the default of Global Investment House more likely. These and other considerations have prompted international rating agencies such as Moody's and Fitch to downgrade the credit rating a significant number of GCC financial institutions, Islamic and otherwise," say analysts at Ifis.

These considerations, according to Ifis analysis, make raising funds more challenging and reduce confidence in the markets and in borrowers' ability to repay their debts. However, mainly due to the enormous currency reserves accumulated in GCC countries over the past few years, they do not expect the severity of the crunch to be comparable to that experienced by Western credit markets. "Therefore in all likelihood, we will start seeing a recovery in the GCC in the second half of 2009, but it will not be a far better year than 2008," it says.

Despite the lacklustre performance shown by sukuks, the Islamic sector still performs better than the conventional one. The January monthly report on the performance of the Dow Jones Islamic Market Indexes shows this. Based on the close of trading on January 26, the global Dow Jones Islamic Market Titans 100 Index, which measures the performance of 100 of the leading Shariah-compliant stocks globally, lost -5.55 per cent month-to-date, closing at 1646.71.

In comparison, the Dow Jones Global Titans 50 Index, which measures the 50 biggest companies worldwide, posted a loss of minus nine per cent closing at 131.03.

Q4 2008 Was lowest 

Global sukuk issuance in Q4 2008 was the lowest since 2002, and 2008 was a worse year for sukuk than both 2006 and 2007.

The decline in sukuk has been global, affecting both South East Asia and the Gulf Co-operation Council (GCC). For Q4 2008, there was no issuance in US dollars at all, and the amount of sukuk issued dropping to a mere $584 million (Dh2.14bn), which makes Q4 the worst quarter since Q4 2002, before the boom in the sukuk market.

South East Asia was more severely impacted than the GCC in 2008, with issuance falling by 76 per cent down to $6.57bn for the entire year. The decline in the GCC was quite severe as well, with issuance falling to $9.06bn, a 51 per cent drop.

The global total for sukuk issuance – $15.77bn – was 66 per cent lower than the figure for 2007.

This is the first year-on-year drop in sukuk issuance since the year 2000.

Islamic VS conventional

In January, the Dow Jones DFM Titans 10 Index, measuring the 10 largest and most liquid stocks listed on the Dubai Financial Market, closed at 1846.57. It is a loss of minus 16.43 per cent month-to-date.

The Dow Jones Islamic Market Kuwait Index posted a loss of minus 21.60 per cent, closing at 682.01. Its conventional counterpart index, the Dow Jones Kuwait Composite Index, was down, closing at 178.30. It represents a loss of minus 23.47 per cent.

The Dow Jones Islamic Market Turkey Index closed at 1899.09, a performance of minus 5.52 per cent month-to-date, while the Dow Jones Wilshire Turkey Index closed at 538.90, a loss of minus 7.75 per cent.

Measuring the performance of Shariah compliant stocks of five of the Gulf Co-operation Council (GCC) member states, the Dow Jones Islamic Market GCC Index closed at 925.55, a loss of -18.88%. The conventional Dow Jones GCC Index was down -22.22%, closing at 1037.85.