Projected economic recovery in core Islamic finance nations to drive growth

The global sukuk market should continue to enjoy record-low interest rates and abundant liquidity throughout 2021 and beyond, S&P Global Ratings said in a report on Tuesday.

It expects total sukuk issuance of about $140 billion–$155 billion this year, thanks to a recovery in issuance in Malaysia, Indonesia, and the Gulf Cooperation Council (GCC) countries. This compares with a drop in issuance to $139.8 billion in 2020 from $167.3 billion a year earlier.

“We expect GDP growth in the core Islamic finance countries--the GCC countries, Malaysia, Indonesia, and Turkey--to recover from a sharp recession in 2020. We also assume that the price of oil will stabilize at about $50 per barrel in 2021. Together, these factors underpin a stronger performance by the global sukuk market in 2021 than in 2020,” the report said.

An increase in issuance by corporates, is also expected. Their activity was muted in 2020 as they held on to cash and deferred capital expenditure (capex) because of the pandemic. They are likely to execute some of this capex in 2021, thereby necessitating access to capital markets.

The report noted that $65 billion of sukuk mature in 2021, and part of this sum is likely to be refinanced on the sukuk market.

However, significant downside risks remain. Chief of these is whether the COVID-19 pandemic can be brought under control, even if a vaccine is widely available by mid-year.

Until then, the main risk is that further waves of COVID-19 and the requisite containment measures may harm the countries' fragile economic recovery, S&P Global said.

The number of defaults or restructurings among sukuk issuers with low credit quality will likely increase in 2021 as regulatory forbearance measures come to an end, the ratings agency warned. This will test the robustness of the legal documents used for sukuk issuances.

“However, if investors are able to get clarity on their financial recourse mechanisms because of these events, this will probably outweigh the negative impact on market sentiment,” the report noted.

Over the next 12-18 months, S&P Global expects to see progress on a unified global legal and regulatory framework for Islamic finance that the Dubai Islamic Economy Development Center (DIEDC) and its partners are developing.

“We believe that such a framework could help resolve the lack of standardization and harmonization that the Islamic finance industry has faced for decades,” it said.

There could be some sukuk issuances that aim to tackle the social problems arising from the pandemic or support the energy transition. These instruments could appeal to investors committed to environmental, social, and governance (ESG) values.

“However, we expect such issuances' contribution to overall sukuk volumes to remain small, due to their additional complexity and the core Islamic finance countries' slow implementation of policies to manage the energy transition,” S&P Global said.

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