Long-term sukuk outlook promising after weak 2008

FinanceAsia:The value of sukuk issuance dropped by more than 56% in 2008 and S&P doesn't expect the market to revive before the second half of 2009. However, several structural factors indicate longer-term growth should be rapid.

The market for Islamic bonds, or sukuk, declined sharply in 2008 as a result of global market turmoil, drying up of liquidity, widening of credit spreads, and a wait-and-see attitude among investors. Although difficult to measure, part of this decline could also have been due to comments about the Shar'iah compliance of some sukuk by the Accounting and Auditing Organisation for Islamic Financial Institutions.

Standard & Poor's considers that long-term prospects for the sukuk market remain strong, however. Although volumes dropped dramatically in 2008 (down more than 56%), the market attracted about the same number of issuers as the year before. Conservative estimates of the pipeline of sukuk that have been talked about or announced are in excess of $45 billion. Several factors support sustainable growth of this market, including the increasing popularity of Shar'iah-compliant products; government openness to Islamic finance; massive investment and financing needs in the Gulf; and issuers' desire to tap investors from the Middle East and Muslim Asia. Issuers from more than 20 countries have expressed interest in issuing, or announced their intention to issue sukuk, and Standard & Poor's anticipates that several new sovereigns will enter the market.

To date, Standard & Poor's has rated 27 sukuk (or sukuk programmes), the bulk of which are ijara (lease financing), or musharaka (venture capital financing). (Please see our "Glossary Of Islamic Finance Terms," published January 7, 2008, on RatingsDirect.)

Credit spreads on sukuk have followed the same trend as for conventional bonds, with a sharp widening in the past 12 months. Meanwhile, the average size of the sukuk issued last year declined significantly, partly due to the lower appetite of investors. At the same time, the US dollar lost its place as the currency of choice for sukuk, with only about 10% of issues raised in this currency. Standard & Poor's expects the sukuk market to continue being skewed toward issuances in local currencies, at least in the foreseeable future...CONTINUE READING