The appetite for quality credit is improving in the global sukuk market, as investors becomes less risk averse amid ample liquidity in global financial markets.
Over the past few weeks, issuers with good credit quality have approached the market, either by reopening sukuk or tapping into their established debt programmes, however, debut issuance “remains rare”, Mohamed Damak, a senior director and global head of Islamic Finance at S&P Global Ratings said in a report on Tuesday.
“Conditions in financial markets are improving but not for all issuers,” said Mr Damak, who co-authored the report alongside credit analysts Max McGraw and Dhruv Roy. “Investors' risk aversion is subsiding, thanks among other factors to strong global liquidity.”
Despite this glimmer of optimism, total issuance of Sharia-compliant bonds this year will remain lower than 2019 as corporates hold on to cash, cut capital expenditure and increasingly look to using bank financing.
“Sukuk issuance volume fell 27 per cent in the first six months of this year, but we still expect it will total around $100 billion (Dh367bn) for 2020, about 40 per cent lower than in 2019,” S&P said. “In the current environment, the number of defaults among sukuk issuers with low credit quality will likely increase, which will serve to test the robustness of legal documents for sukuk.”
Governments and central banks have poured a cumulative $11tn into the global economy in monetary and fiscal packages so far to stabilise financial markets and blunt the impact of the Covid-19 outbreak. Investors who largely stayed on the sidelines during pandemic-induced lockdowns are now returning to capital markets and selectively investing in sukuk issuances, S&P Global said.
However, central banks have already boosted the liquidity of lenders and financial institutions in core Islamic finance countries, so they are unlikely to issue sukuk as liquidity management instruments this year, S&P said. The difficult economic environment led to higher financing needs for sovereigns, but most turned to conventional finance markets, largely due to the complexities involved in issuing sukuk.
“As such, local banks are able to meet most of the economies' financing needs,” Mr Damak said. “We expect bank lending to increase by low- to mid-single digits in most core Islamic finance countries in 2020, and for some loans to be at subsidised rates; so there's little incentive for corporates to issue sukuk.”
The ratings agency last month said the global Islamic finance industry will grow at a slower pace as core Sharia-compliant finance markets grapple with the impact of Covid-19 on their economies.
The industry had registered growth of 11.4 per cent last year on the back of sukuk issuance that was higher than expected, it said at the time.