Asian countries need a sukuk finance push to kick-start their economies

21 Aug 20

Muhammad Afnan Alam outlines the role Sukuks are expected to play this year and beyond in Asia and the Middle East, as Covid-19 and low oil prices shake economies.


Islamic banking and Sukuk dominate the Islamic finance market in Asia. According to the International Islamic Financial Market 2018 report, 90.44% of the $443.78bn Sukuk outstanding globally are issued from several well-established markets – namely Malaysia, Saudi Arabia, UAE, Indonesia and Bahrain.

Turkey, Pakistan, Qatar, Oman and regions such as Africa, in particular, are likely to increase their market share in the coming years. Many predominantly Muslim countries, such as Turkey, Indonesia and Malaysia, are pushing to expand Islamic finance to meet the needs of their populations which support domestic capital markets to increase their depth and liquidity.

In Hong Kong, the Legislative Council passed a bill in March 2014 enabling the government to raise money through alternative bonds, such as Sukuk. In India, the world's second most populated country, the Reserve Bank of India, the country's central bank, has begun a review of regulations on Islamic banking. The Philippines is expected to enter the global Takaful industry shortly, as the Insurance Commission of the Philippines is formulating Takaful regulations to enable Takaful services in the country.

In January 2014, the State Bank of Pakistan prepared its Strategic Plan for the Islamic Banking Industry of Pakistan 2014–2018. The Islamic Finance sector remains underrepresented in global finance, comprising 5% of the global financial system while close to a quarter of the world's population is Muslim.

After witnessing strong market activity during the first two months of 2020, the coronavirus pandemic has put new international Sukuk issuance almost at a standstill, according to a report published this month by ratings agency Moody's. The pandemic has triggered significant uncertainties in the markets, and many jurisdictions are facing an unprecedented combination of challenges, including health issues, reduced oil revenues, economic disruption, severe financial market dislocation and changes in liquidity and investor sentiment.

These developments are negatively impacting new Sukuk issuances, as well as bonds. Active Sukuk issuers and investors continue to evade new issuance in the international fixed income markets, extreme volatilities include interest rates, oil prices, credit-spreads, currency valuation, that are affecting Sukuk investment and issuing decisions.

For instance, the Moody's report mentions a fall in issuance among the Gulf Cooperation Council, a political and economic alliance of six Middle Eastern countries. In Saudi Arabia issuance fell to $6.8bn in the first half of 2020 from $9.4bn in the first half of 2019. Qatar issued no Sukuk despite the expectations for a $6.4bn fiscal deficit this year. Indonesian sovereign issuance also fell 25% year-on-year to $5bn. Interestingly, Malaysia, the global leaders in Islamic financial services registered a 34% Sukuk issuance increase, year-on-year.

This is primarily due to recent innovations and in Malaysian Sukuk market to diverse risk-return profiles and requirements of both issuers and investors. Also, the proliferation of new types of instruments with extended maturity profiles has generated a diversified range of players, both local and foreign, to participate in the Malaysian market.

Banks continue to be the primary source of funding for corporates in the GCC due to several factors, including financial and economic regulations, and the size and development of the domestic corporate base. Amid the ongoing health emergency crisis in GCC, the countries also experienced elevated liquidity pressures from coronavirus and the fall in oil prices. At the same time, authorities in these countries have put pressure on banks to reprofile loans to borrowers at risk from the coronavirus shock and to use additional lending facilities provided by central banks.

According to Moody's, GCC governments may have also been concerned about the potential crowding-out effect on private sector borrowing that a significant increase in domestic issuance could have had. For those sovereigns with liquid government assets like Saudi Arabia, the spike in borrowing costs between March and April would have increased the attractiveness of drawing down liquid assets compared to debt issuance. 

Going further into 2020, it is clear that the Covid-19 pandemic has wreaked havoc on every aspect of life, with no clear end in sight on how long the crisis will last. Undoubtedly, markets have been in turmoil, and this will likely pose uncertainties about future fund-raising activity.

With governments worldwide still weighing the economic implications of the virus, various forms of financial aid through economic stimulus packages and interest rate cuts have been announced. However, the proportion of Sukuk in the funding mix of major issuers will decline this year, primarily due to the preference for conventional issuance over Sukuk during the period of elevated market volatility in the second quarter of 2020.

Moody's and other rating agencies including Fitch expect sovereign sizeable borrowing requirements will support a full-year 43% year-on-year increase in sovereign Sukuk issuance to $94bn in 2020. Turkey is expected to finance a fifth of its fiscal deficit in 2020 via Sukuk issuance given increasing stress in the banking system. Instead, the authorities are likely to rely more on central bank borrowing to meet the $17bn increase in its financing requirements.

Malaysia is expected to finance 69% of its deficit through Sukuk issuance. Indonesia, as per Moody's, is expected to fund 24% of its deficit financing through Sukuk issuance. These figures are slightly below the pre-crisis level.

In May this year alone, Pakistan's government raised $440m through the auction of the five-year Ijarah Sukuk. The country's central bank has previously said it wanted to achieve the twin objectives of stimulating trading in Shariah-compliant debt securities and help plug the budget gap amid the spread of Covid-19. Earlier in April, Pakistan's federal government cabinet approved issuing the Sukuk bond to generate close to $4.15bn for budget deficit financing, particularly to combat Covid-19.

The irony is, however, that the coronavirus crisis will also provide a window of opportunity for sovereigns to raise funds for financial aid packages, and for corporates to lock in more attractive funding rates while taking stock of their financing maturity profiles. In such highly uncertain times, investors will seek safer havens by moving into bonds and Sukuk, thereby benefiting some key economies in the Sukuk market. Falling oil prices will significantly widen fiscal deficits in Sukuk issuing countries like the GCC countries and Malaysia, which are net oil exporters.

In this spirit, the recent Moody's report suggests that monetary stimulus measures implemented by central banks across the GCC, including the easing of capital requirement and prudential liquidity measures, should help to free up liquidity in the banking system, supporting demand for Sukuk and other securities. This, it is expected, will allow the market's largest sovereign issuers to finance their significant borrowing requirements via Sukuk.

In total, the rater estimates that the dual shock has increased the aggregate fiscal deficit of the major sovereign Sukuk issuers by $96bn. In the following months, hydrocarbon exporters Saudi Arabia and Qatar amid lower hydrocarbon revenues are expected to have an increase in their existing fiscal deficits. Nearly 65% of Saudi Arabia's and 80% of Qatar's government revenues are derived from hydrocarbons.

Many developing economies, including in Asia, already face significant infrastructure gaps at current levels of spending. As economies are impacted, countries will come under increasing fiscal pressures, and private sector risk aversion will also remain elevated. As with experience, economic growth declined, and so did public investments in times of economic difficulties. This was particularly clear during the aftermath of the Asian financial crisis, which directly affected the region.

An important and growing segment in Islamic finance in Asia is the market for infrastructure Sukuk. A 2017 Asian Development Bank study estimated the infrastructure financing needs of developing Asian economies will be $26trn from 2016 to 2030, or $1.7trn per year. In many less-developed countries in Asia, the lack of proper infrastructure is one of the significant obstacles to development. The use of cross-border financing and investment through Islamic finance (i.e., Infra-Sukuk) can help to widen the investor base and lower the cost of the funding for the development of infrastructure in Asia.

Malaysia, in the recent past, has utilized Sukuk issuance to finance its PLUS highway project and Malaysian mass rapid transit project in the Greater Kuala Lumpur area. Indonesia is another country seeking to use Sukuk for badly needed infrastructure improvements across its 17,000 islands, although it needs to upgrade its Islamic banking system first to attract respective investors. Another Asian country that has used Sukuk for infrastructure funding on the recent past is Kazakhstan, using it for significant investment in exploration activities and the construction of infrastructure projects for its oil and gas industry.

While the coronavirus pandemic has triggered significant uncertainties in markets and everyday life, sharia-compliant bonds, or Sukuk, are set for a renaissance once the financial landscape has settled, and issuers and investors have readjusted. Other Sukuk issuers like Indonesia could benefit from lower oil prices as they are net oil importers, the adverse effects of lower commodity export prices and reduced tourism revenues caused by the global outbreak will deter growth.

Global economies are indisputably navigating choppy waters. Governments that can effectively use monetary and fiscal tools to steer their economies in the right direction will stand a fighting chance of emerging less battered by Covid-19. In the wake of the global equity market meltdown, the debt and Sukuk markets will serve as a bulwark to shore up a country's financial standing.

  • Muhammad Afnan Alam

    Muhammad is a career federal government civil servant from Pakistan

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