Tuesday, January 04, 2011

Sukuk in 2011

In the December review of sukuk issuance for Zawya, Adnan Halawi points out that most of the December issuance was from secondary issuance in established sukuk program. However, January may see Nakheel return to sukuk markets, despite its difficulty in repaying the Nakheel 1, 2 and 3 sukuk due in 2009 - 2011 (all were repaid on time with assistance from the Dubai Financial Stability Fund). This would be an inauspicious beginning to 2011 for GCC sukuk markets, by reminding investors of the difficulty the market faced with several defaults (International Investment Group, Saad and Algosaibi, The Investment Dar were prominent) in addition to the government support required for the Nakheel sukuk.

The other point from the review that I think is short-term significant is that the issuance in December 2010 was mostly from Malaysia with $5.7 bllion in issuance compared with $364 million from Pakistan and a combined $221 million from the UAE and Bahrain. The general trend in sukuk markets is that GCC issuers have chosen to issue sukuk in Malaysia over the GCC markets.

In my weekly newsletter, I offered three predictions for 2011 including one about the growing trend for issuance in Malaysia over the GCC. Here was my prediction:
The focus of Islamic finance will shift back from Malaysia to the GCC as rising oil prices create excess liquidity to finance infrastructure projects
In the immediate aftermath of the credit crisis, the impact was not felt as much in the GCC as much as it was in Malaysia, with a sharp drop in sukuk issuance, for example. However, the crisis spread to the GCC leading to the Dubai debt crisis-caused investor nervousness about the etire region while Malaysia rebounded quickly. This has led to GCC corporates issuing sukuk in Malaysia. However, despite having a more developed secondary market for sukuk, Malaysia is a much smaller market and cannot absorb all of the sukuk that GCC issuers will want to issue. This will force issuers to turn back to the domestic markets, which will be boosted as the troubled investment banks and government-related enterprises finish up their restructuring or cease to do business entirely. While secondary market liquidity will still be limited, the new sukuk from issuers who have weathered the crisis, supported by continued sovereign issuance, will lead to a more liquid secondary market. International issuers like GE Capital will return to the market, which will increase confidence among investors and regional issues.
My prediction is counter to the current trend (I tend to be a contrarian). However, my prediction is not just based on my own contrariness. I think that the long term future for sukuk lies in the GCC (and to some degree in Luxembourg and the UK where a number of sukuk have been listed).

This is not to underplay the role and significance of the Malaysian sukuk markets. They have been crucial for providing an example of a market where sukuk secondary market liquidity has developed, albeit over nearly a 20 year period. However, it is just too small a market compared to the size of the GCC for that latter region to depend upon for future development.

As I mentioned in my post "What's wrong with GCC sukuk markets?", "Malaysia's GDP in 2009 was $193 billion compared with Saudi Arabia's GDP of $369 billion in the same year and the GCC as a whole representing $912 billion in GDP in 2009. Yet, sukuk issuance in Malaysia makes up 72.3% of the entire sukuk market in the first nine months of 2010 (9M10)." The GCC economy is four and a half times the size of Malaysia and yet issuance in the first nine months of 2010 was three to one in favor of Malaysia. That cannot be sustainable.

If sukuk markets are going to grow to be a significant source of capital for GCC corporates, it will not happen in Malaysia alone; it has to be accompanied by further development in the GCC sukuk markets. Returning to my first point, reminders of the source of the problems in the markets from 2009 (Nakheel was a trigger for the Dubai debt crisis) are not the best start.

That being said, there are more optimistic signs; for example, GE Capital may issue sukuk in the GCC in 2011. There is also the issue of liquidity. Not the secondary market liquidity I have opined about so often, but petro-liquidity. Despite the moves to diversify GCC economies, they are dependent to a large extent of their economic growth on the price of hydrocarbons (mostly oil although Qatar has significant reserves of natural gas). Thus, a large source of the liquidity that will fuel a demand for sukuk (as well as a supply) will be dependent upon the price of oil and natural gas. Oil prices in particular are at some of the highest levels since 2008 and this will create a flow of liquidity into the GCC.

Once this liquidity reaches the GCC, it needs to find a home and the infrastructure needs of GCC countries have been well documented (with various estimates from hundreds of billions to trillions in infrastructure spending over the medium-term future). The GCC economies also have a large population of young people and relatively high youth unemployment. This can be a source for sukuk. The wealthy, Shari'ah-sensitive investors will have resources that they want to invest in fixed income-like products (including higher-yielding non-sovereign sukuk) and the governments will want to meet the needs of their population through infrastructure investment and job creation.

There are many companies who will be called upon to provide services and if a portion of the infrastructure is built using public-private partnerships or joint ventures, it could create a large supply of sukuk if a portion of these private partners raise capital using sukuk. This, in addition to greater economic confidence from other corporates in the GCC region and multinationals diversifying their funding base, probably provide the necessary key for the GCC sukuk markets to develop. Will it happen in 2011? I can't say. Although, I think it can at least start to move in this direction over the course of the year.

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