Where will sukuk markets gravitate?

The markets for Dubai's sukuk are giving the "all clear" with yields falling and the spread between Dubai's sukuk and Malaysia's sovereign sukuk falling to their lowest levels (the Malaysian sovereign sukuk was issued last summer). There are other articles giving warnings of the effect of the protests in many countries, with Bahrain causing the greatest effect on the Islamic finance industry.

The disruption caused by the protests is unfortunate for Bahrain which saw its financial industry grow to around one-quarter of the economy before the protests after capturing share from Beirut in the 1980s after the beginning of the Lebanese civil war. Now the protests in Bahrain could shift the center of finance--and Islamic finance in particular--elsewhere in the GCC if the disruption continues. The old saying about finance reminds that markets and financial firms, while taking risk, will avoid uncertainty. However, despite the disruption to business activity in Bahrain the Central Bank has continued its sukuk issuance with one sukuk al-salam recently that was heavily oversubscribed. However, the yield of 1.15% was sharply up from six months ago when the CBB issued a sukuk al-salam paying just 0.67%.

Even before the protests, the center of sukuk issuance was seen as shifting away from the GCC with Malaysia being the destination of choice for issuers with its much more liquid secondary markets. Although I still belive (as I predicted at the end of 2010) that this would slow and begin to shift back towards the GCC, it will probably take longer than I expected with the disruption in one of the financial capitals in the region. However, given that there has been limited spread in protests to Saudi Arabia, the UAE and Qatar, there should still be issuers looking to issue sukuk domestically (like, for example, Bank Al-Jazira, which just issued a SR1 billion ($267 million) sukuk).

One factor that could be slowing the return of issuers to the GCC besides the events in the region is the currency: the ringgit is the strongest it has been in 13 years against the dollar, to which the GCC currencies are pegged. Given the tendency of financial prices to revert to the mean in the longer term, this would benefit issuers from the GCC who issue sukuk at current levels because their repayment obligations is in ringgit and if the currency returns to the average level over the past five years, it would effectively reduce their local currency obligations. As the ringgit appreciates, it would be expected that this affect would be diminished and coupled with a return to calm in the GCC would encourage issuers to look more to the local GCC markets.

Within the GCC, the impact of the instability in Bahrain will probably lead to a shift of Islamic finance activities--particularly if the protests continue--to another country. While the resolution of some of the Dubai World troubles with cash payments being made to creditors will remove some uncertainty around the Dubai situation, it is unclear whether it will be the preferred destination for any financial institutions fleeing Bahrain. Perhaps Qatar, with its 2022 World Cup, or Abu Dhabi will become the destination. Or perhaps, Saudi Arabia, with its mortgage law expected to come into effect in 2012 will have its bid as a hub for Islamic finance become as significant as its economy's size within the GCC.