Monday, October 08, 2012

Are sukuk 'critical' for infrastructure finance?

The idea of sukuk being used to fund long-term infrastructure needs in Southeast Asia and the GCC is one which holds theoretical appeal (and has back to before the financial crisis), because of the connection between an income-generating asset and the idea of Islamic finance as focused on the 'real economy'.  A recent article suggests that sukuk will play a 'crucial' role in the infrastructure needs in these regions, citing an estimate of $8 trillion in infrastructure needs in Asia over the next 10 years (Looking back I find the same $8 trillion over the next 10 years estimate from S&P being released almost exactly 1 year ago).

The reality is that sukuk markets are quite far away from being ready to play a large part--or even a marginal part--in financing this infrastructure development.  For Islamic finance, the key reason is that bond and sukuk markets in the GCC and Southeast Asia are relatively undeveloped compared to other financial markets, particularly for the types of sukuk that would be required to fund infrastructure projects. 

A recent presentation (PDF) by Sumitomo Mitsui relating to the EU/EMEA area includes the bullet point: "Tenors 15-30 years depending on type of project".  Contrast that time period with the time period of most sukuk (and even many bonds coming out of the GCC/Southeast Asian region, particularly the former) where the tenor is under 10 years, and most frequently 5 years.  In Malaysia, there is much more diversity in tenor, but most of it has been directed towards the domestic market (and is nowhere to close to the scale to make a significant contribution in the estimated annual $800 billion in infrastructure investment across Asia). 

There is also a perception widely held that Malaysia's sukuk market is not as Shari'ah-compliant as the GCC, and there has been a shift towards adopting the standards accepted by investors from the GCC to attract both issuers (looking for the more liquid secondary markets) and investors (looking for a wider diversity of more liquid sukuk).

However, until investor demand combines with issuer willingness to issue longer-tenor sukuk, there will be less of a role for sukuk to contribute to financing the infrastructure needs in the GCC in particular.  This is not to say that there is not the potential for sukuk to serve as financing vehicles for infrastructure finance, I think there is, but it is not something that will develop overnight. 

I think it gets a little ahead of the market development to suggest that sukuk are 'critical' for funding infrastructure in the next 10 years.  It would be a major development if sukuk were a significant source of infrastructure funding even in the second 5 years (2017-2022).  To expect it to develop in the 2012-2017 period is a bit too optimistic for me. 

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