Tough Times for Gulf Sukuk Market

Since hitting a peak of $131Bn in 2012, Sukuk issuances have been gradually falling year on year despite new issuers entering the market.

The current dry run should act as a wake up call to the industry to pursue greater cross border standardisation as well as becoming masters of their own destiny and starting to issue more local currency sukuk and loosening currency pegs to the US Dollar.

The Gulf demand side of the Sukuk market is slowing through reduced liquidity bought on through a combination of uncertainty created by the oil price drop and a surging US Dollar. As the demand side waits on the side-lines, the supply side too is pausing for breath as issuers delay entering the primary market, a Gulf-based Islamic banker said.

Graphic: Chart showing drop in value of Brent Crude Oil price and a surging US Dollar against the Euro.

Oil Price Collapse and Drop in Sukuk Demand Side Liquidity

The speed and depth of the price drop of oil from recent highs of $110 to current lows of $50 has caused a heart attack for the fiscal positions of Gulf economies, and as anyone living or doing business in the region can testify, spending and projects are being put on hold.

Buying Sukuk is not spending though; it is investing, a place to park your cash in uncertain times. The demand for this parking seems to be on the wane. The recent Dubai Islamic Bank Sukuk issuance, whilst still twice oversubscribed, failed to reach oversubscription levels of its previously offering, as well as to comparable offering made only a few months back by other corporates. Furthermore it priced 500 basis points above a similar offering by Dubai Islamic Bank just under 2 years ago indicating buyers were more thin on the ground this time around.

Strong Dollar

A quick analysis of late 2014 Sukuk issuances demonstrates the Middle East continued to supply most of the demand side up to November. Middle East accounts bought 68% of the Sukuk issued by IIFFIm, 30% of the Government of Pakistan Sukuk, and 81% of Mumtalakat Holding Sukuk .

As Gulf buyers step back, increased interest from Asia and Europe should be sufficient to fill the void in normal circumstances. However, two issues present challenges both linked to the surging value of the US Dollar.

Firstly, the biggest Sukuk market is the Malaysian market; but it is largely a domestic market with its buyers purchasing in Ringgit and tending not to stray abroad, and even if they did, they would not possess the buying power currently left vacant by the Gulf.

Secondly, the failure of the Gulf to detangle themselves from fixed US Dollar pegs as well as, Saudi Arabia apart, a failure to develop local currency issuances is coming home to bite as the market has become benchmarked in US Dollar denominated Sukuk.

The surging US Dollar makes European buyers domiciled in Sterling, Euro or Swiss Francs think twice. Buyers in Sterling for example would now be paying around 11% more for the same Sukuk than they would have paid just 3 months ago, and with many pundits pointing to a continued and prolonged Dollar bull market, European buyers seem unlikely to fill any liquidity voids left by lack of Gulf demand.