Financial inclusion and digitalization have been key features of the Islamic finance sector in 2022 and could continue into 2023, underpinned by strong asset prices. Conflict in Europe, geopolitical rivalry and soaring inflation have taken their toll on global economic growth in 2022, but multiple underlying factors have supported cross-border trade and finance this year and will continue to do so in 2023 and beyond, as mentioned in the latest edition of the Future of Trade report.
Indeed, the weather report for next year might well read: Partly cloudy.
Forecasts going into 2023 indicate that global growth could slow to 2.7% in 2023, down from 6% in 2021 and 3.2% in 2022. Those projections from the IMF presage the weakest growth profile since 2001, except for the global financial crisis and COVID-19-linked lockdowns.
In the Islamic world, the picture is more optimistic overall. While open economies could reflect global trends, commodity prices will brighten the picture, underpinning higher-than-average growth. The World Bank expects Malaysia to clock a growth of 4.2% in 2023, down from the 4.5% forecast earlier. The MENA region will grow by 5.5% in 2022 (its fastest rate since 2016) and by 3.5% in 2023.
Elsewhere, bright spots for the Islamic financial world come from digital solutions, which will continue their drive toward inclusion and innovation. Furthermore, the shift toward sustainability could benefit Shariah instruments — perhaps even as, in the most blue-sky scenario, former safe havens turn volatile.
Review of 2022
Strong economics, better inclusion in 2022
Islamic finance assets were expected to post double-digit growth in 2022, following on from an aggregate 10.2% expansion in 2021. Contributing factors included a resilience to macroeconomic shocks from the Ukraine–Russia conflict, a rapid bounceback from the pandemic and fiscal measures by central banks in Islamic markets.
Against that larger picture, three major trends stood out.
• Digitalization brought financial inclusion: The challenges of the pandemic increased the adoption of digital technologies across every sector. In finance, the pandemic served as a catalyst to drive financial inclusion. As the World Bank notes, 71% of people in developing countries have an account today, up from 42% 10 years ago. Globally, the figure stands at 76% of all adults, as compared with 51% a decade ago. With financial inclusion seen as a cornerstone for development, both conventional and Islamic markets will post value and sustainability gains as a result.
• Global Sukuk issuance dropped: Data shows that Sukuk totaling US$100.9 billion were issued in the first half of 2022, according to Refinitiv. However, as a global monetary tightening cycle and elevated oil prices reduce government borrowing, issuance is likely to have slowed over the last six months of the year. Moody’s Investors Service estimates aggregate volumes were likely to have fallen to between US$160 billion and US$170 billion in 2022, from US$181 billion in 2021.
• Fintech showed its potential: Alongside financial inclusion, digital adoption has seen technology making further socioeconomic inroads, driven by the demographics of the Islamic community. From investment apps to Shariah cryptocurrencies, fintechs are providing innovative new ways to reach customers. When expanded to areas such as business and trade, the market could expand to US$128 billion by 2025, according to projections by Dinar Standard and Elipses. This represents a 21% compound annual growth rate (CAGR), as compared with a projected 15% CAGR for non-Islamic fintechs over the same period.
Preview of 2023
Commodity support, sustainable values in 2023
Strong fundamentals and a continued recovery are expected to continue the upward trajectory for Islamic markets in 2023, despite the unwinding of regulatory forbearance and the impact of global events.
• Commodity prices will shore up Islamic banking: DMCC research indicates that higher commodity values could underpin banking growth in Islamic-majority countries over 2023. In the GCC, hydrocarbon prices and the easing of pandemic restrictions will continue to support strong economic recovery through to the end of 2023, boosting the asset quality of Islamic banking entities in the region, Moody’s said in a September report. Malaysia could likewise see its Islamic banking market post double-digit growth, the rating agency said.
• Double-digit growth for Takaful: Commodities could also boost the Takaful sector, where earnings have been weighed down by competition and an increase in claims frequency over 2021. However, a modest recovery on the back of anticipated rate adjustments in loss-making lines and higher interest rates could boost investment returns for business and personal Takaful, S&P forecasts. Gross written premiums/contributions could expand about 10% in 2022 and 5–10% in 2023, it said.
• Sustainable action feeds Islamic finance: Shariah investments typically provide better protection than conventional products, given their exclusion of speculative activities. These values accord with pandemic-linked attention on ESG factors. Accordingly, green and sustainability Sukuk could see higher volumes, while investors look for funds aligned with sustainability themes. The uncertainty in traditional bond markets could also contribute. Since the first green Sukuk facility was launched in 2017, the subsector has reached US$15 billion in valuation. And despite the recent fall in overall issuance, demand for green Sukuk could continue to climb. ESG-related Sukuk were up 2.8% in the third quarter of 2022, as compared with the second quarter, Fitch Ratings data shows. Innovative solutions that capitalize on this newfound appetite could attract greater traction.
• Zakat increase could be a sweet spot: Returning to the digitalization story, fintechs could potentially grow the annual financial value of Zakat, Sadaqah donations and Waqf endowments, according to a survey by IslamicMarkets.com. Some 33% of Islamic fintech professionals forecast a dramatic increase in charitable giving over the next five years, as the digitalization of financial services contributes to increased sectoral transparency. Experts believe the three components could together provide a pathway to mobilizing funds in service of the UN SDGs.
Conclusion
Black swan events may yet return anew to test us — and the impact of global events and trade patterns could cloud economic growth. However, the rollercoaster performance of asset classes over the past three years has weighted sentiments toward safe, ethical and inclusionary investments. In many ways, the trend provides opportunities aplenty for Islamic finance.
Sanjeev Dutta is the executive director of commodities and financial services at the DMCC. He can be contacted at [email protected].