The global economic landscape since the year 2008 has been going through crises or facing a challenging environment and is once again facing an unprecedented economic crisis that is said to be more damaging than the 1970s recession and the 2008 global financial crisis at the collective level. This report discusses the ongoing and going-forward scenario of the global Islamic finance industry in the current economic situation across the world.
Review of 2022
Fitch Ratings’s third quarter of 2022 (Q3 2022) report on Sukuk states that the near-term Sukuk market activity will be slow in the core markets of the GCC, Malaysia, Indonesia, Turkey and Pakistan (including multilaterals) amid continued volatilities as will bond market activity. Rising interest rates, high oil prices, geopolitical events and lower emerging market debt appetite propelled a 14.4% quarterly fall in total Sukuk issuance in the core markets in Q3 2022, with bond issuance similarly falling (down 14.1%).
Funding diversification plans across sectors, upcoming debt maturities and the further maturity of the domestic debt capital market in a number of countries will continue to drive Sukuk issuance. S&P in its report titled ‘If Stagflation Strikes, Loss-Making Corporates Will Double Globally’ states that overall, conditions are tougher compared with December 2021’s semi-annual Global Debt Leverage series. Stress tests on its rated corporates pointed to cash flow stress. It also states that in the US, the share of speculative-grade issuers with free operating cash flow (FOCF) deficits would increase to 39% from 15%.
In Europe, 50% of speculative-grade issuers in 2023 would have a negative FOCF compared with 30% in 2021. In the Asia Pacific test, 25% of issuers would breach rating triggers. The foregoing indicates the impact of current economic challenges on the credit quality of Sukuk issuers or financing seekers over the short to medium term going forward.
Preview of 2023
The combination of monetary tightening in terms of rising interest rates at the central bank levels in the US, the UK and other parts of the world and supply-side shocks in the form of rising oil prices and other commodity prices is widely expected to put pressure on economies from two fronts. One such pressure may be a deep recession and the other may be on the global financial system. The recessionary economic crisis can be tackled to some extent by taking fiscal measures and better supply chain initiatives, etc.
The financial crisis may pose a complex situation this time where measures like quantitative easing and monetary policy softening that were adopted to manage the global financial crisis of 2008 can no longer prove useful and relevant. There seems to be a consensus among economists and finance experts that the current crisis can become a stagflationary debt crisis as well. Now the question is how this scenario may be affecting the Islamic finance industry globally besides not offering a rosy picture for the conventional finance industry internationally too.
The challenge in the first place is going to be for sovereigns and corporates to keep their creditworthiness or credit ratings intact. Further, they have to manage their liquidity to fund ongoing contractual obligations on time while their financial charges would also be increasing due to the high interest rate environment in developed and other economies, ie the spillover effect. Remember, it is not about refinancing existing non-equity liabilities but scheduled contractual payments.
Next comes the refinancing challenge; if sufficient interest would be available for some jurisdictions then at what funding cost would they be able to raise the financing, whether short- term or long-term? Finally, post the risk-adjusted credit profile of issuers of Sukuk and financing seekers, how many would be able to raise funds at the sustainable levels and terms?
The Sukuk market may be expected to remain relatively stable on the international or domestic scale but it is for sure that investors’ and financiers’ comfort level to invest will become quite selective and cyclical sectors of the economy like real estate, technology, financial, construction and automotive can suffer due to fewer financing options and unfavorable terms.
In the foregoing expected economic environment, the sovereigns and the corporate sector can adopt the strategy of focusing on raising short-term financing and instruments to ride over the rising interest rate curve environment and it will be mostly from domestic markets and from international markets, if feasible, for medium- to longer-term tenors. The features of Sukuk or financing may take two extremes: (a) plain vanilla or (b) complex structures to ensure repayments of non-equity schedule obligations.
Conclusion
The current and ongoing expected economic conditions would make fundraising activities more challenging in the short term and terms of financing would be more stringent with the risk of deteriorating credit quality. Seeing through the turbulent times is again making the case pf participatory capital stronger and appealing as it can at least help to address debt crises at the national and international scales that would otherwise aggravate the social and economic well-being of the masses and limit the economic growth of countries.
Mohammad Aamir is an ex-Islamic International Rating Agency credit analyst and Islamic finance practitioner. He can be contacted at [email protected].