As an expected result of the economic effects of the coronavirus pandemic, and according to data issued by S&P, the volume of Sukuk issuances declined by 27% year-on-year in the first half of 2020. Many expectations indicate that the total Sukuk issuances by the end of the year will achieve levels nearer to that of 2019 which hit a record US$146 billion. The most significant decrease in Sukuk issuances was concentrated on Sukuk issued by companies and financial institutions. This article explains the reasons for this decline and the future prospects of this instrument.
Review of 2020
At the beginning of 2020, many expected a new record and great momentum in the global Sukuk issuance market, after 2019 closed at a record high in total global Sukuk issuances at US$146 billion; however, the winds usually only blow in directions that ships do not desire. It took only two months of the year to pass before the coronavirus began to spread globally, constituting the largest global closure of travel and aviation traffic since World War 2, and most economic activities stopped around the world.
Undoubtedly, this had a great impact on Sukuk issuances, especially for corporate and financial institutions. With almost a complete halt on economic activity, global demand decreased which required many governments to adopt quantitative easing programs to counter the specter of economic recession.
The following are the reasons for the sharp decline in corporate and financial institutions Sukuk issuances in 2020:
1) Companies defer investment spending plans for 2020
The pandemic has led many companies to reconsider their investment spending plans, including expansions in current activities or entry into new activities, due to the blurring sight of the global economy and the lack of clarity on when the pandemic will end. This has also led to a decrease in the financing needs of companies, which have postponed their plans toward different funding sources, including Sukuk.
2) Availability of liquidity as a result of quantitative easing programs
In response to the drop in oil prices and the impact of the pandemic on the economy, and fearing that the economy will enter a period of long economic recession, several central banks have launched quantitative easing programs to provide liquidity to help companies adjust and maintain the productive capacity of their economies. This new liquidity resulted in reducing the need to issue Sukuk for many companies, in conjunction with the aforementioned first reason, ie a postponement of investment spending plans coupled with the availability of liquidity from the government in some countries.
3) Global uncertainty prompts postponement of plans to issue Sukuk
The timing of the issuance of Sukuk plays an important factor in the success of the issuance, and at the same time in obtaining preferential prices; the uncertainties have led to the opposite of achieving these goals, as many funds and major subscribers are reluctant to enter into many of the offered issuances, and even if they enter into these issuances they often require higher pricing margins against the risks arising from the uncertainties.
4) The competition from sovereign Sukuk is negatively affecting corporate bonds
In many countries — especially the Gulf countries — that depend on oil revenues as a source of government revenues, the decline in oil prices and the increasing budget deficit have resulted in these governments turning to more sovereign Sukuk issuances as one of the means of bridging the financing gap and meeting the increasing needs that have resulted from this gap throughout the pandemic. This has resulted in what is known as the effect of crowding out — Sukuk issued by governments to finance the budget (sovereign Sukuk) have a better credit strength than Sukuk issued by companies (corporate Sukuk), which has led to some corporates finding it very difficult to issue Sukuk at this time.
5) Central banks support the banking sector
Many central banks in several countries have supported the banking sector by injecting liquidity into banking systems to cope with the economic consequences of the pandemic as part of an attempt to stimulate domestic demand, including postponing the payment of borrowers’ obligations and dealing with defaults, resulting in a situation where financial institutions can adapt without the need for new Sukuk issuances.
Preview of 2021
At the time of writing, hope has appeared on the horizon that the pandemic would abate soon with the announcement of a vaccine for COVID-19, with expectations that it would be ready for wider distribution in the first few months of 2021, which would mean — if it happened — the return of movement and production on the global level, and reactivating the investment spending plans deferred by companies and financial institutions, which would then increase the demand for sources of financing, and which in turn would lead to an increase in the volume of Sukuk issuance from these entities; Sukuk issuance could then return to the 2019 levels again after a few years.
In short, the resumption of the Sukuk market progress for companies and financial institutions is linked to the level of the pandemic prevalence, the return of economic activity to pre-pandemic levels, as well as the extent of the positive effect of the new vaccine and its level of availability in terms of cost and accessibility around the globe.
Dr Ahmed Hassan Al-Naggar is an economic and financial expert. He can be contacted at [email protected]