If Sukuk issuances — which are fast emerging as a significant form of Islamic financing — are a barometer of how the industry in the GCC region is coping with falling oil prices, there may be cause for anxiety. RAHAYU MUSA KAMAL examines the link between the price of oil and the performance of the Islamic finance industry to find out if such anxiety is warranted.
The Gulf Cooperation Council (GCC) region, which accounts for more than half of global Sukuk issuances, saw a 60% drop in the value of such issuances last year resulting in industry observers, who were convinced that Islamic finance was independent and risk-immune, rethinking their stance.
Many now agree that the collapse of crude oil prices from their record high last year and the global economic meltdown — a double whammy — are hurting the Islamic finance sphere, not only in the GCC but also globally.
Dr Mohamed Damak, a Paris-based Standard & Poor’s (S&P) credit analyst, believes there is a correlation between the development of Islamic finance and oil prices in the Gulf as the commodity is the main source of revenue for the region. Mohamed pointed out, however, that Islamic finance has developed geographically beyond the GCC and that the region is not the be-all and end-all for the growth of the industry.
“The link between oil prices and the development of Islamic finance has been reduced because the geographic expansion of Islamic finance has been and is still expected to be significant. More countries have shown interest in Islamic finance, suggesting that growth in future will depend more on the economic conditions in these new countries and not purely on oil prices. But if we talk about the Sukuk market, then the oil price matters as the Gulf region is one of the key centers for issuances,” said Mohamed.
Anouar Hassoune, vice president and senior credit officer at Moody’s Investors Service, thinks that with the reduced flow of petrodollars, Sukuk issuances and funds are witnessing a sharp slowdown, and “this is not good news”.
“Oil liquidity is a key driver of Islamic banks’ growth because they contribute by recycling such liquidity in the economy. Less oil revenue will therefore mean less appetite for banks to issue and carry Sukuk, at a time when the Sukuk market needs more issuances to make it more liquid and suffer less from price distortion. With Sukuk being scarce, spreads tend to widen and bid-ask gaps get larger,” said Anouar. However, he said Islamic financial institutions (IFIs) have accumulated asset liquidity and capital on their balance sheets and these can help them, despite scarcer funding sources. He believes that several Islamic banks are in a position to gain market share at the expense of several conventional peers which were weakened by toxic subprime assets.
“The absence of long-term funding in the form of Sukuk may, however, make it difficult for these banks to apply for proper asset-liability management, and they will be forced to shorten the maturity profile of their assets. This is not what local economies need,” he said.
Mohamed of S&P expects the Sukuk market to start recovering sometime in the second half of 2009 and most probably only in 2010. The pipeline for the long term remains healthy with more than US$45 billion of Sukuk that were announced or talked about in the market. These are expected to come to market once conditions normalize, and may be in line with the expected improvement of the economy, which industry players are optimistic will take place in the second half of 2009.
Meanwhile, several sectors are believed to be badly affected by the current liquidity crunch. According to Anouar, businesses that consist of securitizing assets into financial instruments, in the form of Sukuk or fund notes, are suffering. “Asset and fund management as well as asset securitization need liquidity to properly build up their value proposition, especially in the still developing Islamic sub segment. Without such liquidity, Sukuk and Shariah compliant funds will take longer to kick in,” said Anouar.
Although the not-so-sterling performance of the Islamic finance industry has been linked by many to the volatility of oil prices, Nabil A Issa, a partner in King & Spalding in Dubai and affiliated Riyadh offices in the Islamic finance and investment group, has a different view. He points out that the two jurisdictions that have been dominant in Sukuk issuances are Malaysia and the Emirate of Dubai, as opposed to any of the leading oil producing countries.
In terms of issuances, Gambia in western Africa is among the top. Interestingly, therefore, the leading issuers of Sukuk have not necessarily been the oil producing giants of the region. Nabil also thinks that the most important reason for the downturn in the Sukuk market was due to the Accounting and Auditing Organization for Islamic Financial Institution’s (AAOIFI) Sukuk clarification in 2008 following the points raised by leading scholar Sheikh Taqi Usmani that many Sukuk issuances were not Shariah compliant but were essentially conventional bonds.
He feels strongly that the oil price is not the only factor affecting the Islamic finance industry. “It is naїve to believe that IFIs are not affected by the overall financial crisis that has deeply affected conventional banks. Real estate, for example, is an asset that Shariah compliant financial institutions have traditionally used to underpin transactions. Therefore, the drop in real estate prices globally will most dramatically affect IFIs that invested in or financed the real estate industry.”
Sunarsip, the Indonesia Economic Intelligence’s chief economist, agrees with the notion that there is a definite correlation between the drop in oil prices and the Islamic finance industry. “Even though in the beginning these countries were not affected by the subprime crisis in the US, the drop in oil prices is now tremendously affecting major oil-exporting countries in the GCC,” he said.
However, he believes that the stimulus plan announced by US president Barack Obama in February will strongly sway expectations and restore faith among investors.
“It will not happen that soon but it will definitely improve. The oil price is already showing signs of improvement although it will take some time for it to reach US$70 per barrel, which is the ideal mark set by the Organization of the Petroleum Exporting Countries,” said Sunarsip.
He stressed that for these countries, the price of each barrel should be around US$50 to cover government spending. However, he believes that profit can still be made if the price is as low as US$15 to US$20, but only at the microeconomic level.
Nabil, however, is upbeat and believes that the Islamic finance industry will improve despite the current economic turmoil as he is confident that governments in the GCC will push for the expansion of the industry over its conventional counterpart.
“The last few years have proven that Islamic finance can compete with conventional financing in every manner. The boom years encouraged more players to focus on Shariah compliant structures and documentation. These investments have reduced the cost of structuring or pricing Shariah compliant products,” said Nabil.
He feels that Islamic finance will benefit from high net worth individuals and local companies in Saudi Arabia, Kuwait, Qatar, Bahrain and elsewhere in the region which demand Shariah compliant investments and financing.
“We have been fortunate to have clients who work with us to develop documents and new structures for Shariah compliant financing and funds. “Regional governments will now be the drivers in spending on infrastructure projects in the region and they have the power to require that financing for these projects be conducted on a Shariah compliant basis,” said Nabil.