With the current global pandemic posing severe challenges to the world economy, governments have been forced to provide economic rescue packages on an unexpected scale to mitigate the economic and social costs. According to the IMF, the economic impact of COVID-19 in 2020 will be worse than the outcome of the economic recession in 2008.
Since the first Sukuk issued in the 1990s, the total volume of Sukuk achieved is approximately US$1.3 trillion today. However, we have witnessed Sukuk issuances and achieved a total volume that slowly improved until 2010 because of limited knowledge and legislation implemented by the regulators.
Since 2010, Sukuk have become one of the main instruments for central banks and Islamic banks, especially those operating in Muslim countries, as well as new sovereign and financial institution issuances coming from non-Muslim countries like the UK, Hong Kong and South Africa and European government-owned export credit agencies’ back-structured facilities.
Review of 2020
Sukuk were one of the niche products that showed strong resilience with total volume reaching US$130 billion as of the third quarter of 2020, about US$4 billion more compared with the same period in 2019. However, even if we like to be more optimistic for Sukuk volume to increase in 2020, the general expectation is for the total volume, except for sovereign issues, to be lower than 2019.
Especially in 2020, the main contribution to Sukuk was driven by green Sukuk issuances pioneered by the Islamic markets in Malaysia and Indonesia followed by hybrid issuances and inflation-linked transactions. For example, the Indonesian government issued a US$2.5 billion global Sukuk facility in June 2020, including a US$750 million green tranche — the first time a ‘green tranche’ had been placed in an Indonesian sovereign transaction.
Despite the decrease in the volume of Sukuk issuances by corporates in 2020, sovereign Sukuk issuances have become the main reason why the third quarter of 2020 has already reached a higher amount than the same quarter in 2019. In addition to this, the difficult economic environment has led to higher financing needs for sovereigns.
According to Moody’s Investors Service in its August 2020 report, it was expecting a decrease in Sukuk issuances and the total amount in 2020 because of the negative impact of COVID-19 on the market, as well as the complexity of Sukuk and heavy operational requirements compared to conventional debt instruments.
Contrary to the rating agency’s expectation, decreasing market rates, lower oil prices, the increasing number of investors and a new market for Sukuk (Taiwan’s Formosa Sukuk market) have encouraged more sovereign Sukuk transactions, especially in the GCC region.
According to the Sukuk issuers’ league table, in 2019, the Sukuk market was led by Malaysia followed by Saudi Arabia and other GCC countries; before the COVID-19 outbreak, more Sukuk issuances were expected from Turkey and Indonesia.
In fact, before the end of 2020, better pricing expectation by Sukuk investors compared to low-yield sovereign and corporate eurobond issuances would encourage sovereigns to execute more transactions. For these reasons, even though in 2020 the year-end volume would be less than in 2019, it is still creating an opportunity for the Sukuk market whereby issuers and sovereigns will bring their innovations and structures to the market in 2021.
Preview of 2021
Embracing new technologies and business models is essential to maintain the momentum in sovereign Sukuk issuances in 2021.
However, the unfortunate drop in the global economy in 2020 due to the coronavirus’s negative impact on all sectors has resulted in governments and central banks having to concentrate on financing the markets with low pricing instead of issuing new transactions to prop up financial institution and corporate liquidity in 2021.
According to the IMF and economic analysts, sovereigns are likely to issue more Sukuk transactions in 2021 to meet their compensatory fiscal policy. Due to decreasing financial institution and corporate issuances, sovereigns can offer secure and risk-mitigated investment opportunities to match the expectations of Sukuk investors.
As mentioned earlier, sovereigns are likely to issue more Sukuk transactions in 2021 to meet their compensatory fiscal policy and this, along with the existing appetite of Sukuk investors from the GCC and Muslim countries, would make Sukuk, especially low-risk sovereign Sukuk issuances, more attractive to not only existing investors but also newcomers. However, investors, particularly the newcomers, will remain focused on sovereign issuances with stronger credit fundamentals.
One of the main reasons more sovereign Sukuk transactions are expected in 2021 is because COVID-19 has reduced output and increased government expenditure while decreasing the pricing for hydrocarbons.
Despite the negative impact of COVID-19 on the global market, Sukuk are still major alternative instruments for newcomers, offering a better price compared with conventional bonds and possessing stronger credit ratings — these are concrete reasons for the Sukuk market to continue to be alive and dynamic in 2021.
Cenk Karacaoglu is the senior advisor at Yad Egitim ve Danismanlik. He can be contacted at [email protected]