The Islamic bond market, which had held up relatively well in defiance of the credit crisis, has slumped in the past month because of the sharp fall in the price of oil and deepening gloom over the outlook of the world economy.

Hedge funds, which had pumped money into Islamic products in the Middle East in the first six months of the year because of expectations of revaluations of some of the Gulf currencies against the dollar, have also left the market.

There have been only a handful of Islamic bond deals since the start of October, raising a quarter of the amount issued in September and a fraction of the more than $13bn raised in total this year so far, according to Dealogic, the data provider.

Islamic bonds, or sukuk, which are structured to avoid paying interest in line with the Koran, were among the fastest-growing instruments in the world before the credit crisis hit in August last year, although they are still a small market when compared with conventional bonds.

Sukuk issuance now stands at an estimated $80bn in outstanding debt. This is a dramatic rise since 2000 when the market consisted of just a few deals in the millions rather than billions of dollars.

On the sudden seizing-up of the market, Mohammed Dawood, director of capital markets at HSBC Amanah, says: “We live in a global world ... and a reduction of liquidity has had its impact on the sukuk market and the Middle East.”

“A lot of hot money from hedge funds has exited the market since the summer because revaluations of some of the currencies did not materialise and the dollar has strengthened since then. The lower oil price is also negative for the Middle East.”

Most issuers of Islamic bonds are based in the Middle East or Asia. Asian issuance has not been as badly affected because these economies have not relied as heavily on oil, which has fallen in price by far more than half from highs close to $150 in July.

Issuance had suffered in February and March following a warning from one of the leading Islamic scholars that some sukuk, which are structured to pay profits or rent from an underlying business or asset, usually a building, were not measuring up to religious rules.

Sheikh Muhammad Taqi Usmani, head of the religious board of the leading body that sets standards for Islamic financial products, said two types of bond structures – known as musharaka, an Islamic joint partnership, and mudaraba, a form of trust financing – were not compliant with Islamic laws.

Mr Usmani, head of the religious board of the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions, said musharaka and mudaraba structures were breaking the rules because they offered investors a repurchase undertaking where the issuer promises to pay back the face value of the bond when it matures or in the event of a default.

This looks like a guaranteed return, which goes against the spirit of Islamic finance, where interest is banned and buyers share risk and profit.

Since April, however, the market appeared back on track as Ijara – the one structure not criticised by Mr Usmani – began to attract more interest from investors looking to diversify cash into the Islamic finance sector because its institutions had not been exposed to toxic assets and derivatives in the same way as conventional institutions.

Ijara structures, which involve setting up a sale and leaseback arrangement, escaped the criticism because they use an asset to raise money. As these use lease payments, no interest is paid to fund the project, in line with sharia law.

Issuance between April and September rose to similar levels before the credit crunch, with average monthly issuance rising to $1.9bn raised. This is higher than the $1.8bn monthly average between January and June in 2007, according to Dealogic.

However, in recent weeks as the global economic outlook has deteriorated and the oil price has remained weak, issuers have increasingly struggled to find investors willing to buy Islamic bonds. Shaky property markets have also undermined sentiment and issuance.

Most analysts believe this may turn out to be a blip rather than a permanent trend as the Middle East economies remain strong in spite of the fall in the oil price. The combined gross domestic product of the six Gulf countries – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates – has doubled since 2002.

These analysts expect the market will remain quiet until January, traditionally a time when some investors start looking to change their portfolios.

Mr Dawood says: “Issuers are going to return to the debt markets and we feel 2009 will see new issues in the sukuk market.”