This was supposed to be the year of the rise of sukuk markets. As the Malaysian economy recovered and the Arab spring passed, another record year of sharia-compliant debt issuance was predicted.

But that changed after a day in May. Ben Bernanke dropped hints that the Fed would taper its bond-buying programme, and sukuk sales shrivelled in the third quarter. The number of issues this year is expected to be just above that of 2011.

According to surveys by Thomson Reuters, hesitant issuers waited until uncertainty passed in the middle of the year. When the Fed said in September that tapering would come later rather than sooner, sukuk sales picked up again.

Ratings agency Moody’s predicts a stronger year in 2014. It lists four main reasons:

(1) growing demand for Islamic banking services and assets from the populations of Muslim countries;
(2) the increasing familiarity of both Islamic − and, most critically − ‘conventional’ (i.e. non-Islamic) investors with these instruments;
(3) the promotion of Islamic finance by their governments via the provision of supportive capital markets infrastructure;
(4) the increasing standardisation of unsecured sukuk structures.

Thomson Reuters is slightly more bearish, pointing out that there is still a gap between sukuk yields and other bond yields. The added “sukuk premium” reflects the lack of liquidity and tradability of sharia-compliant instruments. Sukuk with short maturities are few and far between; the market is also constrained by the absence of a large international Islamic bank in the mould of an HSBC.

The sukuk market is still a local affair. International issuances still make up a low share of yearly auctions (see chart, right).

Malaysia accounts for three fifths of all sukuk issuance. Moody’s predicts this will change in due course: Indonesia and Turkey – Islamic countries whose burgeoning companies will depend more heavily on debt financing in the coming years – are tipped as future financial centres. This is still a long way off. The two countries currently issue 5 per cent and 2 per cent of all sukuk, respectively.

Turkey’s growing aviation sector for instance ought to rely more on sukuk over the coming years, says Thomson Reuters:

Sukuk, without a doubt, are optimal for the airline and aviation sector given the excellent match between the long-term nature of the assets with a regular income stream from passenger traffic, in addition to the structure and tenor of the paper.

With government backing, new regulations and the rising importance of the banking sector, take-off is expected.

Related reading:
London and sukuk: the lessons of Malaysia, beyondbrics
Africa adopts Islamic sukuk to fund big infrastructure projects, FT

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