Interpreting Middle East Economic News and Analyzing Market Trends

Emerging Market Debt Issuance Hits Record and Spills Over into Sukuk Market as Investors Worldwide Hunt for Yield

The funny thing about unintended consequences is that they pop up regardless of your original intentions, good or bad. I’m sure central bankers’ in the US and EU had good intentions for keeping interest rates near zero for so long, but their efforts to stimulate their economies and help them recover from a bubble collapse have led to the creation of another bubble. Record low yields in developed markets are pushing investors to search for higher yields.


For 2012, issuance of emerging-market bonds denominated in the U.S. dollar soared to about $375 billion, marking a record high since data provider Dealogic began tracking the data in 1995. Issuance far outpaced the previous year, when emerging-market issuers sold $235.5 billion in new debt.

Ultra-low interest rates in the developed world helped drive the hefty stream of issuance by allowing emerging-market companies and countries such as Chile, Bolivia and Mongolia to issue at cheaper levels. Investors starved for yield piled into the new deals, crowding order books. Some offerings were as much as 10 times oversubscribed.

In one example, junk-rated Bolivia was able to sell its first dollar bond in nearly a century without having to offer additional yield to compensate for the risk of being practically a new issuer. The Bolivian government sold $500 million in 10-year notes at a yield of 4.875%.”

Read the full article from The Wall Street Journal.


So record low yields in developed market debt (US and Europe) is leading fund managers to rush to buy bonds from emerging markets, even those with a very poor history (Bolivia!), in order to show higher returns to their investors. This flood of money into emerging markets is pushing interest rates and yields lower in these markets… so low that these markets can’t believe their luck so they are now rushing to issue more debt for these suckers to buy. Can anyone predict the outcome here? It will end in tears of course.


This rush into emerging market debt has also had a spill-over effect into the sukuk market. The sukuk market has been at the forefront of the Islamic finance industry since it took off less than 10 years ago and hit a new all-time issuance record in 2012.


Falling yields have helped push worldwide sales of debt that comply with Islam’s ban on interest to an unprecedented $46.3 billion in 2012, surpassing last year’s record of $36.7 billion, data compiled by Bloomberg show. Sales may be even higher in 2013 as new countries including Oman, Tunisia and Egypt tap the Shariah-compliant capital market for the first time, CIMB Group Holdings Bhd. (CIMB) and OCBC Al-Amin Bank Bhd. said in December.”

Read the full article from Bloomberg.


post1image1Source: S&P Ratings Services


However, the average yield on sukuk remains below the average yield on emerging market bonds, yet still above developed market yields. There are two reasons for this. First, there has long been a shortage of fixed income instruments in the Islamic finance market. Sukuk issues tend to be well over-subscribed and are thinly traded on the market. Most buyers of sukuk hold the issues to maturity because there is still higher demand than supply.  Second, sukuk have been less volatile and have been performing better than conventional bonds over the past few years.


Yields on sukuk should continue to have lower yields than emerging markets but the flip side for bond investors is that sukuk still outperform the international bond index while offering lower volatility. This should bode well for fund managers. They will also sleep better at night knowing that sukuk issues tend to carry higher average ratings than many emerging market bonds.


To start the year running, the government of Dubai announced the first sovereign sukuk for 2013:


Dubai’s government may raise more than $1 billion from a planned sale of Islamic bonds and has mandated five banks including HSBC Holdings Plc for the offering, according to two people familiar with the deal.

Standard Chartered Plc, Emirates NBD, Dubai Islamic Bank and National Bank of Abu Dhabi have also been hired for the sale of sukuk, the people said, asking not to be identified because the information is private. A sale may start as soon as tomorrow, according to one of the bankers. Reuters reported the story earlier today.

The planned issuance will be the first sovereign sukuk sale in the six-nation Gulf Cooperation Council this year, according to data compiled by Bloomberg. Sales of bonds that comply with Islam’s ban on interest surged to a record $21 billion in the region last year as borrowing costs plunged. The yield on Dubai’s 6.396 percent sukuk due in 2014 tumbled 344 basis points, or 3.44 percentage points, last year to 2.13 percent, the data show.

Investor’s perception for Dubai credit risk has improved significantly in 2012 and the strong risk-on momentum continues into 2013,” said Apostolos Bantis, a credit analyst at Commerzbank AG in London. “Despite the improved sentiment for Dubai’s credit story the emirate has high refinancing needs and taking advantage of the current low-rates environment is a very good strategy.”

Read the full story on Bloomberg.


Though sukuk, in my view, are less risky than most emerging market bonds, I fear that too many emerging market yield-chasers will inflate this market too. Just look at the collapse of the yield on Dubai’s sukuk from 6.396% to 2.13%. We are living in crazy times where unintended consequences are popping up all over and new bubbles have already formed, yet investors prefer not to see the train wreck coming.