Rising uncertainty for the sukuk market in 2015
- Published on Thursday, 22 January 2015 06:13
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In 2014 we saw for the first time the rise of non-Islamic sovereign issuers of sukuk. The governments of Hong Kong, Luxembourg, South Africa and the UK all issued sukuk for the first time in 2014. This marks the starting point of a trend that is expected to increase in the coming years. However, with fizzling global growth expectations from the IMF coupled with crashing oil prices, can the sukuk market maintain its momentum?
Standard and Poor’s in its latest report on the sukuk market highlights some of the challeges facing the market this year, which can be downloanded here:
The report mentions two key factors to support their view, which are expectations of rising interest rates in the US and falling oil prices. We agree with S&P on the second point and disagree on the first point. As we stated in an earlier post here that we do not expect the Federal Reserve to raise rates in 2015. We see the current turmoil in financial markets as an easy exit door for the Fed to back-track on its previous statements of raising rates. On the contrary, if the current turmoil in markets put the brakes on raising rates, it also opens the door for launching another stimulus program, whether they call it QE or not. The EU is expected to launch such a program any day now.
Therefore, in addition to falling oil prices, we feel that the sukuk market will face challenges this year because of Basel III and hot money leaving emerging markets. We are not a fan of Basel III and see it as causing major problems for the already fragile banking system. New rules are being enforced this year causing banks to raise capital, reduce lending or both. The big global banks in particular are under pressure as they clearly need a lot more capital. Any slowdown in lending will put the brakes on any expectations of economic growth as we cannot grow without piling on more debt. This is the dilemma central bankers face. No amount of QE can force bankers to lend more if they are expected to abide by new Basel rules. Banks around the world have been raising fresh capital. In the Middle East we have already seen at least two banks issue sukuk specifically to support their capital position due to Basel III; Qatar Islamic Bank and Dubai Islamic Bank.
As for emerging markets, we expect the trend of hot money fleeing these markets to continue and even accelerate. The more volatility and turmoil in the markets, the more investors will chose to park their money in safer markets. The hunt for yield as we have seen over the past 5 years (due to QE) is now ending. High-flying emerging markets including BRICS are facing enormous challenges. GCC countries are also facing huge budget gaps for the first time in years. This is one of the drivers, however, of the expectation of more activity in the sukuk market… GCC governments tapping the sukuk market to plug holes in their budgets over the coming years. It’s too early to tell whether this will be good or bad for the sukuk market because there are other factors at play.