Business | Markets
Credit crunch derails growth of Islamic debt instruments
Until recently, the Islamic debt market was expanding at a clip, doubling in size every year from 2004 to reach a total outstanding figure of $90 billion. Even the British government was mulling an issue to burnish its credentials as a centre for Islamic finance.
- By Robin Wigglesworth, Financial Times
- Published: 00:13 October 3, 2008
London: Until recently, the Islamic debt market was expanding at a clip, doubling in size every year from 2004 to reach a total outstanding figure of $90 billion. Even the British government was mulling an issue to burnish its credentials as a centre for Islamic finance.
Yet, in the first eight months of this year, issuance fell to only $14 billion compared to $23 billion over the same period last year, according to Standards & Poor's, the ratings agency.
Bankers disagree on what has derailed the growth of Islamic debt instruments, or sukuk. Some blame the credit crunch, others criticisms by a prominent scholar of Islamic finance.
The original idea of a sukuk was that its income stream came from a physical asset and that risk and profits were shared.
Mohammad Taqi Usmani, a Pakistani expert, said earlier this year that the definition had been stretched so that risk was not shared, and that the sukuk had become akin to conventional interest bearing bonds.
Whatever the cause, returns have trailed behind conventional debt. The HSBC-DIFX index of sukuk has declined 0.7 per cent this year, while the comparable conventional debt index has climbed 1.3 per cent.
Islamic debt remains a niche market, and investors - predominantly Islamic banks - have tended to buy and hold the securities, limiting trading on a secondary market.
Sukuk are still being issued though, despite torrid market conditions. Even after the events of recent weeks, S&P expects total issuance to reach $20 billion this year, according to Emmanuel Voland, a credit analyst at the company.
Narrowing
Though the size of issuance and diversity of issuers is increasing, it "isn't even close to being able to be termed a liquid market", says Voland. "The amount outstanding needs to be doubled - or tripled."
Not everyone agrees, however, and recent months have seen the establishment of several funds.
About $40 billion of global sukuk issuance is now "actively traded", particularly larger dollar-based instruments and Malaysian debt, says Mohi Al Deen Kronfol, managing director of Algebra Capital, an asset manager.
In addition to Algebra, Bahrain-based Elaf Bank, Al Arabi Investment Group in Jordan and Jadwa Investment in Saudi Arabia have recently launched sukuk funds.
The yield differential between Islamic and conventional debt is also narrowing. Sukuk have on average yielded 320 basis points over US Treasuries, while comparable conventional debt issued by Middle East borrowers has an average yield spread of 314 basis points, according Kronfol.
Islamic debt still faces some significant hurdles. Chief among these is the dearth of sovereign Gulf sukuk. Oil-rich regional governments have little need to borrow, but a large offering by a highly rated government - Saudi Arabia is a favourite - would act as a benchmark for the rest of the market and improve pricing, say bankers.
Moreover, Gulf states need to finance a large number of big projects. "Liquidity is an evolutionary process rather than a revolutionary one," says Mohammad Dawood of HSBC Amanah, the biggest Gulf underwriter of sukuk.
"The volume of issuance is there now, and now is an interesting time to start looking at the market."
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