The FINANCIAL -- Corporate and infrastructure Islamic financing in the Gulf region has been lower than in previous years. S&P Global’s regional expert and associate director, Karim Nassif, explains why Islamic, or sukuk financing is – despite the current slump – likely to play a strong future role in Gulf Cooperation Council (GCC) infrastructure and corporate financing.
By designating ownership of an asset rather than by issuing a debt, sukuk – Islamic bonds – do not breach sharia law. First issued by the Malaysian government in 2000, sukuk has since become an important part of corporate and infrastructure financing in the GCC and Malaysia. In these regions, sukuk issuance totalled $5 billion and $6.5 billion in 2013 and 2014 respectively. Yet issuance has dropped to $2.5 billion in the first eight months of this year: a reflection, in our view, of the region’s subdued economic growth since the recent drop-off in oil prices. Certainly, the GCC region is known for its substantial reliance on oil revenues to fund state operations and infrastructure development.
As low oil prices persist, and in a bid limit concentration exposure to weakening GCC banks’ liquidity, it is likely financing methods will increasingly diversify in the mid- to long-term.
Reasons behind the decline
One reason for the reduction of sukuk issuance can be attributed to governments’ attempts to control overall expenditures, which would mean a pause in new project financing to address the fiscal challenges caused by low oil prices.
Other factors have also contributed to the decline in sukuk issuance this year. Alongside depressed oil prices is the sparse number of sukuk issuers, the global predominance of conventional bonds, and the competitive pricing of bank lending compared to the associated costs of issuing sukuk.
As a relatively new financing tool, sukuk lacks the market standardisation required to encourage new issuers. The complexities associated with sukuk issuance typically result in high legal costs as well as additional time and effort to identify the assets linked to each transaction (a requirement for sharia compliant investments). And that means a small pool of primary sukuk issuers, and a big percentage drop in overall issuance if just one corporation chooses an alternative financing route.
In fact, data shows that 90% of GCC and Malaysian corporate and infrastructure funding for the first eight months of 2016 came from bank loans, up from 74% in 2013. Moreover, total GCC sukuk issuance (corporate and infrastructure, financial institutions, and sovereigns) totalled around $9 billion in the first eight months of 2016, compared to $12.7 billion the same time last year. While there has actually been a growth in GCC capital market project financing (mainly from GCC sovereigns), the lessening in sukuk issuance can be interpreted as issuers shying away from the complexity of the instrument in comparison to easier fund raisings, for instance via the banks.
Financing diversification is necessary to meet the demand
But the future outlook is different. Over time, as oil prices potentially remain relatively low, bank liquidity in the region is expected to dry up. But the development of the GCC as a region relies on financing a significant number of planned infrastructure projects. For instance, from 2016-2019, total spending on GCC projects (including infrastructure) is estimated to be about $330 billion, of which $50 billion is estimated to be allocated specifically for infrastructure and transportation projects.
In addition to necessary infrastructure financing, GCC corporate entities’ refinancing needs are significant – approximately $23.6 billion is expected to be refinanced between 2017 and 2019.
If the demand is to be met while bank liquidity weakens, financing methods will need to diversify. This increases the potential for alternative methods of funding through financing tools like sukuk bonds.
Sukuk Bonds could fill the gap
As a result of draining liquidity throughout the region, sukuk bonds are expected to fill the gap and become a more heavily-utilised source of infrastructure and corporate financing.
But this does depend on the level of standardisation the instrument is able to achieve. In particular, government strategies to promote sukuk issuance may be key to aiding higher levels of issuance – this may be as simple as more clearly defining compliance standards, or taking measures to simplify the issuance process.
Given increased market standardisation and efficient processing, sukuk financers can hope to play a heightened role in GCC financing over the medium to long-term.
Report was prepared for the FINANCIAL. Karim Nassif is the Credit Analyst and and Associate Director at S&P Global Ratings.