This article first appeared in The Edge Malaysia Weekly on March 14, 2022 - March 20, 2022

A bounce-back in global sukuk issuance is unlikely this year, says Moody’s Investors Service, citing higher crude oil prices as a key dampener.

Higher crude oil prices will lead to lower sukuk issuance for the second consecutive year, mainly because of lower financing needs in Gulf Cooperation Council (GCC) countries, according to Ashraf Madani, a senior analyst at Moody’s.

Global sukuk issuance fell 12% to US$181 billion in 2021, after five straight years of growth that culminated in a record issuance of US$205 billion in 2020. Last week, Moody’s forecast that issuance is likely to decline further this year to US$160 billion-US$170 billion, which suggests a decline of as much as 11.6%.

Six months earlier, it had expected that issuance could bounce back to positive growth as early as this year.

Long-term drivers of growth in global Islamic finance assets and sukuk issuances remain intact, Madani assures.

“However, year-to-year fluctuations in sukuk issuance volumes are largely driven by changes in the major sukuk-issuing sovereigns’ funding needs, especially Saudi Arabia. From this perspective, 2020 was an exceptional year when sovereign funding needs increased significantly due to large declines in government revenue and simultaneous increases in spending related to Covid-19,” he tells The Edge in an email response to questions.

“The decline in sukuk issuance volumes in 2021 and our projections for 2022, therefore, simply reflect a normalisation of sovereign funding needs as sukuk-issuing governments continue to unwind emergency spending measures and see their revenues recover, most notably in the case of the oil-exporting sovereigns,” he says, explaining Moody’s change of stance in issuance forecast.

Russia’s invasion of Ukraine, which commenced Feb 24, has led to crude oil prices rising sharply to more than US$100 a barrel — the highest level since 2014. Brent crude was trading at about US$116 a barrel at the time of writing last Thursday.

“Significantly higher oil prices will further reduce funding needs of oil and gas-exporting sovereigns, at least in the near term, although our current sovereign issuance projections already assume that in 2022, GCC sovereigns will issue sukuk mainly to refinance scheduled sukuk repayment,” Alexander Perjéssy, also a senior analyst at Moody’s, tells The Edge when asked about the impact of the invasion on sovereign issuance.

“In contrast, sovereign funding needs of Turkey, Indonesia and Malaysia may increase, commensurate with the extent of the global economic slowdown,” he adds.

Madani notes that although most sukuk-issuing corporates do not have direct geographic or financial exposures to Russia and Ukraine, the unfolding military conflict could reduce corporate issuance volumes.

“[This could happen] if rising geopolitical risks and sanctions on Russia’s energy exports disrupt the ongoing global post-pandemic recovery and tighten global financing conditions,” he says.

Madani is of the view that rising interest rates around the world will have a limited downside risk on sukuk volumes.

“Some corporate borrowers may defer their issuance activity as a result of higher rates but the impact on overall issuance activity will be limited. We believe oil price impact will be the key factor affecting issuances,” he says.

“A sharp rise in commodity prices due to the military conflict in Ukraine and international sanctions on Russia — including energy, metals and agriculture — poses a further significant upside inflation risk to global inflation and interest rates, although the impact could be tempered by a global economic slowdown,” he adds.

Madani believes that, during this period of crisis, green and sustainable sukuk will be more resilient, supported by increased investor demand and a wave of new issuers joining the market.

In Malaysia, Moody’s estimates sukuk issuance this year to come in flat at around US$70 billion.

“It is difficult to estimate accurately sukuk issuances for Malaysia given the large portion of short-term issuances, which is around 45%. However, our expectation is that sukuk issuance in Malaysia would be around US$70 billion, the same level as in 2021,” says Madani.

Of that projection, sovereign long-term issuance could come in at around US$21 billion, up from US$19.5 billion in 2021, according to Perjéssy.

In a March 8 report on Islamic finance, Moody’s says it expects Malaysia and Saudi Arabia to continue to dominate global sukuk issuance volumes. Last year, Malaysia accounted for 39% of total volumes and Saudi, 26%.

“We expect the long-term positive trend to remain in place, supported by governments’ initiatives to spur growth in this market, which is becoming more widely accepted and appealing for both local and international investors,” it says.

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