Weaker Oil Receipts May Further Stimulate Gulf Appetite for Sukuk, S&P Says

As declining oil prices could strain  future budgets, governments across the Arab Gulf will likely review their available funding options for the planned infrastructure upgrades that will require hundreds of billions of dollars in the coming years.

One obvious source is to tap the still nascent capital markets in the region, in particular instruments such as Islamic bonds, according to Standard and Poor’s.

“The GCC can see that the capital markets are a good opportunity to share some of the burden away from national banks and the governments,” said Karim Nassif, a Dubai-based credit analyst at S&P. “If there is to be a real change in the commodity pricing, it is very useful to have that market available to them.”

A sizeable chunk of any capital markets financing will be inevitably done in the form of Islamic bonds or sukuk as financing according shariah principles continues to gain ground in the Middle East and around the globe.

The broader Islamic finance industry has been growing at an average annual pace of around 17% in recent years and could transform into a $3 trillion industry in the near future, according to S&P’s global head of Islamic Finance, Mohamed Damak.

Going via the sukuk route offers issuers access to a different class of investors while its fundamental underlying principles like the prohibition on interest, speculation and funding of sectors such as gambling are appealing to a growing number of people, not least the estimated 1.6 billion Muslims worldwide.

But aside from the usual challenges the Islamic finance industry wrestles with – lack of standardization, sufficient human resources and clear regulation – the question remains whether sukuk alone can fill the void for governments seeking fresh revenue sources should oil prices go down.

“At this moment in time it’s more of an optionality rather than a necessity,” said Mr. Nassif. “The reality is that we’re still early days in terms of using sukuk directly to fund project finance–type infrastructure but the potential is there,” he said.

The potential role sukuk can play in helping governments fund their large infrastructure investments coincides with Dubai’s efforts to establish itself as the world’s leading Islamic finance center, an ambition it is on course to realize if one looks at this year’s new sukuk listings.

But whether promoted by governments across the region or not, issuers will ultimately look at pricing and availability when considering Islamic bonds. In other words, sovereigns or corporates still demand a compelling financial reason to issue sukuk rather than conventional bonds.

“Can you get the tenors that you need, can you get the amounts that you need so that it is competitive? The factors have to be there to propel them to choose sukuk and continue to do that,” said Mr. Nassif.