Sukuks to be the preferred mode of deficit financing

by  — 17 January 2016

December’s news that oil and gas prices were descending below their recent historic low inched up the pressure on the government budget. With many major new infrastructure projects rolling out or in the pipeline, too, alongside the ordinary demands of state, the hunt for alternative sources of financing is on in earnest, writes Oliver Cornock.

One area that will likely benefit from this in the year ahead is the fixed-income market, with Islamic bonds, or sukuk, already seeing a rise in popularity, both in Qatar and in the wider region.

“The decrease in oil prices has caused national budgets to go into a deficit for some Gulf Cooperation Council (GCC) member countries,” Abdulbasit Ahmed Al Shaibei, CEO of Qatar International Islamic Bank (QIIB), recently told Oxford Business Group (OBG). “This translates into a greater momentum for issuances by governments, or an avenue for GCC member countries to start tapping this market to finance the deficit.”

In an era of rising interest rates, too, sukuk offers a way to ride out some of the effects of United States’ Federal Reserve hikes on conventional bonds.

The decline in oil and gas prices, caused by a global glut, saw international benchmark Brent Crude down at USD38.70 (QAR140.87) a barrel in mid-December, the lowest level since the dark days of the global financial crisis. Meanwhile, liquefied natural gas (LNG) prices have also stumbled, with deliveries to Northeast Asia – Qatar’s biggest market – seeing price falls that even outstripped the decline in Brent crude during 2015.

While these declines – and the prospect of higher interest rates – may lead to a cull in the number of energy companies currently in the production business, with a consequent stabilisation of oil prices, the prospects for LNG continue to be a concern. In Qatar, this all translates into a decline in the oil and gas sector’s contribution to gross domestic product (GDP) – down 40.6 percent in nominal terms in Q2 2015 year-on-year – and to government revenues, with the budget in deficit in Q2 2015 – an unusual event for a country used to surpluses.

Yet Qatar continues to be committed to a USD220 billion (QAR800.8 billion) project roll-out over the next decade, albeit with a revised set of priorities. This has had major implications for banks, as well as for government and corporate entities.

“On local funding markets,” Al Shaibei said, “liquidity may tighten as the government optimises its spending in the light of reduced government income, thus pushing local banks to also seek funding from the international sukuk market.”

In times of uncertainty, that Islamic market may hold several advantages over its conventional competitor.

Sukuk issuances tend to be more insulated against market events, with issuers in countries like Qatar also strongly backed by well-rated credit risks. Barwa Bank is a good case in point – it listed a USD2 billion (QAR7.28 billion) sukuk programme on the Irish Stock Exchange early December, with Moody’s and Fitch giving this programme strong ratings, A2 and A+, respectively. The agencies pointed out that Barwa is 53 percent government owned and thus qualified as systemically important.

Sukuk programmes also tend to be of a lower duration and thus have less sensitivity to interest rate fluctuations than conventional bonds. This brings less volatility, while maintaining attractive returns.

Demand for sukuk issuances when they come has demonstrated the popularity of this approach. A USD750 million (QAR2.7 billion) sukuk sale in October by Qatar Islamic Bank (QIB), for example, drew USD1.75 billion (QAR6.4 billion) in orders. The two other Qatari Islamic banks, QIIB and Masraf Al Ryan, have also both announced plans for future sukuk issuances, with the latter declaring this intention in March 2015, while Al Shaibei told OBG that “based on the current outlook, one may expect some activity from our bank with regards to issuance during 2016”. 

Oliver Cornock is the regional editor, Middle East, Oxford Business Group.


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