The Gulf’s once red-hot Islamic bond market is coming back to life after a nine-month lull as sellers look to benefit from talk of Gulf currency revaluation and rock-bottom interest rates, bankers said.
Still, with more of the bonds priced in local currencies – potentially limiting interest from foreign buyers – the pace may not be quite as feverish.
Islamic bonds, or sukuk, are highly sought by both Muslims – who are increasingly seeking investments that comply with their beliefs – and non-Muslim investors seeking exposure to booming Gulf Arab economies.
A global credit crunch triggered by defaults on US home sales last summer prompted several companies to scrap sukuk sales as borrowing became more expensive. But firms cannot postpone borrowing indefinitely and some sense the time may now be right to look at sukuk again.
Activity is on the rise with a slew of companies planning issues or completing new issues, including property developer Nakheel and air-conditioning firm National Central Cooling Co in the UAE as well as mammoth chemicals firm Saudi Basic Industries Corp and Kuwaiti real estate firm Gulf Holding Co.
Ras Al Khaimah announced a sukuk programme worth up to $2 billion, the first tranche of which is likely to be in dirhams.
“Local currency sukuk are coming back to life and I think that will continue because there’s huge liquidity in the system and issuers really want to take advantage,” said Jaafar Badwan, a managing director at Bahrain’s Unicorn Investment Bank.
All but one of the new sales are in Gulf currencies, which investors hope will eventually be allowed to strengthen, increasing the value of future bond returns. Most sukuk were previously priced in US dollars.
Aside from the Kuwaiti dinar, Gulf Arab currencies are pegged to the falling dollar and, despite official statements to the contrary, there is constant speculation central banks may revalue to stave off soaring inflation in the region. Monday’s forward rates indicated the UAE dirham could appreciate 4.6 per cent in two years.
A nearly six-fold rise in oil prices since 2002 has flooded the Gulf with cash that bankers are scrabbling to invest. Global investors have been piling into assets denominated in Gulf currencies since last year, snapping up stocks and property, and the same appeal exists with Gulf currency bonds.
A key driver behind recent sukuk issuance has been falling benchmark interest rates in the region, which help keep spreads looking attractive.
Spreads on the HSBC-DIFX US dollar Gulf sukuk index were 66.1 basis points over the benchmark three-month London Interbank Offered Rate when the credit crunch first hit last June. By May, they had soared to 220.79 basis points, or about 1.55 per cent.
But a series of rate cuts by the US Federal Reserve in recent months has seen Gulf Arab states also slash rates to maintain their currency pegs.
Three-month inter-bank rates in the UAE and Saudi Arabia have fallen 346 basis points and 296 basis points, respectively, since the day before the Fed first started slashing interest rates to ward off recession.
Since then, the Fed has cut its benchmark rate by 3.25 percentage points, driving down rates across the Gulf Arab region. The UAE’s three-month interbank rate is now 1.93 per cent and Saudi Arabia’s is 2.15 per cent.
“The rise in spreads has been offset by the fall in interest rates,” said the head of Standard Chartered’s Saadiq Islamic division, Afaq Khan. “Spreads may have gone up 200 basis points but interest rates have gone down 200 basis points, so overall you’re getting the money at the same price.”
Islam bans interest, and sukuk are typically based on physical assets that pay a rent or dividend to bondholders. However, the returns are compared to benchmark interest rates.
Firms have hedged against future interest rate rises or allowed for gradual rises in their plans, bankers said.
The trickle of Gulf sukuk coming to market mirrors improving sentiment in global credit markets since mid-March, but the resurgence in Islamic bonds could be limited for now.
Up to 80 per cent of past Gulf Arab dollar sukuk sales have been snapped up by Western investors, who may not have access to the Gulf currency funding needed for the current crop of sukuk.
Sabic’s sale is only open to nationals of Gulf Arab states.
“For the next three or four months at least, I do not see a resurgence in the sukuk market,” said a banker. “Buyers who do not have access to Gulf currencies are shut out. In terms of distribution it’s limited.”
Bankers said dollar sukuk would eventually return, but when would depend on Gulf currency revaluation sentiment. “If there is a one per cent chance of revaluation, nobody wants to be on the wrong side of the trade,” said HSBC regional debt capital markets chief Declan Hegarty.