This was primarily driven by the jumbo local and foreign currency issuances by some GCC governments, including the $9 billion sukuk issued by Saudi Arabia in April, which was one of the largest sukuk issued globally to date. While this augurs a good year, S&P thinks it represents an exception rather than a new norm as some of the large issuances of 2017 are unlikely to be repeated in 2018.
Total issuance is expected to be around $75bn-$80bn in 2017, up from previous expectations of $60bn-$65bn. Two main reasons explain the updated forecast. Governments are not under pressure to raise funds quickly and want to diversify their investor base and regional and global liquidity remains good.
Over the past 18 months, the stabilization of oil prices, the policy response of GCC governments and issuance of large bonds helped reduce liquidity pressure on some GCC governments. After tapping conventional markets, they have turned to the sukuk market to diversify their investor base and tap pockets of local and regional liquidity.
S&P said: “We still foresee significant financing needs for GCC governments, which we estimate at around $275bn between 2017 and 2019. We think that around 50% will be debt-financed, through a combination of bonds and sukuk. Governments are likely to continue to prefer bonds over sukuk, however”:
Regional, global liquidity remain good
GCC investors are among the main investors in sukuk. Within this universe, banks are playing the biggest role. Over the past two years, S&P observed a reduction in liquidity in GCC banking systems due to lower deposit inflow. This situation started to reverse in the first half of 2017, thanks to the stabilization of oil prices.
“Moreover, we observe that GCC banks tend to keep sizable amounts of cash and money market instruments on their balance sheets. In their current challenging operating environment, marked by lower opportunities for lending, we think that some of them might divert a portion of their liquidity toward assets that generate higher income compared with cash and money market instruments,” said S&P.
In this context, bonds and sukuk appear more attractive than interbank deposits or deposits with the central banks.
Global liquidity also remained abundant in the first half of 2017 and this situation should continue in the second half. The European Central Bank (ECB) Quantitative Easing (QE) Program, the slow increase in the US Federal Reserve Bank (the Fed) interest rates and good liquidity in some Asian countries will continue to support market activity for both bonds and sukuk.
The cost of funding might be on the rise though as the Fed increases its rates and the ECB starts to taper its QE program. An additional 25-basis-point increase is expected in Fed rates by the end of 2017, after the recent 25-bps increase in June 2017.
However, ECB should normalize over a very long period of time, with its QE program brought to (close to) zero by the end of 2018 with the risk of further delays into 2019 if external conditions (commodity prices, exchange rate) turn more deflationary–and interest rates starting to move in 2019.
Given the low interest rates in developed markets, emerging-market issuers with good credit stories might still be on investors’ radars, as shown by the large oversubscription rates of some recent transactions. Therefore, we believe liquidity will continue to leak into the sukuk industry from developed markets.
It remains to be seen if the recent developments in Qatar will impact issuance out of the country. Qatar was placed under sanctions by a group of governments that cut diplomatic ties and trade and transport links.
This event is likely, in S&P’s view, to deter the appetite of some investors to invest in sukuk issued by Qatar-based entities in the short term. The longer-term impact will depend on how the situation evolves.