Higher oil prices this year have reduced the need for energy-exporters in the Middle East to raise funds through the Islamic bond market — threatening the growth of a niche finance sector that has been struggling to gain wider traction.
Oil prices have stayed above $60 per barrel so far this year. That's expected to persist: S&P Global Ratings has revised upward its forecast for oil to an average $65 per barrel this year from the $55 per barrel it projected earlier.
As the key commodity inched higher in its price, global issuance of Islamic bonds fell 15.3 percent year-over-year to $44.2 billion in the first six months of this year, according to S&P. The agency said it expects 2018 to end with $70 billion to $80 billion in total volume — coming off 2017's three-year high of $97.9 billion.
Islamic bonds, also called sukuk, are debt instruments that comply with Sharia principles. Sharia is an Islamic law that prohibits earning interest on loans and bars funding activities involving alcohol, pork, pornography or gambling.
Oil-exporting Arab countries were among the largest sukuk issuers last year. Saudi Arabia, for one, issued a sovereign sukuk worth $9 billion — the largest ever Islamic bond.
But higher oil prices have resulted in “a decline in financing needs in some of the (Gulf Cooperation Council) countries,” said Mohamed Damak, senior director of financial services research and global head of Islamic finance at S&P Global Ratings, in a conference call last week.
The Gulf Cooperation Council is made up of six Arab nations: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. Those countries were forced to diversify their revenue sources when oil prices slumped and stayed at multi-year lows from 2015 to 2017.
In addition to current higher oil prices, the better fiscal discipline that the countries now have — from cutting spending and subsidies when oil revenue fell — has given them fewer reasons to replicate last year’s large sukuk deals, Mohamed said.
The decline in sukuk issuance adds to challenges confronting Islamic finance, which has seen growth slowing despite efforts to expand the sector outside its traditional markets in the Middle East and Southeast Asia.
The industry has seen some new participants outside Muslim-majority countries in recent years, but their presence hasn’t helped Islamic finance gain much wider traction.
In fact, the industry’s growth has been slowing for five straight years, according to the latest Global Islamic Finance Report released this month. In 2017, the size of the Islamic financial services industry increased 6 percent from the prior year to $2.431 trillion, slowing from 2016's 7 percent growth, the report said.
Experts identified one big hurdle that’s preventing the industry from growing faster: The lack of standardization. Currently, many jurisdictions interpret Sharia differently, which leads to differences in how products are structured and the way disputes are resolved.
“Greater standardisation in these areas would help sukuk gain wider acceptance among international investors,” Bashar Al Natoor, senior director and global head of Islamic finance for Fitch Ratings, said in a report.
“We think that structural constraints mean growth may be steady but unspectacular,” he added.