The pricing of most sukuk and comparable bonds continued to be similar and highly correlated in 1H23, with this trend likely to persist, Fitch Ratings says. This is despite macro developments such as rising interest rates and volatile oil prices and complexities in sukuk structures linked to sharia compliance. Most Fitch-rated sukuk are senior unsecured obligations of the issuer and rank equally with other senior unsecured obligations, including bonds.
Fitch analysed the pricing of 38 sukuk and comparable bonds issued by the same obligors from the Gulf Cooperation Council (GCC), Indonesia and Turkiye (based on yield-to-maturity) with more than 60% being sovereign issuance. Between 2018 and 1H23, sukuk and bonds had a high pricing correlation of 0.95 (out of 1) on average and low average spreads between them. The measures are a good gauge of investors’ credit risk perception for sukuk and bonds.
Fitch also noticed periods of global volatility or sukuk-specific developments where the correlation between sukuk and bond yields fell and average spreads expanded, albeit temporarily. This includes during the pandemic in 2020 where the liquidity of Islamic banks was affected for few months, and during Russia’s invasion of Ukraine in 2022 and the subsequent effect on global debt capital markets.
Spread differentials could also be explained by the buy-and-hold nature of most sukuk’s Islamic investors, mainly Islamic banks, with secondary-market liquidity of sukuk tending to be limited compared with bonds. There remains a dearth of sukuk and comparable bonds in the market based on payment rank, date of issuance and maturity by the same issuer and in the same currency denomination.
Fitch also analysed Pakistan’s US-dollar denominated sukuk and bonds (rated CCC), although both types of instruments are not directly comparable in date of issuance and tenor. The correlation between the sukuk and bond yields was high between January 2022 and August 2023 at 0.95; however, the yield spreads have widened between the two with sukuk pricing not falling as steeply as bonds. Both are rated senior unsecured instruments by Fitch and reflect the same credit profile, with such pricing changes likely to be reflective of market dynamics.
As of 1H23, a US Dollar Sukuk Market Index analysed by Fitch increased 2.7% yoy, while a broad Emerging Markets Bond Index expanded 5.8% in the same period. However, a MENA Sukuk Index analysed by Fitch was up 1.3% yoy, while MENA Bond Index was up 0.03% only.
Issuing sukuk does not always entail a pricing advantage for issuers compared with bond issuance, with pricing swinging in both directions. Nevertheless, sukuk generally have a more diverse investor pool, in key issuing markets including Islamic investors from mainly the GCC and other key Islamic finance markets.
Sukuk are also a sizable part of emerging-market debt issuance (excluding China), with its share reaching 6% in 1H23 (2022: 6.6%). Key sukuk-issuing jurisdictions of the GCC, Malaysia, Indonesia, and Turkiye are sizeable emerging markets, with their bonds and sukuk forming 20.5% of all emerging-market debt issuance (excluding China) in 1H23.
In 2Q23, sukuk issuance from the core markets of the GCC, Malaysia, Indonesia, Turkiye and Pakistan (including multi-laterals) expanded 10% qoq to USD49.1 billion, while bond issuance fell 4.8%. Global outstanding sukuk volumes expanded 10% yoy and for the first time crossed USD800 billion, with sovereigns being the key issuers. Most Fitch-rated sukuk continued to be investment-grade at 79%, with 12.6% of issuers having a Positive Outlook, and 77.5% having a Stable Outlook at 2Q23. Sukuk defaults continue to be low at only 0.21% of all issued sukuk.
