Stronger economic growth in key Islamic finance countries is expected to increase industry assets by around 10 percent from 2022 to 2023.
The global Islamic finance industry continued to expand in 2021, with assets growing by 10.2 percent, up from 11.4 percent in 2020 (excluding Iran), supported by growth in banking assets. Last year’s increase was supported by Islamic banking assets in some GCC countries and Malaysia, maturing sukuk issuances and solid results from the Islamic funds industry.
Higher commodity prices this year are expected to support a stronger recovery in many key Islamic financial markets.
Moreover, most of these countries are relatively resistant to macroeconomic shocks resulting from the Russian-Ukrainian conflict. This will support the industry outlook for 2022-2023. However, global headwinds could change the picture with continued stubbornly high inflation, lockdowns related to Covid-19 and the US Federal Reserve and other major central banks stepping up their fight to contain inflation.
The faster growth of banks is expected to contribute to the expansion of the industry. With a more favorable economic outlook for many Islamic finance countries, bank funding growth is expected to accelerate.
In Saudi Arabia, continued demand for mortgages and the implementation of Vision 2030 projects will create opportunities for industry expansion. In other GCC countries, more positive economic sentiment, government spending and investment will help accelerate growth.
In Southeast Asia, we expect the $290 billion Islamic banking market to expand at a compound annual growth rate of around 8 percent over the next three years.
In 2022, we expect total sukuk issuance to decline compared to stabilization at $147.4 billion in 2021, compared to $148.4 billion in 2020, and a 105 percent increase in foreign currency-denominated issuance over the same period.
There are several factors at play. Shrinking global liquidity and increasing complexity around regulatory standards are likely to hold back sukuk issuance in 2022, assuming any negative disruption related to Covid-19 in key Islamic finance countries remains under control.
We also expect lower funding needs for some key Islamic finance countries and some corporates to remain cautious with their capital expenditures for growth following a slow recovery from the pandemic.
At the same time, a more favorable economic environment and government spending are likely to create opportunities in commodity-exporting countries. Moreover, local currency issuance by some governments is likely to continue as they seek to develop local capital markets and offer alternative means of financing their economies.
We note that total issuance volume decreased by 23.2 percent and foreign currency-denominated issuance increased by 12.3 percent in the first quarter of 2022, after some issuers advanced their plans to benefit from market conditions before interest rate increases.
Many of these issuances were either by low-rated counterparties or in the form of capital raising instruments. Despite the decline in volume, we expect sukuk issuance to continue to exceed sukuk maturing in 2022, which we estimate to be around $96 billion.
Although their contribution to the industry remains small, we also expect the takaful and fund sectors to expand this year. We continue to see the takaful sector expanding at an annual rate of 5 to 10 percent. Fund growth is less certain due to market moves from early 2022, with one quarter of industry equity funds and another 60 percent of money market or sukuk funds likely to suffer from higher global interest rates.
We also see opportunities in aligning certain Islamic financial products with environmental, social and governance (ESG) factors. We expect to see higher volumes of green and sustainable sukuk (from a low base) as issuers look to broaden their investor base to include funds aligned with sustainability themes.
Many Islamic finance countries are exposed to climate transition risks, and several are developing or implementing transition strategies, including significant investments in clean energy. This presents real opportunities for sustainable sukuk in core Islamic finance countries.
However, the energy transition is expected to take a long time to materialize in the GCC and Malaysia, and as such sporadic recourse to green sukuk.
The social angle of Islamic finance presents another opportunity for sustainable sukuk. As the economic effects of the pandemic continue to emerge in the form of higher unemployment rates, especially in fiscally constrained countries, social sukuk can help cushion the shock. These and other Islamic financial instruments could have even greater impact if used properly.
Mohamed Damak is a senior director and global head of Islamic finance at S&P
Updated: July 12, 2022 at 4:30 am