Burst bubble fears on Middle East sukuk sales

The Middle East's sukuk markets are prime for a sell-off which could inflict losses on investors if liquidity is withdrawn suddenly, according to the private bank Coutts.

Majid Al Futtaim, which opened Fujairah City Centre last year, issued sukuk. Sarah Dea/ The National

The Middle East's recent surge in sukuk sales could fall victim to the bursting of a bubble in emerging market debts, according to the London-based private bank Coutts.

The bank, part of Royal Bank of Scotland, is recommending a switch towards equities and other assets less vulnerable to a sharp withdrawal of investment.

"There's a correction coming," said Gary Dugan, the bank's chief investment officer for Asia and the Middle East. Investors should "beware in the Middle East of a significant sell-off in sukuk, [where] a lot of leakage from emerging market bond funds is looking for further sources of returns".

Islamic bond sales, which comply with a Sharia ban on charging interest, had a record year in 2012 as companies sought to lock in cheap interest rates.

Banks raised US$21.2 billion (Dh77.87bn) in sukuk debt for borrowers across the Arabian Gulf, including the Dubai Government and local family-owned companies such as Majid Al Futtaim Holding, while the HSBC/Nasdaq Dubai US Dollar Sukuk Index rose 9.6 per cent during the year. The index has fallen 0.2 per cent so far this year, in spite of a substantial rally on global financial markets.

In recent weeks, financial firms including Fitch Ratings and Goldman Sachs have joined a debate over whether a "bubble" is brewing in fixed-income markets.

Interest rates on government bonds have been flattened by easing programmes by the Federal Reserve and other central banks, creating a hunt for yield which has pushed investors first into investment grade corporate credit, and more recently into high-yield debt and emerging market bonds. Bond yields move in the opposite direction from prices.

A scarcity of Sharia-compliant assets has also attracted large numbers of buyers in the Arabian Gulf, many of whom must comply with Islamic law, resulting in heavily oversubscribed sales of sukuk debt.Mr Dugan said many investors were buying sukuk for their capital gains, pushing yields to unsustainable lows.

The global credit expansion sparked by central banks' crisis-era easing measures should compel investors either to seek out inflation-protected assets or get used to lower returns, wrote Bill Gross, the founder and co-chief investment officer of Pacific Investment Management Company.

"The countdown begins when investable assets pose too much risk for too little return; when lenders desert credit markets for other alternatives such as cash or real assets."

Flows into fixed income exchange-traded funds rose 28 per cent during the fourth quarter of 2012 to $15.8bn from three months earlier, spurred by record inflows to emerging market debt funds of $3.7bn, according to data compiled by BlackRock, the world's biggest asset manager.

In addition to dwindling returns, the low-interest rate environment "creates problems for places like Dubai", Mr Dugan added.

America's Federal Reserve would not take into account countries with dollar-pegged currencies such as the UAE and Singapore when setting rates, which could feed into local asset bubbles.

"Interest rates will be inappropriately low 12 months from now," he said. "When we give free money to people - which is where we are with interest rates as low as this - they tend to make the wrong decisions."

Policymakers would be likely to attempt to tighten borrowing requirements as a consequence, Mr Dugan added.

In the UAE, proposals for a cap on mortgage lending has provoked anxiety from property agents and lenders, slowing activity.