By Brai Odion-Esene

WASHINGTON (MNI) - The medium-term growth prospects for the world Islamic bond -- Sukuk -- market are good in 2010, although tight liquidity in the capital markets and the weakness of the dollar means is unlikely to regain its dominant position in Sukuk issuance until the following year.

In a report published Wednesday, Standard & Poor's predicted steady growth in Islamic bond issuance in 2010, with about $20 billion of Sukuk publicly announced in the past that is likely to come to market if conditions permit.

"In addition, we understand from unofficial market sources that about $10 billion more could potentially enter the pipeline. If that comes to market, total Sukuk issuance in 2010 could approach the current 2007 record of $34.3 billion," the report said.

However, given the sluggish economic conditions, corporate entities are less likely to be major issuers of new Sukuk in the short term, Anouar Hassoune, senior credit officer with Moody's told Market News International.

In the longer term, he added, there are signals that global companies may be far more attracted by such an alternative source of funding.

As for how much of the issuance will be denominated in dollars, S&P said the U.S. currency is likely to only slowly regain its position -- lost in 2008 -- because of tight liquidity on international markets and the relative weakness of the currency.

"Therefore, Standard & Poor's expects local currencies to dominate issuance in the next 12 months, with the U.S. dollar taking up a relatively limited portion," it said. It added, "Once market conditions return to normal, dollar-denominated Sukuk should regain a stronger position."

At this point in time, financial institutions are not identified as major issuers of Sukuk, but as early as 2010 -- as markets slowly recover -- Hassoune predicted that Gulf-based as well as global banks will likely emerge as the most frequent Sukuk issuers, once the Islamic debt space becomes less dominated by sovereign and quasi-sovereign entities.

This is not specific to the Middle East or Asia region at all, he added, noting that in France, large utilities, car and financial services companies are exploring the Sukuk option, with the support of the authorities. Although, it's unlikely the French state itself would go for Sukuk issuances for many political, social, legal and technical reasons.

As for the UK, despite initial explorations by the government into possibly issuing an Islamic bond, Hassoune noted that once former Prime Minister Tony Blair left office, the Sukuk project started to become less of a priority.

"Should the UK opt for Sukuk, it will unlikely be a sovereign issuance, but more probably a corporate transaction within the private sector," Hassoune said.

Outside of Europe, he pointed out that multilateral, sovereigns and government-related issuers have now become the most common Sukuk issuers as they face a need to launch a variety of funding programs amid declining economic activity, fiscal deficits and lower commodity prices.

He also noted the lingering effects of the crisis and the gradual recovery in oil prices have resulted in fewer oil-producing nations in the Gulf recording a budget deficit, while several others -- like Qatar and Saudi Arabia -- boasted relative surpluses, for the first time in almost five years, driven by governments' commitment to strategic sponsored projects, including infrastructure, education and tourism.

Hassoune said the recent surge in sovereign or government-backed issuance -- amid continued uncertainty over the timing and magnitude of the economic recovery -- is a long-awaited development that should help create a more efficient and soundly based Sukuk market.

Overall, he said, "We view the surge in Sukuk issuance by governments and government-related issuers as a necessary step towards creating a stronger Sukuk market in the longer term, driving more corporate Sukuk issuances that can be more transparently priced."

The UAE -- and the struggles of Dubai -- will impact the outlook for the Sukuk market in 2010. S&P warned that the major economic slowdown in the UAE and the correction of Dubai's real estate sector cloud prospects for Dubai-based issuers, making investors more risk-adverse.

"That sentiment could potentially spread to other Gulf countries as well, and impede access to the market for some issuers there," it said, although, "One brighter spot in the Gulf is Saudi Arabia, with its strong pipeline of government-sponsored projects, some of which, we understand, may be financed through Sukuk issuance."

Hassoune said the recent events in Dubai have constituted an extraordinary crisis, but it is the first for the embryonic Sukuk industry.

"The youth of the market has meant that such funding instruments are untested as various sectors of regional economies contract or even collapse," he said.

Restructurings are common occurrences in mature markets, Hassoune said, but the immature and opaque nature of the local legal and creditor environment as well as that lack of precedent give little comfort to investors spread across the world.

He opined that given the sheer scale and complexity of Dubai World, "this event will be an important test of investors' rights."

"We believe that once investors have a clearer view of the possible outcome of the two recent defaults, the Sukuk market is likely to grow more strongly, perhaps after making some adjustments reflecting lessons learned," S&P said.

However, "If indeed some Sukuk are not found to be equivalent to conventional bonds in a default or restructuring, it will have a significant effect on the shape of the Sukuk market to come," he predicted.

** Market News International Washington Bureau: 202-371-2121 **