The global volume of Islamic bond, or sukuk, issuances is projected to rise in 2021 following an expected market and economic recovery in core Islamic finance countries, according to S&P Global Ratings.

The total volume of sukuk transactions in 2021 will likely climb to between $140 billion and $155 billion after falling year over year to $139.8 billion in 2020 from $167.3 billion in 2019, the rating agency said in a report. The drop in 2020 upended four years of annual growth from 2015 when total issuances amounted to $59 billion.

The assumption is based on S&P Global Ratings' expectation that GDP growth in the Gulf Cooperation Council, Malaysia, Indonesia and Turkey will recover from the pandemic-induced recession in 2020. Along with a projected stabilization in oil prices, markets are expected to remain buoyant amid record-low interest rates and abundant liquidity, the agency said.

The agency said the COVID-19 crisis could be under control in developing countries from the second quarter, owing to vaccines and medical technologies, allowing social distancing and lockdown measures to be lifted, which would spur economic activity. Governments are also expected to continue tapping the sukuk market despite a potential decline in financing needs, although transactions are still expected to fall short of historical levels.

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Meanwhile, financial institutions are expected to embark on fewer sukuk transactions this year after rallying in 2020 to take advantage of supportive market conditions. However, the drop will be more than offset by corporates, the agency said.

Additionally, S&P Ratings said some sukuk transactions in 2021 could be used to tackle social issues especially as investors seek to boost their environmental, social and governance activities. Green sukuk transactions could also be recorded as many core Islamic finance countries transition to sustainable energy.

However, social and green sukuk deals are not expected to be "game-changers," the agency said, due to the additional complexity and the slow progress in the energy transition.

Risks beckon

S&P Global Ratings also warned of downside risks that could hamper sukuk transactions in 2021, including the uncertainty surrounding core Islamic countries' ability to bring the pandemic under control, and the imminent defaults and restructurings among sukuk issuers with unfavorable credit qualities.

A further rise in COVID-19 cases in core Islamic countries and any additional containment measures continue to be the main risk for issuers, the agency said, reiterating that such countries are set for a fragile economic recovery. Any further curb measures could directly or indirectly hurt recovery through lower commodity prices, exports and capital flows.

More defaults and restructurings also beckon, especially for banks as payment holidays slowly lapse, which could result in higher credit risk. If extensions to the forbearance are not granted, the agency said default rates are likely to go up among corporates and sukuk issuers this year, particularly those with low credit quality or business models that are dependent upon market and economic conditions.