Liquidity in the sukuk market is showing signs of gradual recovery following disruptions caused by the ongoing conflict in Iran, according to an analysis by Fitch Ratings. While overall liquidity remains below pre-war levels, improvements have been observed, particularly among higher-rated sukuk and sovereign issuances.

Fitch’s latest report, dated June 9, indicates that investment-grade sukuk hold an average liquidity quantitative assessment (LQA) score of 66, up from 64 in March but still short of January’s 72. In contrast, speculative-grade sukuk lag behind with a June average LQA score of 41, improving from 33 in March but below the 48 recorded in January. The "B" rating category within the speculative grade demonstrated the most notable liquidity gains between May and June.

The sukuk market experienced a sharp decline in liquidity following the outbreak of the Iran conflict, attributed to heightened investor risk aversion, reduced trading activity, and elevated market volatility. However, the recovery has been uneven across sectors, credit ratings, countries, and currencies. Sovereign sukuk, along with asset-backed and supranational issuances, exhibited the strongest liquidity improvements, with sovereign issues largely driving overall gains.

Tony Hallside, CEO of STP Partners, attributed the liquidity rebound to a stabilization in risk appetite and the absence of a default cycle since the initial market downturn. He cited ongoing demand for high-quality issuers, particularly sovereign and quasi-sovereign entities benefitting from stronger balance sheets, policy support, and benchmark status, as key factors restoring market confidence.

Geographically, sukuk from Malaysia, Hong Kong, Indonesia, Qatar, Kuwait, Saudi Arabia, and supranational issuers maintained the highest liquidity levels on average. Fitch noted that notable liquidity improvements from March to June were seen in sukuk linked to the United States, Bahrain, Ireland, UAE, Kuwait, Egypt, and Qatar. Hallside observed that Gulf Cooperation Council (GCC) issuers are expected to exhibit the most robust recovery due to proximity to the conflict, deep regional liquidity, and sustained demand from Islamic banks and institutional investors. Malaysia and other ASEAN markets are better insulated, supported by substantial local-currency investor bases.

The largest sukuk market, Malaysia, recorded LQA scores consistently above 85, reflecting the depth of its domestic investor base. In Saudi Arabia, more than half of sukuk by volume had liquidity scores between 70 and 90. Qatari issuances also showed strong liquidity, with most scoring above 50. In the U.S. dollar-denominated segment, Indonesian sukuk outperformed conventional dollar bonds in liquidity, with nearly 40% scoring above 80, a significantly higher proportion than their conventional counterparts.

Regarding currency profiles, Malaysian ringgit sukuk remained the most liquid in June, accompanied by strong liquidity in euro and UAE dirham-denominated sukuk. However, liquidity scores for U.S. dollar sukuk, which make up most of the rated universe, have yet to return to January levels.

As of early June, 72% of Fitch-rated sukuk maintain a liquidity score above 50, an improvement from 64% in March but still below the 81% level seen before the conflict.

Looking ahead, Hallside emphasized that a full return to pre-war liquidity levels depends on multiple factors, including visible geopolitical de-escalation, stabilization of oil markets, and the reopening of the primary sukuk market with successful benchmark issuances from high-quality borrowers. He noted that while the sukuk market is fundamentally large and predominantly investment-grade with strong structural demand, normalization will hinge on both political developments and credit fundamentals. Market participants are expected to maintain a risk premium for regional exposures, particularly in lower-rated and longer-duration sukuk, until greater certainty is achieved.