Now, however, the relatively comfortable way in which Turkey’s economy is coping with global weakness ̶ combined with strong appetite for sukuk in general, since they have proved less volatile during this year’s market instability than conventional bonds ̶ may be changing Gulf investors’ priorities.

“Turkish government USD paper and bank paper have been in issuance for a number of years now, but have not been a focus of MENA market players as there have been plenty of more locally- issued and better-understood names out there,” said Mark Watts, head of fixed income at National Bank of Abu Dhabi.

“There are signs that this is changing as the ever-present hunt for yield forces investors to widen their horizons. Sukuk from Turkey is a relatively new phenomena for GCC investors… Turkey’s performance dynamics mean that any smart fund manager will want to take a look at gaining exposure.”

Stability

Sentiment towards Turkish debt, like that towards other countries, has been hit by jitters over the European debt crisis; five-year Turkish sovereign credit default swaps surged to 251 basis points, 30 points wider on the day, in response to news on Monday that Greece would call a referendum on its bailout.

But Turkey, which is rated BB, Ba2 and BB+ by the three major rating agencies, slightly below investment grade, with positive outlooks from all of them, has not seriously underperformed Gulf credits. Its CDS are tighter than unrated Dubai and BBB-rated Bahrain, though wider than AA-rated Abu Dhabi and Qatar.

Also, the profile of sukuk investors favors a hold-to-maturity investment which makes secondary market trading of Islamic bonds less liquid, but also less volatile. This has helped sukuk in general perform better than many conventional bonds in recent months.

The yield on the first Turkish sukuk, a $100 million, three-year bond issued in 2010 by Kuveyt Turk , an affiliate of Kuwait Finance House , is down about 55 bps since end-2010 and up only 20 bps since the start of September, when the Greek crisis began worsening further. This is probably because there is minimal trading in the bond — but it still underlines how sukuk, with their more conservative investor base, are less vulnerable to wide price swings.

By contrast, the yield on Turkey’s 7 percent, $1.5 billion conventional sovereign bond, issued in 2008 and maturing in March 2019, is up about 4 bps this year and 30 bps higher than its level at the start of September.

“The pricing in the (conventional) bond market is difficult. There is liquidity around in the sukuk market, so there might be better pricing,” said Debashis Dey, partner at law firm Clifford Chance in Dubai.

A further attraction of Turkish sukuk is that legislative changes by Turkey this year have created a relatively favorable environment for Islamic debt issuance ̶ in some important ways, more favorable than the environment in the Gulf.

For example, last month’s sukuk from Kuveyt Turk was able to combine asset-backed elements, including the sale and transfer of tangible real estate to an onshore special purpose vehicle, with asset-based elements; this increased the perceived safety of the bond for investors. In the Gulf, factors such as high land transfer fees make asset-backed deals more expensive and difficult.

Outlook

Turkey’s Bank Asya has completed roadshows for a potential five-year sukuk of up to $300 million, and one United Arab Emirates-based trader said there was “decent” interest from Gulf accounts in a deal. The trader said any issue was likely to come after the Eid al-Adha holidays in the region next week. Asya has mandated Citi and UBS for the deal.

Another bank, Albaraka Turk , has awarded a mandate for a sukuk of around $200 million which it wants to issue before year-end, its general manager Fahrettin Yahsi told Reuters in September.

For Turkey to become a major issuer of sukuk, however, it will have to move beyond bank issues of sukuk to issues by a wide range of companies. This may prove difficult, at least in the short term with the global economy so weak; the International Monetary Fund expects Turkey’s economic growth to slow to 2.5 percent next year from 7.5 percent this year.

“We have recently almost exclusively seen Turkish financial institutions come to market to raise funds, either through conventional or Islamic paper,” said Rizwan Kanji, debt capital markets partner at law firm King & Spalding, who advised on the Kuveyt Turk sukuk.

“One primary reason may be because the Turkish banking sector is highly regulated and supervised and therefore faring relatively better than other non-financial sector-related industries in Turkey.”

Another big question is whether the Turkish government will issue a sovereign sukuk, which could give a big boost to the market by providing a benchmark off which other Turkish Islamic debt could price.

“It’s time for the Turkish government to issue a sovereign sukuk as a starter and that will hopefully be followed by other institutions and banks,” said Mohieddine Kronfol, chief investment officer at Franklin Templeton Investments in Dubai.

“Certainly if that happens it will be very good for Turkey and very good for the Islamic banking industry.”

A sovereign sukuk may be a step the country is not yet ready to take, however. Prime Minister Tayyip Erdogan’s ruling AK Party, a socially conservative but economically liberal party with roots in political Islam, might well favour such an issue, and the government has previously indicated it could issue a sukuk to diversify its funding options.

But issues such as pricing and Turkey’s desire to satisfy appetite for its conventional debt may continue to delay a sovereign sukuk. Also, a need to accommodate secular sentiment ̶ because of Turkey’s secular tradition, Islamic banks are referred to in the country as “participation banks” ̶ means the government may wait a while.

“I think the fact that they are a secular nation and they made an effort to leave religion out of financial factors has been a contributing factor” to the lack of a sovereign sukuk so far, Kronfol said.

“But it doesn’t make sense, especially since you have countries like Luxembourg and France issuing guidelines to issue sukuk.”

Legislation for a Turkish sovereign sukuk is in place but there has been no clear signal from the government on its intentions for the past couple of years. The Treasury’s new financing programme for 2012 includes the sentence, “Depending on market conditions, new external or domestic debt instruments may be issued.”