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After spooking investors with a calamitous array of defaults and near misses, the Islamic bond market these days is looking less accident prone. So much so that one Kuwaiti research house forecast on Monday that global issuance this year could climb to $30bn.

The research house KFH also highlighted how Islamic bonds are “globalising”, as the stable of issuers broadens beyond the Gulf and Malaysia to unexpected outposts including Japan, and possibly the UK.

The research house says the market is experiencing a “remarkable recovery” from the effects of the global financial crisis, notching up $16.5bn of new issuance in the first half – more than double the amount in the same period last year.

A quick recap on Islamic bonds: otherwise known as sukuk, they are backed by cash flows from tangible assets in order to comply with sharia’s prohibition on earning interest.

But their reputation took a battering during the financial crisis as some high-profile sukuk defaulted, or came close to doing so. Dubai World sparked a local crisis of its own when it narrowly avoided defaulting on a $4bn bond. It is still negotiating the restructuring of its debt.

So what’s driving the recovery in issuance now? The main thing, according to KFH, is that Gulf governments need to raise large amounts of capital to fund stimulus (or “development”) projects:

Saudi Arabia has allocated almost $70bn to development projects for 2010, an increase of 16 per cent year on year. In Qatar, the government and state-owned companies plan to spend as much as $100bn in the next four years on projects including roads, sewage treatment, water treatment, ports and airports. The UAE is investing in nuclear power and railways to revive economic growth in 2010 and 2011.

Another state looking to fund a splurge of nearly $1bn on infrastructure and housing is Bahrain. But it may need to regroup after its credit rating was downgraded one notch by Moody’s on Monday, due to concern over the island kingdom’s deteriorating government finances.

KFH’s $30bn forecast for the year as a whole compares to total issuance of $24.7bn in 2009 and $15.5bn in 2008. In a report on Islamic bonds last month Standard & Poor’s (mixing its metaphors) said: “We estimate that about 150 sukuk are either already in the pipeline or warming up on the sidelines.”

S&P’s figure for first half issuance was a bit lower than KFH’s at $13.7bn. It also said Malaysia had cemented its position as the world’s top sukuk issuer during the first six months, contributing 52.7 per cent of the new bonds.

Sukuk are more arduous, time-consuming and expensive to structure and sell than normal bonds, but those drawbacks have not deterred some novice issuers.

Last month Nomura, a Japanese investment bank, sold $70m of Islamic bonds, while General Electric issued its first Islamic bonds last year. The FT reported last week that governments and companies in the UK, Russia and France are also considering selling Islamic debt.

Doing so enables issuers to broaden their funding base – and can also help them to curry favour in the increasingly important Middle East.

On the buy-side, Islamic bonds are attracting more interest from non-Muslim countries, and KFH highlights the potential for investment from parts of “Asia” – read China – with surplus savings and large reserves of foreign exchange.

The yield on the HSBC-Nasdaq Dubai sukuk index has shrunk markedly in recent months to 5.2 per cent, because of improving investor sentiment and the inclusion of more highly rated sovereign Islamic debt in the index.

But sukuk are still not for every buyer. Most governments of Muslim countries issue conventional bonds as well as the Islamic version. And if Dubai tries to sell new bonds after a planned Asian roadshow designed to rebuild its reputation, they are likely to be nothing more than plain vanilla.

Related reading:
Islamic Finance, FT Special Report