Korea’s recent failure to legislate tax benefits for sukuk, or Islamic bonds, is seen to begin taking a toll on the country’s access to one of the world’s fastest growing financial sources.

The Malaysian government is said to have declined requests by Korean companies to grant issuance of corporate bonds in the country, spurring concerns that it may be the first reaction to Korea’s reluctance to grant benefits on Islamic financing.

Hyundai Capital is said to have requested legal rights to extend issuance of its Medium Term Notes in Malaysian ringgit, industry sources said. The Islamic government turned it down, ending the corporate financing program for the Korean financial institution. Hyundai Capital earned rights to issue 2 billion ringgit ($655 million) of MTN in 2008.

Industry officials speculate the rejection reflects uneasy feelings of the Islamic government after launching of a local sukuk in Seoul faced oppositions from Christian groups and opposition politicians.

Sukuk is different from other debt in that it provides dividends or returns to its holders, not interests, to comply with Islamic law that prohibits charging or paying of interest. The government aimed to introduce sukuk to diversify funding sources for Korean companies by tapping into capital from Middle Eastern investors.

Christian lobbying groups opposed the move, citing cultural and religious conflicts. Opposition politicians have been arguing that giving tax benefits for sukuk would be unfair, especially as some of the proceeds of sukuk deals may finance terrorist groups.

“The chances of Islamic countries slapping Korean companies with trade or financing disadvantages would be low, but they may extend their uneasy feelings to other means. Raising capital for Korean companies could become more expensive,” a Finance Ministry official said.

Hana Bank, which was granted to issue 1 billion ringgit of MTN in 2009, also faces difficulty in raising capital as it approached limits. Woori Bank, NH Bank and the Industrial Bank of Korea plans to slow its bond issuance plan before they also hit their limits.

Former Malaysian Prime Minister Mahathir bin Mohamad in a Seoul forum said it is not right for Korea to oppose to the issuance of sukuk bonds from concerns that it could finance Islamic terrorist groups.

The Finance Ministry is currently pushing a bill that grant tax exemption on profits earned by sukuk bondholders after the bill failed to pass legislation in December. It expects sale of sukuk to attract low demand in the local market without tax benefits as investors would shun the tax-carrying securities.

Former Malaysian prime minister Mahathir Mohamad defended Islamic financing in Seoul.

“There’s no reason why countries should reject Islamic banking. It’s not about religion, it’s about using banks,” he said Thursday on the sidelines of a conference.

By Cynthia J. Kim (cynthiak@heraldcorp.com)