Bloomberg Indonesia Plans Sukuk Shift to Fund $140 Billion Program: Islamic Finance

Indonesia plans to increase the type of assets that can be used to pay returns on Islamic bonds to road and rail projects in a bid to support its $140 billion development program.

The government is seeking approval from the country’s Shariah board to use future fees from transport facilities to be constructed over the next three years as the underlying asset for sukuk, Rahmat Waluyanto, director general of the finance ministry’s Debt Management Office, said in an interview in Jakarta on Jan. 11.

The cash flows that back Islamic bonds are currently restricted to state-owned property and land, he said.
Islamic banking assets in the nation with the world’s largest Muslim population were 9 percent of Malaysia’s in 2010, according to central bank data. The government also plans to offer tax cuts on Shariah-compliant investment accounts, while Bank Indonesia is streamlining the approval process for new products to expand the industry.
“Once they allow infrastructure projects to be used to issue the debt, investors will have more choice and that will improve liquidity,” Akbar Syarief, a Jakarta-based fund manager at PT Bhakti Asset Management, who helps oversee 700 billion rupiah ($77 million), said in an interview yesterday. “Right now, we can’t find new options, so we can’t trade the papers we hold.”

Ijarah Structure
Sukuk backed by finances from construction of highways are often based on Istisna, a purchase order for an underlying asset that will be delivered at a future date. Investors can also be co-owners through an agreement known as musyarakah, where buyers of the debt and the government contribute funds in cash or in kind. Islamic debt with real estate as the underlying asset is known as Ijarah sukuk, or a sale and lease agreement.
Indonesia’s government can issue up to 30 trillion rupiah of Ijarah debt this year and total offerings of Islamic bonds may climb more next year once legislation is approved to sell Istisna sukuk, said Waluyanto.
“The government is preparing regulations to enable projects as the underlying asset and we’ve made some progress, but we also need to get approval from the Shariah board and get the legal framework in place,” he said.

Indonesia, home to 209 million Muslims according to Central Intelligence Agency estimates, had 86 trillion rupiah of Islamic banking assets as of October 2010, or about 3 percent of the total, central bank data show. The amount compares with 337.6 billion ringgit ($110 billion) in Malaysia, or 20 percent of banking assets, according to the Finance Ministry.

Indonesia Sukuk
Sales of sukuk, which pay asset returns to comply with the religion’s ban on interest, rose 56 percent in Indonesia to 26.2 trillion rupiah in 2010, according to Bloomberg data. The government has sold 42 trillion rupiah of the debt since 2008. In Malaysia, issuance dropped 11 percent to 28.5 billion ringgit, while global sales declined 15 percent to $17.1 billion.

Shariah-compliant bonds returned 12.8 percent last year, the HSBC/NASDAQ Dubai US Dollar Sukuk Index shows, compared with 19.8 percent the previous year. Debt in emerging markets gained 12.2 percent, from 29.8 percent in 2009, according to JPMorgan Chase & Co.’s EMBI Global Diversified Index.
The difference between the average yield for sukuk in developing nations and the London interbank offered rate narrowed seven basis points to 282 since Dec. 31, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index. The spread narrowed 178 basis points, or 1.78 percentage points, last year.

Project Failure

The yield on Malaysia’s 3.928 percent sukuk maturing in June 2015 rose one basis point to 2.84 percent today, according to prices from Royal Bank of Scotland Group. The extra yield investors demand to hold Dubai’s government sukuk rather than Malaysia’s narrowed two basis points to 322, Bloomberg data show.
Investors in Indonesia are “comfortable” with the existing Ijarah sukuk because they know there’s a physical asset and they will get their money back, said Marciano Herman, president director at PT Danareksa Sekuritas, in an interview in Jakarta yesterday.

“If the laws can ensure that investors will be protected should the project be uncompleted, then people will buy such sukuk,” said Herman. “It will take some time before investors get used to such structures because what happens if the project fails?”

Savings Account

Indonesia plans to sell 200.6 trillion rupiah of local and foreign-currency debt in 2011, including sukuk, to fund a budget deficit estimated to reach 124.7 trillion rupiah, or 1.8 percent of gross domestic product, said Waluyanto.

The government may issue dollar-denominated Islamic and non-Islamic bonds in the first half and also plans to sell sukuk to individual investors next month, he said. Indonesia sold 8.033 trillion rupiah of so-called retail notes in February last year, more than the 3 trillion rupiah it targeted.

The yield on Indonesia’s 8.8 percent dollar sukuk maturing in April 2014 was little changed today at 3.26 percent, according to RBS prices. The debt returned 9 percent last year.

“The government is probably pushing to sell debt early before any possible interest-rate increase,” said Syarief at PT Bhakti Asset. “Yields for the retail sukuk have to be more than the average 7 percent that depositors get if they leave their money in a savings account.”

To contact the reporters on this story: Suryani Omar in Jakarta