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Indonesia's issues

July- August 2010
The year began full of hope for the Indonesian Sukuk market, as the Islamic finance industry looked to Asia to shore up the Sukuk market as Gulf issuers struggled to recover from the impact of Dubai's debt crisis; however, half way through the year, optimism is waning in the Southeast Asian country. Isla MacFarlane asks if the glass will remain half full for the second half of a difficult year.

At the beginning of the year, HSBC Amanah predicted that Sukuk issuers in Asia were likely to sell at least 10-20 per cent more of Islamic paper with the European debt crisis having barely made a dent on Asia's growth prospects.

Mukhtar Hussain, HSBC Amanah 's Global Chief Executive, said that Malaysia and Indonesia would probably remain the region's main Sukuk issuers, although centres such as Hong Kong, Japan, Singapore and South Korea would emerge as issuers over time. He said, "In Asia we have positive economic growth, we have relatively high savings rates, we have liquid markets."

According to Standard & Poor's, global Sukuk sales totalled $23.3 billion last year, and Malaysia, Pakistan and Indonesia together accounted for just over half of total global Sukuk issuance. In February, CIMB Group Holdings predicted that sales of Islamic bonds could increase by 24 per cent over the year, led by Southeast Asia, as the region's expansion would help drag the world out of recession.

Badlisyah Abdul Ghani, Chief Executive Officer of CIMB Islamic Bank, said, "Economic growth will trigger the need for funding. Most sales will come from this part of the world, with countries including Indonesia and Thailand moving aggressively to facilitate the industry."

Hopes were especially high for Indonesia, the world's most-populous Muslim nation, after making a late entrance onto the Islamic finance scene. Farouk Alwyni, Director of Treasury & International Banking for Bank Muamalat, said, "Indonesia just recently really looked into the potential of the Islamic finance. It has, to some extent, due to the legacy of the past, been somewhat suspicious toward things associated with Islam. As a result, it was late in taking advantage of the growth of Islamic finance, especially on the regulatory side. The Sukuk law was just enacted in 2008, the law that enable the Government to issue Sukuk, before that, the Government could not issue Sukuk due to the lack of legal foundation. Compare this with Malaysia that issued its first sovereign Sukuk in 2002. So, all of this 'regulatory' bottle-neck contributed to the slow growth of Islamic finance in Indonesia."

Although Islamic finance has been slow to take off in the country, the industry has transformed over the last two years, after stepping up its efforts last year by eliminating double taxation of such Shari'ah products, which had hampered the growth of the industry. The Government of Indonesia issued its first global Sukuk in 2009 amounting to around $600 million, and in February this year the country raised $848 million from its first sale of Sukuk to individual investors - almost three times more than originally planned. "Demand is strong because the Government is paying a bit of an extra yield from what you can get in the secondary market," said Suryandy Jahja, Managing Director at PT Kresna Graha Sekurindo in Jakarta. "Sukuk is a special product that appeals to a lot of retail investors in this country and there's a lot of untapped cash in the system."

"It shows market confidence in the government's debt-management policy," said Handy Yunianto, a fixed-income analyst in Jakarta at PT Mandiri Sekuritas. "With the tripling in the amount it originally sought, the government should be able to reduce the sales of conventional bonds aimed for institutional investors."

In April, ministry officials teased the public with talk of issuing Islamic treasury bills and retail Sukuk later in the year to diversify funding sources, develop the Islamic debt market and finance the state budget deficit. However, despite the Government's intention to sell $750 million of global Sukuk in July, plans were trimmed back to $500 million over fears that Greece's debt crisis would spread.

"If officials expressed their concern about the Greek crisis, or they fear that such a crisis would have a spillover effect on Indonesia, that's normal," said Branko Windoe, Head of treasury at PT Bank Central Asia.

Indonesia's Finance Ministry has been holding regular domestic Sukuk auctions to encourage more issuance and deepen its Islamic capital market, however, the Indonesian Government has often failed to raise its target amount. Investors typically demand higher yields for the domestic Islamic debt than for comparable conventional debt to compensate for the lack of a liquid secondary market in Islamic securities, prompting the Government to reject bids.

In June, Indonesia's Finance Ministry rejected all bids in a Sukuk auction amid investors' concerns over poor trading liquidity in the paper, in sharp contrast to strong demand for the country's conventional debt. The auction only attracted IDR 474 billion ($72 million) of bids. The ministry had targeted raising IDR 1 trillion ($110 million) from the auction, which is usually held once a month, to help plug the state budget deficit.

Dahlan Siamat, the Finance Ministry's Director in charge of Islamic financing, said, "We realise there must be a difference in the yields between conventional and Sukuk but not that much."

The Ministry had expected to sell Sukuk maturing between five to 20 years. Five-year Sukuk attracted IDR 246 billion ($27 million) of bids, with yields ranging between eight to 9.5 per cent. This compared to a yield of around 7.5 per cent for conventional five-year debt. Total outstanding tradable rupiah-denominated Government Sukuk stood at IDR 24.5 trillion ($2.7 million) as of the middle of June, a tiny amount against comparable outstanding conventional government debt of IDR 590 trillion ($65 billion).

Indonesia now plans to issue a benchmark size global Sukuk in October, which could be around could be about $500 million to $600 million, although a Ministry official said that the authorities are monitoring markets before making a decision on the sale.

Siamat said "We still have three months. Let's watch the market. We are not desperate to sell Sukuk or bonds. There's no crucial reason to be desperate to go to tap the international markets."

The Sukuk would be based on the Ijarah structure and the underlying assets would be Government buildings. "We prefer much longer (tenors). But if you see the appetite of international investors at this point in time, they are willing (to take) shorter, say five (years)," Siamat said. "We prefer somewhere between seven and 10 (years)."

At the WIBC Asia, Siamat revealed that the Government may pick three of 11 shortlisted foreign investment banks as joint lead managers for the sale. He said, "We want to be a regular issuer and at the same time a global Sukuk would create a benchmark for Indonesian bonds."

Quote
According to Standard & Poor's, global Sukuk sales totalled $23.3 billion last year, and Malaysia, Pakistan and Indonesia together accounted for just over half of total global Sukuk issuance. In February, CIMB Group Holdings predicted that sales of Islamic bonds could increase by 24 per cent over the year, led by Southeast Asia, as the region's expansion would help drag the world out of recession

© Islamic Business and Finance 2010