Indonesia Cuts Taxes After Trailing Malaysia: Islamic Finance

Indonesia’s plan to offer tax incentives for Islamic finance may spur sukuk issuance, which was 32 percent that of Malaysia last year.

Sales of Shariah-compliant debt rose 56 percent to 26.2 trillion rupiah ($2.9 billion) in Indonesia in 2010, compared with an 11 percent drop to 28.5 billion ringgit ($9.3 billion) in Malaysia, data compiled by Bloomberg show. The central bank plans to submit proposals, including tax cuts for mudarabah investment accounts, Mulya Siregar, director of Islamic banking at Bank Indonesia, said in a Dec. 30 interview in Jakarta, without saying when. A mudarabah is a partnership in profit, in which each party provides either capital or labor.

HSBC Holdings Plc and Citigroup Inc., the third- and eighth-biggest sukuk underwriters in 2010, said the plan will boost sales of Islamic debt from the nation with the world’s biggest Muslim population. Lebanon, Afghanistan and Australia have announced plans to revise laws to avoid excess levies on financial products that involve transfers of assets to comply with the religion’s ban on interest payments.

“The Indonesian authorities are looking at facilitating their corporate sector to issue sukuk,” Rafe Haneef, Kuala Lumpur-based managing director of global markets for HSBC Amanah, the Shariah-compliant unit of Europe’s largest bank, said in a Dec. 23 interview. “Though there is significant demand for the country’s corporate sukuk, there will be resistance in issuance until tax implications are clear.”

Issuance Drought

Indonesia had 86 trillion rupiah of Islamic banking assets as of October 2010, or about 3 percent of the total, according to the central bank. That compares with 337.6 billion ringgit in Malaysia, or 20 percent of banking assets, according to the Finance Ministry.

The government failed to raise the targeted amount in 12 consecutive local-currency sukuk auctions in 2010 as investors demanded higher yields than the government was willing to offer, saying the debt was riskier to hold because of a lack of secondary market trading volume. It raised 382 billion rupiah, less than the targeted 1 trillion rupiah at its last sale Oct. 5.

“Once the tax issues are resolved, we expect a strong pipeline of corporate sukuk from Indonesia,” Singapore-based Mudassir Amray, head of Asia Pacific Islamic banking at Citigroup, said in a Dec. 29 interview. “At present, the law supports sovereign issuances. The applicability of the law to the companies will also help the corporate sector tap the international Islamic capital market.”

Global Sales

Global sales of sukuk, which pay returns based on asset flows, dropped 15 percent to $17.1 billion in 2010, according to data compiled by Bloomberg. Issuance reached record $31 billion in 2007.

Indonesia, which sold its first global Islamic bond in April 2009, will tap the international sukuk market in the first half of 2011, Rahmat Waluyanto, director-general of the Debt Management Office, said in an interview in Jakarta on Sept. 29. PT Bank Muamalat Indonesia, the nation’s oldest Islamic lender, aims to sell Islamic debt in 2012 depending on its business plan, Andi Buchari Fathoeddin, its director of compliance and corporate planning, said in an interview yesterday from Jakarta. Indonesian companies haven’t announced any other plans to sell sukuk, Bloomberg data show.

Yield Declines

The yield on Indonesia’s 8.8 percent sukuk maturing in April 2014 fell one basis point to 2.86 percent today, according to prices from Royal Bank of Scotland Group. The yield was as high as 8.77 percent in its first month after issuance.

The yield on Malaysia’s 3.928 percent Islamic note due June 2015 fell one basis point to 2.94 percent today, according to RBS data. It has dropped 97 basis points since June 3. The extra yield investors demand to hold Dubai’s government sukuk rather than Malaysia’s widened three basis points to 331 today, according to data compiled by Bloomberg.

Shariah-compliant bonds returned 12.8 percent last year, the HSBC/NASDAQ Dubai US Dollar Sukuk Index shows. Debt in emerging markets gained 12.2 percent, according to JPMorgan Chase & Co.’s EMBI Global Diversified Index.

The difference between the average yield for emerging market sukuk and the London interbank offered rate narrowed 178 basis points to 290 last year, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index.

Approval Process

Bank Indonesia is also streamlining the approval process for new Islamic banking products, Siregar said in the interview last month. A 10-member joint committee including representatives from the central bank, the national Shariah board and the Indonesian Association of Accountants will start work from January, he said. Under the existing system, products have to be first reviewed for compliance with Shariah law by the panel of scholars and then Bank Indonesia.

An increase in Islamic savings would help support demand for sukuk. Bank Indonesia is proposing reducing income tax imposed on returns earned from mudarabah accounts to 10 percent from 20 percent for customers and banks, Siregar said.

“Indonesia needs to move its timetable for tax reforms more quickly,” Arfat Selvam, an Islamic finance lawyer and managing director of Arfat Selvam Alliance LLC, said yesterday in an interview from Singapore. “There is so much infrastructure development that could benefit from Islamic finance. They have to eliminate double stamp duties so that the cost for Islamic finance is not more than in the conventional.”

To contact the reporter on this story: Khalid Qayum in Singapore kqayum@bloomberg.net; Suryani Omar in Jakarta at somar6@bloomberg.net

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net.

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