Sukuk Auction Failures Send Indonesia Overseas: Islamic Finance

The failures of 10 rupiah sukuk auctions this year are prompting Indonesia’s finance ministry to revive demand for its Islamic debt by tapping international investors and possibly changing its sales practices.

The world’s most-populous Muslim nation raised 4.9 trillion rupiah ($540 million) from notes that comply with Islam’s ban on interest in 2010, down 40 percent from a year earlier, according to the finance ministry’s Debt Management Office. The next auction on July 13 is seeking 1 trillion rupiah. Malaysia, the biggest market, has generated 15 billion ringgit ($4.7 billion) from five sukuk sales, government data show.

Indonesia may negotiate rates with potential investors in so-called book-building rather than in a single auction, Dahlan Siamat, director for Islamic financing at the ministry, said yesterday in a phone interview from Jakarta. Domestic investors are demanding higher returns from Islamic bonds because they aren’t actively traded, according to PT Bank Danamon Indonesia and PT Bank Syariah Mandiri in Jakarta.

“We may use a different approach of a book-building process if we can’t sell Islamic notes in the next auction,” Siamat said. “The auctions failed because investors asked for higher yields above our benchmark because the market isn’t liquid.”

Indonesia sold its first domestic sukuk in August 2008 through book-building. State-owned PT Danareksa Sekuritas, PT Mandiri Sekuritas and PT Trimegah Sekuritas arranged the sale, which raised 2.7 trillion rupiah, according to the finance ministry’s website. The government had 38 trillion rupiah of sukuk outstanding as of June 29, 2010, the ministry data shows.

Islamic Assets

Indonesia’s dollar-denominated sukuk due 2014 handed investors a 4.9 percent return so far in 2010, according to data compiled by Bloomberg. The yield, which was as high as 8.63 percent when the bonds were first sold in April 2009, fell 79 basis points this year to 3.81 percent.

Shariah-compliant bonds returned 6.6 percent this year, according to the HSBC/NASDAQ Dubai US Dollar Sukuk Index, while debt in developing markets gained 6.5 percent, JPMorgan Chase & Co.’s EMBI Global Diversified Index shows. Global sales of sukuk fell 23 percent to $6.58 billion in 2010, according to data compiled by Bloomberg.

Indonesia’s Islamic banking assets totaled $8 billion at the end of last year, 2.9 percent of its total, Mulya siregar, a director of Islamic banking at the central bank, said yesterday. By contrast, Malaysia’s $93 billion of Shariah-compliant assets account for 19.6 percent of the industry, according to Bank Negara Malaysia’s website.

Market Development

“Until the market is fully developed, investors will continue to demand a very high liquidity premium,” Helmi Arman, a strategist at PT Bank Danamon, the nation’s sixth-largest lender by assets, said in an interview yesterday in Jakarta. “There won’t be much improvement in the auction as the outstanding sukuk aren’t liquid enough.”

The government plans to sell five-, seven-, and 10-year Islamic bonds on July 13, according to the finance ministry’s website. Indonesia failed to sell any sukuk at three auctions this year. The remaining seven sales all fell short of target.

The government raised 474 billion rupiah at its last auction on June 15, less than the 1 trillion rupiah sought because yield bids were too high. It received offers amounting to 1.76 trillion rupiah. The yield on the seven-year sukuk dropped 20 basis points from the previous sale to 8.65 percent.

International Market

The yield on the sukuk maturing in January 2017 rose one basis point to 8.07 yesterday, according to prices from Indonesia’s Interdealer Market Association. The yield on the seven-year non-Islamic government bond is lower at 7.9 percent and fell seven basis points yesterday.

“Last year, the government offered yields of 11 percent at one point, so investors want to bid at 11 percent,” said Tutuy Guntara, an investment manager at PT Bank Syariah Mandiri in Jakarta. “The government wants about eight percent.”

The industry’s assets may almost triple to $2.8 trillion by 2015, according to the Kuala Lumpur-based Islamic Financial Services Board. Transactions are based on the exchange of asset flows rather than interest to comply with the religion’s Shariah principles.

“We haven’t seen much interest from foreign investors in our regular sukuk auctions,” according to Siamat. “It’s very possible” that a book building will raise their participation, he said.

‘Growth Story’

Indonesia is turning to global investors this year to finance its budget deficit, which the government estimates will increase to 2.1 percent of gross domestic product in 2010 from 1.6 percent.

The government is planning to sell as much as $650 million of Islamic bonds overseas in October, Siamat said on July 7. The nation sold its first international sukuk last year.

“We are going to look at Indonesia’s global and domestic sukuk offerings,” Rafael Martinez Dalmau, director of Islamic investments at BNP Paribas Investment Partners, the asset management unit of BNP Paribas SA, France’s biggest bank, said in a July 7 interview in Singapore. “Indonesia is a growth story and its economics are very solid. We favor the Indonesian market as a whole.”

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