Indonesia Weighs Fighter Jet-Backed Islamic Bonds in Sales Push

  • Murabaha structure will make it easier to increase issuance
  • Shariah banking assets have shrunk 27 percent so far this year

Indonesia looks set to adopt a structure common in Malaysia for its sovereign sukuk, allowing it to more easily ramp up issuance and support a shrinking Shariah-compliant banking industry.

The government is considering using Murabaha contracts to arrange sales, Suminto, Islamic financing director at the Budget Financing and Risk Management office, said in an interview on Friday. That would let it use state purchases of everything from fighter jets to tractors to back its offerings rather than just revenue streams from property or infrastructure projects under the Ijara structure used at the moment, he said.

“The government’s budget has a large allocation for goods and services acquisitions that we can use as underlying assets,” Suminto said in Jakarta. “With this new innovation, it will allow us greater scope to increase sukuk sales.”

Indonesia’s Islamic banking assets have shrunk 27 percent in 2015, after almost tripling over the previous five years, as economic growth slowed to the least since 2009 and lenders struggled to attract new accounts. A larger and more liquid sovereign Shariah bond market would give local banks more options for investing their funds and enable them to compete more effectively with their non-Islamic counterparts. 

The yield on Indonesia’s sovereign Shariah-compliant notes due September 2020 has risen 100 basis points to 9.21 percent over the past 12 months, according to data compiled by Bloomberg. That compares with a yield of 8.62 percent on the country’s non-Islamic securities due July 2021, Inter Dealer Market Association prices show. Sukuk typically command higher yields due to a relative lack of liquidity in the market.

‘More Liquid’

Indonesia’s Shariah-compliant banking assets rose from 97.5 trillion rupiah ($7.1 billion) at the end of 2010 to 272.3 trillion rupiah by the finish of last year, before falling to 200 trillion rupiah at the end of August, data from the Financial Services Authority shows. While Indonesia has a Muslim population that’s around 12 times as large as Malaysia’s, it has less than a seventh of the Islamic banking assets that its neighbor has.

The use of Murabaha contracts would remove a constraint on increasing government sukuk sales, said Khalid Howladar, the global head of Islamic finance at Moody’s Investors Service in Dubai. Sovereign issuance dominates the Indonesian market as corporates have sold just $2.5 billion of Islamic notes since 2002 amid a lack of clarity on tax regulations.

“Government sukuk issuance helps create a more liquid domestic sukuk market,” Howladar said  “This helps the banks in terms of liquidity management but the local Islamic banking sector is still very small. The country needs to create economic incentives for Islamic banking to thrive.”

Sukuk pay returns from an underlying asset such as property to comply with the religion’s ban on interest payments. Those assets and any revenue streams have to conform with Shariah law, which bars speculation, encourages risk-sharing and prohibits involvement in businesses deemed unethical such as alcohol or gambling. In a Murabaha contract, goods are bought and then resold with a pre-agreed mark-up. Ijara sukuk are typically backed by property that a bank purchases on behalf of the customer and leases it back at a mark-up.

Sales Increasing

Malaysia, which pioneered Islamic finance in the 1980s, started using Murabaha contracts for its local-currency government sukuk in 2013. The move drove an increase in foreign buying of the country’s Shariah debt as some Middle Eastern investors rejected a previous structure Malaysia had been using on the grounds it resembled interest-based financing.

Indonesian companies have sold the equivalent of $81 million of rupiah sukuk this year, while state-controlled airline PT Garuda Indonesia issued $500 million of Islamic debt in May in the country’s first global Shariah corporate offer, data compiled by Bloomberg show. That’s just a fraction of the 33 billion ringgit ($7.8 billion) of local-currency sales by Malaysian companies in 2015.

The trajectory for Indonesian sovereign sukuk issuance “has been very good” and sales are forecast to increase 46 percent to 110 trillion rupiah this year, the risk management office’s Suminto said. Issuance rose 42 percent in 2014 after falling 6.8 percent in 2013.

“Murabaha looks to be a more streamlined process to have underlying assets for the sukuk issuance, which would mean they can issue more Islamic bonds next year,” said Ezra Nazula, who manages more than $2 billion as head of fixed income at PT Manulife Aset Manajemen Indonesia in Jakarta. “Liquidity is key to accelerating the growth of the sukuk market.”

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