Sharia Banking and the Financial Industry

Indonesia’s borrowing costs relative to Malaysia’s have narrowed to the lowest level since January ahead of a planned sale of global Islamic bonds in the second half of this year. The extra yield investors demanded to buy Indonesia’s 8.8 percent dollar sukuk compared with Malaysia’s 3.928 percent note shrank to 21 basis points on Friday from 71 basis points on March. The spread with similar-maturity US Treasuries was 176 points, down from 705 when the Southeast Asian nation sold the debt in April 2009, its first overseas sukuk offering.

Confidence in Indonesia is improving as the central bank projects economic growth this year will be the fastest since 2004, while currency reserves have climbed to $105 billion, almost double the holdings in 2009. Ratings agencies have raised the government one step short of investment grade, which may be reached by September, according to Hatta Rajasa, the coordinating minister for the economy. Fitch Ratings lifted its credit assessment to “positive” from “stable” on Feb. 24, citing favorable economic prospects, and kept the ranking at BB+. Moody’s Investors Service increased its rating to Ba1 on Jan. 17 with a stable outlook. The government needs at least three months to prepare the issuance, Dahlan Siamat, director of Islamic finance at the Finance Ministry, said on Wednesday.

Sales of Islamic bonds in Indonesia reached Rp 16.8 trillion ($1.9 billion) this year, according to data from the Finance Ministry’s debt management office and the Capital Market and Financial Institution Supervisory Agency (Bapepam-LK). Issuance rose 45 percent to Rp 27.76 trillion last year. While Indonesia is home to the world’s largest Muslim population, its Rp 100 trillion of Islamic banking assets are 10 percent of Malaysia’s 351 billion ringgit ($116 billion) sector. Bank Indonesia aims to increase the market by up to 55 percent this year to try to close the gap.

Indonesia plans to start selling short-term treasury bills that comply with Islam’s ban on interest for the first time in the second half of the year.
Source : Bloomberg

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Yields on Indonesia’s Shariah- compliant dollar-denominated bonds dropped to a six-week low as Southeast Asia’s largest economy moved a step closer toward winning an investment-grade rating.The rate on the benchmark 8.8 percent Islamic note due April 2014 fell 7 basis points, or 0.07 of a percentage point, this week to 3.47 percent and reached 3.4 percent, the lowest level since Jan. 20, according to the Royal Bank of Scotland Group prices. That’s a turnaround from last month’s climb to a seven-month high of 3.84 percent as inflation accelerated to 7 percent in January, the fastest pace in more than two years. Consumer price gains eased to 6.8 percent last month. Fitch Ratings raised the assessment on Indonesia to “positive” from “stable” on Feb. 24 while keeping the ranking at BB+, a step below investment-grade, citing favorable economic prospects. Based on this rating, a lot of foreign money flowed into Indonesia and its currency appreciated strongly. The economy expanded 6.1 percent in 2010, the most in six years, and the central bank raised borrowing costs last month from a record low to temper inflation.

Sales of Shariah-compliant debt may rise this year and help ease a supply shortage. The government was waiting on House approval to allow Rp 30 trillion ($3.4 billion) of assets to be used to back sukuk, or Islamic bonds. Surging crude oil prices and concern the government will reduce fuel subsidies in a nation that’s a net importer are putting pressure on inflation. Core inflation, which excludes food and fuel, may climb to 5 percent this year from 4.28 percent at the end of 2010.

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Global sales of Islamic bonds are forecast to rise nearly 60 percent this year to more than $22 billion as economic recoveries and high crude oil prices revive the market, a Reuters quarterly poll demonstrated. An upswing in corporate spending, an increase in issuers seeking to diversify their sources of funding and improving investor sentiment in the Gulf are also expected to fuel fund-raising activities, according to the 15 respondents. Issuance fell 26 percent to $14 billion in 2010 in the aftermath of Dubai’s debt restructuring and high-profile sukuk defaults. That estimate excludes issues which are callable in less than a year, those which are not rank eligible or underwritten and self-funded ineligible issues. Qatar Islamic Bank and National Bank of Abu Dhabi have launched sukuk sales in recent months, with the Dubai government, Saudi Arabia’s civil aviation authority, Gulf Investment Corporation and Saudi International Petrochemical Company expected to tap the market too.
However, some experts have said global issuance of Islamic bonds would take another year to fully recover, with new markets in Europe and Asia yet to offset the fall in Gulf issuance. Sukuk issuance can be more costly than conventional bonds as they tend to involve the transfer of assets that attract tax. The bulk of sukuk in 2011 are expected to emerge from issuers in Malaysia and the Middle East, although some issuance could also come from the United States, Singapore and Indonesia. Banks, governments and companies in the infrastructure, real estate and energy businesses are expected to be the main issuers.

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The nation’s dollar Islamic bonds fell for a second week, after a record decline last quarter, as concern inflation will quicken outstripped optimism the nation will win an investment-grade rating. The yield on Indonesia’s 8.8 percent sukuk due in April 2014 has climbed 68 basis points to 3.33 percent since reaching an all-time low of 2.65 percent on Oct. 14, according to prices from the Royal Bank of Scotland Group. It jumped 23 basis points in the fourth quarter.

The extra yield for the debt over Malaysia’s 3.928 percent note widened to 48 on Friday, from 26 basis points less on Jan. 5. Indonesian yields may rise further because inflation will accelerate this year as fuel subsidies are reduced and rice prices increase, according to Mandiri Sekuritas. Moody’s Investors Services placed its rating for Indonesia on review for a possible upgrade in December after raising the ranking to Ba2 in September, two steps below investment grade.

The yield on Indonesia’s sukuk is a negative 3.63 percent when adjusted for inflation compared with 0.76 percent in Malaysia. Indonesian yields may rise further relative to Malaysia’s because of the country’s lower credit rating, according to AmInvestment Management Sdn. Malaysia is rated A3 by Moody’s, five levels higher than Indonesia. The Malaysian sukuk are cheap, so people should start to buy. Indonesia’s sales of sukuk, which pay asset returns to comply with Islam’s ban on interest, rose 56 percent to Rp 26.2 trillion ($2.9 billion) in 2010. The Finance Ministry plans to sell Rp 200.6 trillion of local and international debt in 2011 to fund a budget deficit estimated to reach Rp 124.7 trillion, 1.8 percent of gross domestic product.

Source :Bloomberg

Indonesia plans to add road and rail projects to the types of assets that can be used to pay returns on Islamic bonds 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 , or Islamic bonds, said Rahmat Waluyanto, director general of the Finance Ministry’s Debt Management Office. In a bid to catch up, the government also plans to offer tax cuts on Shariah investment accounts, while Bank Indonesia will streamline the approval process for new financial products to expand Shariah finance.

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. The government may issue up to Rp 30 trillion ($3.33 billion) of Ijarah debt this year. Total offerings of Islamic bonds may climb next year once legislation is approved to sell Istisna sukuk. Sales of sukuk, which pay asset returns to comply with Islam’s ban on interest, rose 56 percent in Indonesia to Rp 26.2 trillion in 2010, according to Bloomberg data. (more…)

Indonesia’s Islamic bonds may extend this year’s rally that drove yields to record lows on prospects of further ratings upgrades. Bhakti Asset Management’s BIG Dana Muamalah fund, which returned 13.4 percent this year, bought rupiah-denominated government sukuk in March, the same month Standard & Poor’s raised the country’s rating to BB, two levels below investment grade. BIG Dana, the top performer in 2010 among 67 Shariah-compliant fixed-income funds tracked by Bloomberg, expects more Indonesian companies to sell Islamic bonds next year. (more…)