Indonesia Prepares an Islamic Bonds Industry

The
world’s biggest Muslim nation struggles to build its Islamic
finance industry

 

indo-centbank

 Bank Indonesia Headquarters, Jakarta

In a bid
to drive growth in the fledgling Islamic bonds industry, Indonesia’s
central bank says it will relax the rules for investors who buy the
bonds.

Despite
being home to roughly 10 percent of the world’s estimated 1.3
billion Muslims, Indonesia has struggled to build up its Islamic
finance industry, lagging well behind countries such as Malaysia,
Singapore and even Pakistan.

However,
the recent introduction of a new law that would allow the government
to issue Sukuk, or Islamic bonds, is expected to trigger significant
growth in the sector. The government announced this week it has
already set aside US$2 billion in assets to back the bonds, which it
expects to sell in two separate issues this August and October. Sukuk
bondholders are paid income derived from assets such as rent from
property because Islamic law bans lending for interest.

Mulya
Siregar, Bank Indonesia’s head of Islamic finance, pledged this
week that the central bank would change the rules surrounding Sukuk
to boost investor interest in the securities.

As the
rules stand, investors in Islamic bonds are required to hold them
until maturity.

“We
will change that regulation,” Siregar told an investment
conference Thursday.

“That
regulation was made in 2000 or 2002, when Bank Indonesia was still
learning about how to develop Islamic finance so it just worried at
that time whether the securities of Sukuk were an asset or not. But
now, I think we agree they should be an asset so that investors are
able to trade them.”

Pushed on
the timing of the change and whether it would be before the
government’s planned August issue, Siregar said it would be “as
soon as possible.”

The move
could be a significant boost for Sukuk in Indonesia, which have so
far received little interest from traditional investors. In Malaysia,
on the other hand, more than 50 per cent of Sukuk issuances are taken
up by commercial bond traders.

“A
real issue for Indonesia is that conventional investors do not
participate in the Sukuk market,” said Badlisyah Ghani, head of
CIMB Islamic Bank in Malaysia

“This
is a peculiar situation that does not exist in Malaysia. All
investors, including conventional banks, chase after Islamic
instruments. As a result Islamic bonds in Malaysia are cheaper by 5
to 20 basis points compared to conventional bonds.”

If the
Indonesian government and central bank get the regulatory framework
right, a sovereign Sukuk would set a benchmark price for corporate
bonds and allow the country to capture a significant share of the
global market for Islamic bonds, which Moody’s estimates was
worth US$100 billion last year.

“Sukuk
is important for Islamic banking development,” says Siregar.
“Right now, the problem for Islamic banking in Indonesia is
liquidity.”

It would
also allow Indonesia to attract investors from the Middle East and
provide another funding source for the government, which is
struggling to finance its budget deficit as the record-high oil price
leaves it saddled with a bulging fuel subsidy bill. The government
raised fuel prices by an average of 28.7percent Saturday in an effort
to control its surging subsidy problems.

But
experts warn Indonesia still has a long way to go to set up the right
regulatory framework. The new Sukuk law, introduced last April, was
restricted to dealing with the government’s ability to issue
Islamic bonds. It did not deal with the unfavorable tax treatment of
the securities or the lack of incentives for companies to issue
Islamic bonds.

Most
Islamic bonds involve a sale and purchase, or leaseback, of assets,
which attracts Value Added Tax. That generally means they are taxed
twice as much as conventional securities.

“The
government is dealing with its own issue first and then with that
liquidity, creating the necessary benchmark for industry, it needs to
extend the regulatory system to have good laws for corporate
issuers,” says Ghani.

Still, he
believes demand is already strong, despite the lack of regulatory
certainty.

“Even
without those tax incentives, there have already been 17 Sukuk issues
in the market worth 2.2 trillion rupiah or about US$250 million. It’s
a very exciting market.”

There are
only three purely Islamic banks in Indonesia with another 20
mainstream banks offering shariah services. Islamic banking made up
just 1.6 per cent of national banking assets in 2006, according to
Bank Indonesia and the capital markets regulator Bapepam estimates
Sukuk bonds make up about 2.5 per cent of total issuance.

According
to Moody’s, the global Islamic finance market has grown by
about 15 per cent for each of the past three years and is worth
US$700 billion. Sukuk is the fastest growing part of the market with
volumes of US$97.3 billion last year. New issuance increased 71 per
cent to US$32.65 billion.

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