Monday, January 28, 2013

Indonesia to continue issuing sovereign sukuk

A week ago, Indonesia said it would reduce its use of foreign currency bonds to finance its budget deficit.  However, it said recently that it would not reduce--nor likely expand--its use of sukuk and may shift from an ijara structure to a wakala structure.  A top official speaking to Reuters said the country would issue as much as Rp 57 trillion ($5.9 billion) in sukuk.  
The director of Islamic financing policy at the finance ministry, Dahlan Siamat, told Reuters: "There is no reason to stop issuing sukuk, it has become part of our strategy. We don't want to be completely dependent on conventional bonds, so it is important that we have this alternative"  He further elaborated that Indonesia would not issue more sukuk this year because "the market is not quite developed yet, and of course we have had to see things from the cost perspective," and said the additional cost was around 25 basis points, down from 50-60 basis points a few years ago.  
In an earlier post, I described the paradox of the Indonesian sovereign sukuk market.   The lack of liquidity in government sukuk means that despite the growing demand for the now-investment-grade sukuk, the government has trouble issuing it because it is (not without reason) unwilling to pay more on sukuk than conventional bonds.  Investors, on the other hand, want to buy Indonesia's sovereign sukuk (represented by the high number of bids for government sukuk) but demand a premium yield to compensate them for the illiquidity.  
What then is the solution to developing liquid secondary markets if the government limits the supply (thus creating scarcity that leads many investors to hold-to-maturity, further reducing the secondary market activity)?  The government believes it will come through appointing primary dealers for government sukuk who will act as market makers: "They will have the responsibility as market makers, with this the market will be much more liquid".  
Expanding the number of market makers in secondary markets should make them more liquid, but when the supply is limited compared to demand (both to limit the use of higher cost sukuk and to limit the use of foreign currency debt), there should be a shrinkage of the bid-offer spread, but also more trading activity, which--if the demand is sustained for local currency sukuk--should lead to higher prices for sukuk (and therefore, lower yields on which new sukuk can be priced)
The process will likely proceed in fits and starts because there will still be the problem of pulling sukuk from hold-to-maturity investors who may not want to sell their sukuk at any price because of the challenges in replacing it in with a new sukuk.  However, if the liquidity develops and high demand leads to rising prices and falling yields, it should support the compression of the yield premium for sukuk, which will encourage greater issuance over the longer-term.  If successful, it may provide an example of how to support secondary market liquidity that can be applied in other regions.

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