Retail state sukuk offer
investors a decent return

The government is selling the first retail state sukuk series SR001, which carries a 12 percent coupon and will have a maturity of 3 years. The offering period is from Jan. 30 to Feb. 20.

The issuance of the sukuk is an endeavor by the government to diversify the sources of state budget financing. The financing for the state budget is provided by issuing government securities. These comprise bonds, Treasury Notes, retail bonds, zero coupon bonds and state sukuk (SBSN). In addition, financing for the state budget also comes from bilateral and multilateral loans.

Issuing retail state sukuk is a form of commitment by the government to develop the country's sharia financial industry. After issuing the SBSN series IFR001 and IFR002 in August 2008 and the retail state sukuk this month, it also plans to develop the market by issuing dollar-denominated SBSN.

The SR001 uses the same scheme as the SBSN series IFR001 and IFR002, known as the ijarah sale and lease back scheme. Under this scheme, the government will sell the title of state owned assets to a special purpose vehicle (SPV), the so-called Perusahaan Penerbit SBSN Indonesia. The available state-owned assets comprise land and buildings owned by the Ministry of Finance in all regions.

Subsequently, the SPV will sell retail state sukuk certificates to individual investors. The government will receive the proceeds from the sale of state owned assets through the SPV, amounting to the total issuance of the SR001. Until maturity (Feb. 25, 2012), investors will receive coupon payments or fees in monthly installments.

At maturity, the SPV shall buy back the retail state sukuk certificates from investors, and then the SPV will sell the sukuk assets back to the government. Bank Indonesia will act as the agent, paying the coupons and the total amount back to investors at maturity.

The structure of the retail state sukuk is the same as the structure of the retail bond (ORI). An investor's cash flow is no different than that from an ORI. During the holding period, retail state sukuk investors will receive income on a monthly basis in the form of lease rental, stemming from the beneficial rights of the sukuk assets. In the secondary market, just as for ORI, investors with retail state sukuk may also attain capital gains.

Retail government bonds are well known to Indonesian investors. To date, the government has issued ORI five times, receiving funds of Rp 34.63 trillion. However, the latest issuance - the ORI005 - only raised Rp 2.71 trillion due to tight liquidity in Indonesia's monetary system. As a result, the ORI005 coupon rate was high at 11.45 percent, as it had to compete with the bank deposit rate of more than 12 percent annually.

For this first retail state sukuk, the government has decided to offer an attractive coupon of 12 percent. The coupon is much higher than the yield on the ORI004 of 10.43 percent as of Feb. 3, 2008. This is a useful comparison, as ORI004 has a similar maturity of 3.1 years.

In January 2009, the secondary market for ORI was very liquid, with total trading volume reaching Rp 4.13 trillion. The average trading volume per bond was Rp 826.70 billion, while the market turnover ratio stood at 11.94 percent (or much higher than the figure of 7.17 percent for government bonds).

The liquidity of retail state sukuk will be boosted by the fact that both institutional investors and banks will be allowed to purchase retail state sukuk in the secondary market.

Despite the global economic crisis, the government is still issuing the retail state sukuk this month. We believe that there are three factors which will support this issuance. First, there is untapped potential for this type of investment option from sharia investors who seek investments that are free of interest (riba), uncertainty (gharar) and speculation (maysir).

Moreover, with high risk aversion among investors as a result of the global financial crisis, domestic investors will be more attracted to place their funds in government instruments or quasi-government institutions such as retail state sukuk, rather than in foreign banks which may have exposure to "toxic credit".

The second supporting factor is the improved condition of the domestic bond market. In October 2008, the bond market came under massive pressure and the average yield on government bonds soared to 19.76 percent. After, the average on government bonds then fell by 8.20 percent to 11.56 percent as of Feb. 3.

The third supporting factor is the downtrend in inflation. Year-on-year inflation had risen to 12.14 percent in September 2008 but then declined to 9.17 percent in January 2009. Indeed, the country has experienced deflation in the last two months: 0.04 percent in December and 0.07 percent in January.

As a result, Bank Indonesia will have more room to cut interest rates further. This will push yields on the bond market down, and as bond prices go up when yields decline, the SR001 will have the potential for strong capital gains in the secondary market.

All in all, we believe that the issuance of retail state sukuk is a good way for the government to raise funds, while encouraging the development of the sharia financial industry. Despite the global economic crisis, domestic investors should still be drawn to the offer since the coupon of 12 percent is very attractive.

The writer is a bond market analyst at Danareksa Sekuritas.

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