T

he Indonesian government will issue rupiah-denominated sukuk Islamic bonds to finance state projects next year, a move welcomed by analysts as a breakthrough in the development of the country’s undersized Islamic finance sector.

The Finance Ministry plans to borrow up to Rp 1 trillion (US$103.5 million) through sukuk issuance to finance state projects next year, according to the 2013 state budget financial note. Sukuk should be seen as alternative source of financing for the government’s infrastructure projects, the note adds.

“We will start picking the most feasible projects listed in the Finance Ministry’s Directorate General for the State Budget in January 2013. Precisely which projects will be funded by sharia bonds will depend on our evaluation,” Dahlan Siamat, the director of Islamic financing policy at the Finance Ministry’s debt management office, said on Monday.

At the moment, the debt management office has expressed interest in issuing sukuk to finance some state projects, including the Transportation Ministry’s plan to build a 126-kilometer, double-track railway from Cirebon to Kroya in West Java, valued at Rp 1.5 trillion.

“The Cirebon-Kroya railway plan is a multi-year project. In this case, we may issue sukuk worth Rp 800 billion for the first year, and the rest of the needed funds could be raised in the upcoming years,” he added.

Indonesia’s progress in building infrastructure remains sluggish, analysts have said, due to the fact that Indonesian banks are reluctant to finance infrastructure-related projects because of the low internal rate of return (IRR) and high risks. Banks are concerned about liquidity mismatches, as most infrastructure projects are of a long-term nature.

Islamic-based bonds could be the solution, Dahlan said, adding that the issuance of project-based sukuk would be mutually beneficial for potential investors and the government in its bid to expedite infrastructure construction.

Despite its status as the world’s largest Muslim nation, Indonesia lags behind in the development of Islamic finance, with sharia-based financing still comprising a small share of both the country’s banking industry and its bonds market.

“I always talk publicly about how promising the potential of our Islamic finance actually is,” Dahlan said, adding that the issuance of sukuk would diversify Indonesia’s debt portfolio.

The government aimed to raise Rp 270 trillion from bonds this year to bridge its budget deficit, with sukuk accounting for only Rp 57 trillion of the total. Very little from Indonesia’s sharia bonds are specifically earmarked for infrastructure projects, while more than 40 percent of Islamic bonds in Malaysia were issued to finance infrastructure projects.

Sukuk adhere to Islamic investing principles, where the bondholders have a share in the ownership of tangible assets, which act as collateral. This is different from conventional bonds, which do not offer ownership but offer bondholders profits from the interest paid by the issuers.

The issuance of sukuk for infrastructure projects is an “excellent breakthrough” to develop Islamic finance and increase the outstanding portfolio of sharia bonds, according to Handy Yunianto, a bonds market analyst with Mandiri Sekuritas.

“Infrastructure projects can be used as underlying assets for the sharia bonds,” said Yunianto. He explained that presently there were few entities that could be used as underlying assets for Indonesia’s sukuk, a situation that prompted doubts among investors in the Islamic-based bonds market and hampered its development.

Sukuk for infrastructure projects, which would be issued in rupiah, would also curb Indonesia’s dependency on offshore borrowing, he added. (sat)