The recent issue of $650 million  of Indonesian government dollar-denominated retail Islamic bonds with a five year maturity and an 8.8 per cent yield, backed by a 100 percent government guarantee and underlying assets, received orders totaling $4.7 billion and was massively over-subscribed.

This was despite the global economic and financial crisis and question-marks over poor Western banking and finance practices, with possible repercussions for Islamic banking and finance.  Bond proceeds will be used to finance government debt.

Islamic banking and finance remains underdeveloped in Indonesia with only 3.79 million customers in 2008 and just over 589,000 loans, compared to 512,000 in 2007, in a country with a population of 230 millions. The industry only has about 1,500 outlets compared to 6,500 conventional banking outlets and needs substantial investment plus up to 25,000 new staff if it is to increase its share from three per cent of banking assets up to the targeted five per cent.

Ahmad Riawan the chairman of the Indonesia Sharia Bank Association noted in a recent Jakarta seminar on the Shari’ah economy that the Central Bank (Bank Indonesia) was confident the Shari’ah economy could contribute to Indonesian development without leading to inflationary pressures, since it forbade transactions involving derivatives and high leverage, according to the Jakarta Post.

Meanwhile, the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions, or AAOIFI, led by its secretary-general Dr. Mohamed Nedal Alchaar, recently said it will launch a global study to see how Islamic financing markets are adhering to benchmarks, with a view to standardising products, to remove a key barrier to the growth of Islamic finance, according, once again to a report by the Jakarta Globe and Reuters.

AAOIFI sets accounting, auditing and governance standards for the plus $1 trillion Islamic finance sector, but the chairman of its board of scholars shocked markets in 2007 by declaring that 85 per cent of Islamic bonds were not Sharia compliant as they included repurchase undertakings. These remarks reportedly contributed to a big drop in issuance of Islamic bonds in 2008.

The global Sukuk were ordered by investors from Asia (32 per cent) Middle East (30 per cent) US (19 percent) Europe (11 per cent) and Indonesia (eight per cent). Orders were made via fund managers (45 per cent), banks (37 per cent) retail investors (14 per cent) and insurance and pension fund companies (four per cent).

Meanwhile in Jakarta the Finance Ministry has also introduced the Indonesian Haj Funds Sukuk (SDHI), overseen by the central bank and the Supreme Audit Agency (BPS), offering a one year Islamic bond with a fixed coupon of 8.52 percent on maturity, backed by 100 per cent government guarantee and underlying assets.

The current holdings of trust funds by the Religious Affairs Ministry amounted by April 2009 to about $1.6 billion in Haj Trust Funds  and Ummah Trust Funds, mostly held in Indonesian Rupiah, with about  $650 million coming in annually.

The SDHI bonds mean a higher return on funds and lower risk of mismanagement. Public officials and politicians are alleged to have embezzled the interest on Haj and Ummah trust funds, according to a report in the Jakarta Post. 

The Religious Affairs Ministry will buy Rp 9 trillion of sukuk this year (about $830 million). In Indonesia Islamic bonds are also being used by government to clean up public administration as well as to finance the state budget.

Although Sukuk proceeds will be used to help plug a forecast $12.8 billion gap in the 2009 state budget, (to counter the global economic crisis), the success of the dollar-denominated retail issue reflected its good terms, the strength of underlying assets and the outstanding reputation of Indonesia for political and economic stability, relative to most countries in ASEAN and globally.

Terry Lacey is a development economist who writes from Jakarta on modernization in the Muslim world, investment and trade relations with the EU and Islamic banking.