(Adds lower yields, analysis)
By Celine Aswad
DUBAI, Aug 22 (Reuters) - Saudi Arabia’s finance ministry pushed yields down slightly in its second monthly sale of domestic Islamic bonds on Tuesday, a sign of healthy appetite for the debt as Riyadh covers a budget deficit caused by low oil prices.
Riyadh auctioned 13 billion riyals ($3.5 billion) of local currency sukuk, with the offer 295 percent subscribed. It sold 2.1 billion riyals of five-year, 7.7 billion riyals of seven-year and 3.2 billion riyals of 10-year sukuk, the ministry said.
The size of the issue was down slightly from the government’s first monthly offer in July, when it sold 17 billion riyals and attracted 51 billion of bids.
However, while the ministry did not disclose the pricing of its sales, bankers said the latest auction saw the five-year sukuk priced at a profit rate of 2.7 percent, the seven-year at 3.2 percent and the 10-year at 3.5 percent.
That was down from rates of 2.95 percent, 3.25 percent and 3.55 percent in July’s sale.
“Good demand pushed down the yields a bit,” one Saudi banker said.
Tight banking system liquidity forced Riyadh to suspend domestic sales of conventional bonds in late 2016, but a modest rebound in oil prices has now strengthened state finances, allowing the government to pay more of its bills to the private sector and leaving banks with more money to buy sukuk.
Increasing familiarity with the sukuk may have contributed to the drop in yields.
The ministry qualified 13 Saudi banks to buy its sukuk issues in the primary market but hopes other institutional and professional investors will eventually buy in the secondary market.
Also, yields on Riyadh’s internationally issued U.S. dollar sukuk have come down by about 12 to 15 basis points since the last domestic sale, partly because of fading expectations of more U.S. interest rate hikes this year.
Mohieddine Kronfol, chief investment officer for global sukuk and Middle East fixed income at Franklin Templeton Investments, said the way in which domestic and international Saudi yields were linked was a positive sign for Riyadh’s effort to develop a healthy debt market.
“Similar to the sukuk issued in July, we can continue to see consistency between Saudi riyal and U.S. dollar-denominated issues, which is a giant leap forward for the country’s domestic capital markets,” he said. (Additional reporting by Tom Arnold; Writing by Andrew Torchia; editing by John Stonestreet)