With abundant natural resources, increasing foreign investment opportunities and huge market potential, SCOTT WEBER discovers that Indonesia has significantly more to offer the Islamic financial industry than the sheer size of its Muslim population. FULL STORY HERE and visit the brand new look of http://www.islamicfinanceasia.com
Nothing moves quickly in Jakarta, especially the traffic. Similar comparisons can also be drawn to its Islamic finance industry which, while offering great potential to the country, still remains stuck in a bottleneck. Initiatives to raise the profile of the country’s Islamic banking sector by both the government and Bank Indonesia, the country’s central bank, have proven successful yet underwhelming in their execution. Indonesia’s economy still remains fragile and in need of significant reform and direction. As a primary commodity exporter, its rebound will be heavily dependent on future commodity prices and how other economies recover from the latest financial downturn.
Overall, Indonesia remains a resilient market that has demonstrated tremendous resolve in tackling its many issues. Last year Indonesia was the only country in the G20 leading economies to lower its public debt to GDP ratio, a reflection of improved economic management over recent years, as well as appropriate policy responses during the crisis. However, this continued economic recovery has put upward pressure on prices across the board. Predicted cuts in fuel subsidies and higher food prices are threatening to further accelerate inflation, currently standing at 7% double that of 2009, and a situation that will hinder Indonesia’s recovery and undermine strong growth figures in 2010. As such Indonesia remains vulnerable to swings in investor sentiment, and is susceptible to capital flight.
Market overview
Indonesia was an early adopter of Islamic banking, with the formation of the country’s first Shariah complaint bank, Bank Muamalat Indonesia, in 1991. The Islamic banking industry in Indonesia continued to support the industry with the introduction of banking act No.7 in 1992 which implicitly recognized Shariah based financial operations in the country.In 1998, the Indonesian parliament ratified the Islamic banking and Syariah government bonds act, providing a stronger legal framework and operating environment.
Since then, Islamic banking in Indonesia has grown rapidly. A blueprint, introduced in 2002, outlined the proposed strategy and development of an Indonesian. Shariah banking system that would comply with international standards in terms of products and services. The blue print seeks to promote greater supply and demand within the sector whilst strengthening the Shariah banking system in terms of capitalization and management. In 2007, Indonesia only had three fully fledged Islamic banks with total assets of IDR36.5 trillion (US$4 billion) or 1.84%market share. Currently Indonesia has 11 Islamic banks with total assets reaching IDR90 trillion (US$9.94Billion) or 3.1% market share.
The market has been further enriched through money market instruments that allow the banks to manage their liquidity more efficiently. As has been declared, Bank Indonesia and the government remain strongly committed to developing Islamic banking in Indonesia. By promoting a market-based system, prudent banking practices and product innovation, it is hoped that Islamic banking can support sustainable economic development and prosperity.In the past five years, Islamic assets in Indonesia have grown annually at around 35%, according to Dr. Mulya Siregar, Deputy Director, Directorate of Islamic banking, Bank Indonesia. The Indonesian Islamic capital market has also flourished with an increasing number of regular Sukuk issuances including those from the overnment. On the capital market front, the first corporate Sukuk was issued in early 2002 and has been followed by a further 10 corporate Sukuk issuances in subsequent years.
The prominence of Islamic finance in Indonesia has been further boosted by the inclusion of the Islamic capital market into the 2005 Indonesian capital market master plan. New amendments to the Tax laws provide tax neutrality and the removal of double taxation on Islamic financial transactions, considerably improving their competitiveness.
Dr Mulya goes on to add that in 2011, Bank Indonesia expects the same robust growth of the Indonesian Islamic financial industry to continue, fueled by a better prospective economic outlook aided by a growth in private consumption, exports and existing fiscal stimulus measures not to mention the recent upgrade in the Indonesia sovereign credit rating to Ba2, attributed to an appropriately managed and gradually strengthening domestic market in accordance with a well-tested economic framework.
Market offerings
The country is due to offer its third retail Sukuk issuance in the second half of 2011. The move is one of a range of financing solutions that the government is implementing in order to plug the 2011 state budget deficit of IDR124.7 trillion (US$13.7 billion).
The issuance originally planned for February has been delayed, as the parliament is yet to approve the IDR30 trillion (US$3.31 billion) of underlying assets. The government is seeking approval from the country’s national Shariah board to use future fees from transport facilities, as the underlying asset for Sukuk differs from the current state-owned property and land assets.
Although only 3.1% of Indonesia’s total banking assets are Shariah compliant, as opposed to almost 20% in Malaysia, the former is taking steps to rival the latter as a desired location for Islamic investment. In order to bolster the country’s Shariah compliant bond issuances, the government is planning to introduce further tax incentives for Islamic finance which are expected to spur growth in new Sukuk issuances.
The Indonesian market is expected to take the tax incentives as a positive sign and the prospects are positive for future sales of Shariah compliant debt, which have increased by56% to IDR26.2 trillion (US$2.9 billion) in 2010 from 2009.
Currently the yields on Islamic bonds are relatively high due to lack of a secondary market and a dearth of quality issuances hampering overall market liquidity. Local industry players are being cautious on the recent incentives, especially regarding the secondary market for Islamic bonds, where they believe much activity would not take place until the liquidity problem is solved.
Farouk Abdullah Alwayni, the director of treasury and international banking at Bank Muamalat Indonesia, states that there is an extraordinary amount of potential for Islamic Banking in Indonesia and that this potential is on a scale comparable with its population. Given the Indonesian banking industry’s current low penetration rate and the Islamic banking capabilities to attract new business, success shouldn’t be difficult to attain.
Islamic banks in Indonesia are currently retrenching, taking the fight to the conventional banks by improving their infrastructure to fully maximize their potential and allow them to compete on par with conventional banks. Great emphasis is currently being shown to the retail banking sector within Indonesia, with its robust consumer market, rising income and increasing middle class providing much of the growth.
Problems still exist for corporate issuances, especially with regards to taxation and transfer of ownership, even with common Islamic structures such as Ijarah Sukuk. The issues have been raised to the tax directorate and change is expected. Should these issues be ironed out, interest is already there from foreign investors, particularly from the Middle East and Malaysia. It is these markets that see the potential in Indonesia: it’s just a matter of securitizing the interest, putting it to paper and then we have Sukuk, according to Farouk. He goes on to add that the market is there, the buying power is there, therefore there is no reason why we cannot rely on governments’ encouragement and support in pushing forward corporate Sukuk issuance.
Ultimately, the success of Islamic finance will depend on its ability to capitalize on the forecasted growth of the Indonesian economy. Simply having the largest Muslim population will not be enough to attract investors who prioritize good products and sound regulations over market potential.
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