Indonesia’s ranking in Islamic finance jump six spots but major challenges remain

Indonesia’s Islamic finance rank has improved exponentially this year, but challenges remain to further develop the sharia economy.

Based on the 2019 Islamic Finance Development Indicator (IFDI) launched on Tuesday by the Islamic Corporation for the Development of the Private Sector (ICD) and financial market data provider Refinitiv, Indonesia’s ranking jumped six steps to fourth from 10th place in 2018 after Malaysia, Bahrain and the United Arab Emirates.

Refinitiv’s proposition manager, Shaima Hassan, said that the leapfrog in the ranking was caused by the fact that the country’s score improved by 37 percent this year driven by several factors, one of which was the establishment of the 2019-2024 sharia economy master plan.

The master plan, launched in May by President Joko “Jokowi” Widodo, was intended to empower Indonesia’s halal value chain and turn the country into a net producer instead of a market for halal goods and services.

Hassan explained during a media briefing following the launch of the report that several other factors also supported the jump in the country’s ranking, namely “raising awareness on Islamic finance, increased Islamic finance assets that reached US$86 billion in 2018, as well as well-established regulations for Islamic finance that promoted Indonesia as a leader in the industry”.

Despite the achievement, the country still struggles in tackling the challenges to develop sharia finance and the sharia economy. Some of the challenges came from the lack of participation from sharia banks in financing infrastructure projects, low optimization of waqf – a form of endowment specifically intended for charitable causes, usually given in the form of assets such as land or buildings – and zakat (alms) assets for economic development, as well as the higher rate of spending on halal products compared to production.

According to the Financial Services Authority, as of July 2019 Islamic financial assets (not including Islamic shares) amounted to Rp 1,359 trillion (US$97.07 billion), a 5 percent increase from the beginning of this year. Its market share is 8.7 percent of the total national financial assets.

National Committee for Sharia Finance (KNKS) executive director Ventje Rahardjo said the country’s sharia banks had actually been involved in a number of the country’s infrastructure projects, one of which was the Jakarta-Cikampek elevated toll road linking Jakarta with West Java.

“However, sharia banks can only participate in syndicated loans with other sharia and conventional banks as they have limited capital,” he said, referring to the Indonesian banking regulation that only allowed banks to disburse a maximum of 30 percent of its capital for big project loans like infrastructure.

He further explained that currently only state-owned lender Bank Mandiri’s subsidiary, Bank Syariah Mandiri (BSM), fell under the BUKU III category (core capital of Rp 5 trillion (US$357.14 million), while other sharia banks fell under the lower categories of BUKU I and BUKU II.

To tackle this issue, he continued, the committee was working to cooperate with other financial institutions to encourage more sharia banks to disburse larger loans in government-backed infrastructure projects through public-private partnerships.

One of the upcoming projects that will use this scheme will be a hospital construction project in Aceh, which is obliged by the province’s local sharia law to be financed through an Islamic financing scheme. The project is expected to begin in 2020.

At the same time, he said, the KNKS was encouraging sharia banks to increase their capital so they could have a bigger role in infrastructure projects, while also promoting the establishment of Islamic investment banking so that more sharia banks and financial institutions could participate in financing the government’s infrastructure projects.

Another challenge the country faced in developing its sharia economy came from the low usage in the social sector of alms and waqf in supporting development, Bank Indonesia (BI) deputy governor Dody Budi Waluyo said.

He said Indonesia’s large Muslim population meant that the country had huge potential in social finance. “Around 85 percent of our total population of 268 million are Muslims, which means that we have huge potential in social finance that comes from alms and waqf,” he explained.

Ventje, however, said the lack of data collection on the two instruments hindered the country in reaching its full potential as the KNKS recorded national alms collection at only Rp 8 trillion, much lower than the Islamic Development Bank estimate of Rp 200 trillion.

Lastly, one of the biggest challenges the country faced in developing the sharia economy was the lack of halal goods and services production, Dody said.

Despite the large Muslim population, Indonesia was more of a consumer of halal goods and services instead of a producer, he said, creating a problem not only for the sharia economy but also for the current account deficit, which worsened every time consumers imported their needs.

“If we can boost our production in halal goods and services, we can fulfill our household spending needs, as well as stabilize our inflation, prices, and currency and reduce our deficit,” he said.

Copyright reserved – The Jakarta Post – 2019

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