Indonesia looks to Islamic finance for infrastructure needs

Indonesia looks to Islamic finance for infrastructure needs.

JAKARTA -- Measures to boost Indonesia's relatively small Islamic finance sector could help the government implement an ambitious infrastructure modernization program across the 13,000-island archipelago, according to the country's recently appointed finance minister.

A week after she was appointed finance minister by President Joko Widodo in a cabinet shake-up, Sri Mulyani Indrawati described Indonesia's infrastructure development needs as "huge." Indrawati was speaking at the World Islamic Economic Forum in Jakarta.

After taking office in late 2014, Widodo pledged to improve Indonesia's notoriously rickety infrastructure by building or improving dozens of ports, airports, power plants and roads. Total spending could reach around $500 billion -- equivalent to more than half the country's gross domestic product -- an outlay that the government says it cannot fund alone.

Malaysian Prime Minister Najib Razak, left, and Indonesian Finance Minister Sri Mulyani Indrawati at the World Islamic Economic Forum in Jakarta on Aug. 2. (Photo by Simon Roughneen)

"I am sure there is the potential to develop instruments for financing based on Shariah (Islamic law), we will look at this, the need is there," said Indrawati, who resigned from a senior World Bank role to rejoin the Indonesian government.

A key difference between Islamic banking and conventional models is the prohibition on usury, a ban derived from passages in the Koran and which includes charging interest, according to Islamic scholars.

Islamic finance also bans speculation and gambling -- prohibitions that lessened the sector's exposure to the derivatives meltdown and similar problems that lay at the heart of the 2008 global financial crisis. Instead, Islamic bond issuances must be based on tangible or physical assets. To some, including the finance minister, this increases its viability as a source of infrastructure financing, given that it is directly linked to the objects to be built.

Dwarfed by neighbor

"Asset-backed securities is popular in Islamic financing, so we can see that this has huge potential that can be linked successfully, from the source of financing to the project itself," Indrawati said. Already Indonesia has moved to sell its first Islamic savings bonds, which will be issued on Aug. 22 and which could be worth 3.9 trillion rupiah ($297 million) to the country's coffers.

Despite being home to the world's biggest Muslim population -- accounting for around 210 million of the country's 250 million people -- Indonesia is a relatively small player in the global Islamic finance economy, a growing sector that is dominated by Iran, Saudi Arabia and Malaysia.

Between them the three countries hold 65% of Islamic finance assets, mostly in the form of banks that are run according to Islamic law. Indonesia is a distant ninth, with less than an eighth of the total Islamic finance assets held by neighbor Malaysia, a much smaller country with a population of 30 million, 60% of which is Muslim.

While banking makes up over 70% of the world's Islamic finance sector, Malaysia dominates the sukuk, or Islamic bond market sector, which accounts for 17% of the global total, according to research by Thomson Reuters. The sector has seen increasing interest from Western countries in recent years, with the U.K. in 2014 becoming the first non-Muslim country to issue sukuk.

A weekend afternoon at the Baiturrahman Grand Mosque in Banda Aceh. Indonesia's westernmost province, Aceh has implemented a stricter form of Islamic law than elsewhere in the vast country. (Photo by Simon Roughneen)

Indonesia's $900 billion economy, though only roughly the same size by some measurements as that of Tokyo, is nonetheless by far the biggest in Southeast Asia. Not only is Indonesia the world's biggest Muslim majority country in terms of population, its economy, which is slightly bigger than Turkey's, is the biggest of any country with a Muslim-majority population.

Speaking at the same forum as Finance Minister Indrawati, Indonesia's Planning Minister Bambang Brodjonegoro said that the government was serious about boosting the country's Islamic finance sector.

"It is time the government of Indonesia together with the financial regulators embark on expanding our Sharia financial system into a broader dimension, market and playing field," he said, announcing a new action plan aimed at pulling together a range of previously announced ideas. One of these, announced in mid-2015, included a committee on Islamic finance led by the president, five-year "roadmap" that aims to triple the market share of Islamic banks to 15% by 2023.

Other aspects of the Islamic economy are growing in popularity in Indonesia -- sectors such as halal fashion -- which may in turn help raise awareness of Islamic banks.

Also in 2015 Indonesia and Turkey jointly proposed setting up a World Islamic Infrastructure Bank, which would fund infrastructure development in Muslim countries. But plans to set up the bank have stalled, due partly to political turmoil in Turkey. Turkey recently tried to pressure Indonesia into closing nine schools linked to Fethullah Gulen, a U.S.-based cleric accused by the Turkish government of instigating an attempted coup in July -- pressure that Jakarta rebuffed.

Plans and reality

Just as the international effort has stalled, it is unclear how quickly the government can implement its domestic Islamic finance plans.

"There is a huge gap between potential and reality," said Irfan Syauqi Belik, director of the Center for Islamic Business and Economic Studies at Bogor Agricultural University. "Often in Indonesia one government regulation conflicts with another, so this harmonization is needed if Indonesia is to develop its Sharia finance."

Playing catch-up with the neighbors will not be easy. During three decades of autocratic rule under the late President Suharto, Indonesia mostly ignored religious norms as a basis for policy-making. The tenor of Indonesian Islam, usually described as "moderate," means that Indonesia is culturally very different from societies across the Middle East and North Africa.

Azyumardi Azra speaks at an Organization of Islamic Cooperation conference in Jakarta in December. (Photo by Simon Roughneen)

Although the cultural differences between Indonesia and Malaysia are less overt than those between Indonesia and Arab nations, there are divergences that help explain why Islamic finance has boomed in Malaysia but not in Indonesia.

"Islam is not central to identity politics in Indonesia as it is in Malaysia. Here 90% of the population is Muslim, there is no other major demographic group," said Azyumardi Azra, a leading Indonesian scholar of Islam.

Unlike in Malaysia, where Malay Muslims and non-Muslim Chinese Malaysians have had a fraught relationship over many decades, "in Indonesia there is less of an obligation among Muslims to go to an Islamic bank," Azra said, explaining that many Indonesian clerics differentiate between usury and interest, regarding the latter as permitted by the Koran.

Malaysia became a global leader in Islamic finance after nurturing the sector for decades. "Malaysia passed its Islamic banking act in 1980. We did not get our first Islamic bank until 1992 and the Islamic banking act here was not passed until 16 years later," said Irfan.

According to the World Bank, less than 40% of Indonesia's adult population had a bank account as of 2014, another limit on the potential spread of Islamic finance, given that the sector is dominated by banking.

"We need more state intervention," said Irfan. "Our financial literacy, even in the conventional banking sector, is still low."