Indonesia is the world’s largest Muslim-majority nation, and should be a pioneer and an axis of global Shariah economic development. Yet the reality is far different, as this sector’s growth in Indonesia lags behind other member states of the Organization of Islamic Cooperation (OIC), including Malaysia.
In 2019, Malaysia ranked first in the Global Islamic Economy Indicator with 111 points, while Indonesia was fifth with 49 points. The ranking of 15 countries with Muslim-majority populations was based on indicators of Islamic finance, halal food, Muslim-friendly travel, the modest fashion industry, media and recreation, and pharmaceuticals and cosmetics. This presents a paradox, considering that out of a population of 260 million, 209 million Indonesians are Muslim, while only 61 percent of Malaysia’s 28 million residents are Muslim. Despite the huge gap in terms of Islamic economic development, Indonesia’s large market potential and relatively stable economic growth may allow its Shariah economy to grow considerably in the coming years. However, this will require strategic efforts by the government to boost Islamic economic development.
Shariah economic ambition
The global Shariah economy has grown steadily over the past two decades, not only in countries where Islamic law applies, such as Saudi Arabia and Iran, but also in more secular Muslim nations such as Malaysia, Indonesia, Pakistan and other OIC members.
A key factor in this growth was the establishment of the Islamic Development Bank by OIC finance ministers in 1975 to support long-term sustainable and ethical financing structures among its 57 members. A growing Muslim population, which will make up 27.5 percent of the world’s total population by 2030, will increase demand for halal products and services. Rapid development of the Shariah economy will inevitably challenge conventional systems that are based on principles such as capital accumulation and the invisible hand of self-interest.
The global Islamic finance market is growing at a moderate pace due to significant investment in the halal sector, infrastructure and sukuk, or Shariah-compliant bonds. According to key stakeholders, the total value of the Shariah financial industry across its three main sectors – banking, capital markets and takaful (or Shariah insurance) – amounted to about $2 trillion in 2017, having increased by 8.3 percent and reversing two preceding years of stagnation, according to the Global Islamic Economy Report.
More people are moving to the Shariah economy, in particular the finance sector, as it offers alternatives to the often burdensome terms of conventional banking, such as high interest rates, administrative fees and considerable risk or uncertainty. Shariah banking, on the other hand, strictly adheres to Islamic principles based on the Koran and the teachings of the Prophet Muhammad, which prohibit riba, or usury, gharar (excessive risk) and maysir (gambling). In 2016, the global Islamic finance sector was worth an estimated $2.2 trillion, and it is projected to expand by about 72 percent to $3.78 trillion by 2022. Assets managed by Islamic banks grew at around 1.5 percent globally between 2018 and 2019, while those managed by conventional banks increased by only 1 percent.
Compared to Malaysia, which constitutionally adheres to Islamic law and has been developing its Shariah economy and financial sector for more than three decades, marked by the establishment of the country's first Islamic bank, Bank Islam Malaysia Berhad in 1983, Indonesia's Shariah economy lags behind.
Indonesia’s first national Shariah bank, Bank Syariah Muamalat, opened in 1991 and no other Islamic banks were established until after the end of the Soeharto era in 1998. This saw the establishment of Islamic rural banks under Bank Syariah Muamalah across the country, mainly under the auspices of Islamic organizations such as Nahdlatul Ulama and Muhammadiyah, Indonesia’s largest and second-largest Islamic organizations, respectively. The Indonesian government became more serious about developing its Shariah economic sector with the establishment of the National Shariah Financial Committee (KNKS) in 2016.
It is apparent that Indonesia's Shariah economy is still lagging behind those of other OIC countries in terms of sukuk and Islamic funds under management, despite its large potential market. However, KNKS executive director Ventje Rahardjo Soedigno expressed optimism that there is room for the Shariah economy and Shariah finance to grow. “We are not too late, and more importantly, we are fully committed to developing this sector, so I believe we can adjust our pace and grab the global halal economic potential by 2022,” he said.
Ventje’s optimism is not unfounded. According to Indonesia's Financial Services Authority (OJK), the country’s Islamic financial market has shown continuous growth in recent years, to a value of Rp 1.34 trillion ($97 million) by mid-2019. This includes Islamic capital markets, Islamic non-banking financial institutions and Islamic banking. Indonesia had 199 Shariah-compliant banks as of September 2019, comprised of 14 commercial banks, 20 banking units and 165 Islamic rural banks with $36.7 billion in total assets. The OJK did not provide data on the number of Islamic banks that Indonesia had five years ago, only saying the number had increased by nearly 6 percent. The government will soon rename the KNKS as the National Shariah Economy Committee (KNES), which will widen its coverage of Islamic finance in general and give it greater authority. This move was initiated by Indonesian Vice President Ma’ruf Amin, who oversees development of the Shariah economy during President Joko Widodo’s second term.
Ventje said the KNES would soon submit a law on the Shariah economy to the House of Representatives, targeted for ratification before 2024. Without giving details of the proposed law, he said it would serve as an umbrella for all Shariah-compliant economic activities in Indonesia, from finance to the halal industry, in recognition of the fact that the Shariah economy is part of the government's efforts to develop the national economy. “The most important part of this bill is that we want to educate people to understand that when we develop the Shariah economy, we don't want to destabilize the conventional economy,” Ventje. “It is not that we are taking market share from conventional financial institutions – it will happen by itself eventually – but it will also increase the size of the pie for both the conventional and Shariah economy.”
Although it looks promising, businesspeople might want to keep their expectations for more regulatory certainty in the Shariah economy in check for now, as it is not yet clear what the functions of the KNES will be and how long it will take for the proposed Shariah economy draft bill to become law. Aside from the policy infrastructure, the limited number and uneven distribution of players in the Shariah sector, variety of products and human capital capacity should be thoroughly addressed. Increasing human capital capacity, for example, might require greater effort, such as adding Shariah economic faculties at institutions of higher learning, as the existing number has yet to meet growing demand.
It is only natural for people to want to see real benefits before embracing any product or service. This tendency also applies to the Shariah economy, which is still considered somewhat novel due to a lack of public knowledge about the sector.
Many Muslims are also reluctant to make the change from conventional finance to the Shariah-compliant alternative because they do not understand the system. The convenience of conventional banking has been developed over decades to meet customer demand through a wide range of products and services, such as credit cards, investments, bond insurance and internet and mobile banking.
Despite the requirement to strictly adhere to Islamic law, the Shariah economy is flexible in that it can support real sectors of the halal industry. “As long as it is halal, does not involve fraud or any other crimes, and does not violate Shariah principles, we are allowed to do it. Unfortunately, many people have yet to realize this potential,” said Abdullah Firman Wibowo, president director of state-owned Bank Negara Indonesia (BNI) Syariah. Abdullah said Islamic financing has a rich array of financial instruments and services that have been developed to meet the challenges of a changing world, including digital transformation. He said BNI Syariah was one of the pioneers in developing a Shariah internet and mobile banking system and a travel card for halal destinations.
The travel card works exactly like a credit card, but it is based on terms and conditions that comply with Islamic law, such as that both parties – borrower and lender – acknowledge where the card will be used and how much will be spent, to eliminate the principle of excessive risk or uncertainty. “Innovation is allowed in Islamic banking, as long as it doesn't violate any Shariah principles,” Abdullah said. BNI Syariah had, as of August 2019, provided $193 million in Islamic financing in Indonesia, which is relatively small compared with the potential. “I will say we still have huge room for improvement, but we cannot do it alone,” he said, adding that Shariah finance needs more support to grow.
According to reports, the number of financial institutions in Indonesia committed to allocating a minimum of 20 percent of their total assets to the development of Shariah-compliant subsidiaries remains small, with most of the capital still going toward their conventional banking operations. There are also no signs that the government plans to establish more state-owned Islamic banks anytime soon.
Room for growth
With its large population, Indonesia indeed has massive potential in its Shariah economy, and strategic action will ensure that it becomes part of the country’s economic development. In a bid to encourage growth, the Shariah economy must have a firm but flexible structure that will give it enough room to expand to its full potential.
Mohamed Eskandar Shah Rasid, a World Bank consultant on Islamic finance, told Concord Strategic in December that the main reason for Malaysia's superiority in the Shariah economy was simply that it had started much earlier than Indonesia. Malaysia is not only an Islamic finance pioneer in the region, but it has also managed to sustain its growth. “We started many, many years ago, and you have to understand that in Malaysia, the market is small,” he said. “We only have about 30 million people. Even if we want to double the halal sector, for example, it will still be smaller than in Indonesia, but we don’t only serve Malaysia, but also abroad.” Rasid also said that Malaysia regulates both the Shariah and conventional economies together, side by side, with all Islamic practices integrated under the Shariah financial umbrella.
This integrated structure is seen to be more effective for the banking and halal industries to expand their branding and marketing overseas. Meanwhile in Indonesia, the Shariah economy and Shariah finance have been developed separately, including halal certification, which is currently under the authority of the Ministry of Religious Affairs. “But that's OK, because unlike us, you have a bigger population, which means a bigger market share for each special (Shariah) component,” Rasid said on the sidelines of the 2019 Meeting of Minds Forum on Islamic Finance in Banking in Jakarta.
Malaysia’s advantage in the Islamic economy was not built overnight. Its Shariah finance sector was formed by centralizing halal certification, halal economic partnerships, Islamic economic regulations and its halal industry under a single regulator, the Malaysia International Islamic Financial Centre.
The MIFC has maintained nearly 48 percent of global outstanding sukuk by domicile, while Indonesia’s share was only 7.2 percent of the $141 billion total global sukuk issuances as of the end of October 2019. Despite the huge gap between the two countries in terms of Islamic economic development, Indonesia’s large market potential and relatively stable economic growth may allow its Shariah economy to grow by up to 9 percent annually, Rasid predicted. This outlook could be achieved if the government makes strategic efforts to boost Islamic economic development by providing fiscal and non-fiscal stimuli, improves the country’s human capital, promotes financial literacy and inclusion, and ensures greater coordination among its state financial institutions.