Asia’s Isolated Islamic Finance Flashes

Indonesia and Malaysia stock markets lagged on the Morgan Stanley Capital International index through July, with the former up 7%, just behind behind the overall gauge increase, while the latter fell 2.5% despite strong Islamic finance indicators. In the first half sukuk issuance rose almost 55% to near $90 billion, with Malaysia accounting for half and Indonesia one-tenth the global sum. The total outstanding is now over half a trillion dollars, but only half a percent of world fixed-income activity, according to a recent report by the London-based Official Monetary Institutions Forum (OMFIF). Saudi Arabia is the other main market with a 15% share, followed in the Gulf with Qatar’s 3%. Sovereign is catching up with dominant corporate placement, as governments and central banks establish yield curves and liquidity facilities. Indonesia floated the first “green” $1 billion sukuk last year to promote clean energy transition, and Malaysia engineered several murahaba commodity buybacks beyond traditional techniques.

Sharia-compliant assets are 30% of Malaysia’s banking and 10% of its insurance industries, with longstanding official support of commercial and regulatory development. Tax benefits and professional fee discounts are available for Islamic funding, with small and midsize company borrowing rates lowered an average 2% compared with conventional sources. In the Gulf ratings agency Standard & Poor’s predicts 25% sukuk growth this year for debt refinancing and budget deficit coverage. Asia and the Gulf Cooperation Council cooperate to harmonize rules, and in 2018 Malaysia’s Islamic financial services and Bahrain’s accounting and auditing bodies agreed to devise common prudential and governance norms. However “regulatory dissonance” prevails in the OMFIF’s view as thousands of scholars in dozens of countries differ over interpretations and standards following the Koran’s text. Despite a global market estimate of trillions of dollars in the medium term across the complex, multilateral convergence is lacking and may be further delayed as new administrations in Indonesia and Malaysia confront messy domestic policy agendas.

 An Indonesian court confirmed President Joko Widodo’s re-election by a 10% margin, with his coalition also winning over half of parliamentary seats, despite continued Jakarta street clashes in part over the durability of 5% gross domestic product growth. Consumption dependence in the world’s fourth most populous nation is a buffer against external shocks, but heightened by manufacturing and foreign direct investment weakness, after the latter dropped 9% last year. The government unveiled consecutive infrastructure packages to close the gap with neighbors, but spending eroded budget balance and fueled the 2% of GDP current account deficit with equipment imports. Instead of direct control, Finance Minister Sri Mulyani Indrawati, expected to stay in her post in the second term, proposed tax breaks for land acquisition and feasibility studies that will also apply to securities buyers. Likely looser fiscal policy will be matched on the monetary front, as bank reserve requirements were already eased in June, and the 6% benchmark rate  is due to normalize after emergency hikes nine months ago.

Rate cuts must be weighed against the need to preserve foreign portfolio inflows, particularly in local government bonds where international ownership is 30%. They may help stimulate bank credit, which jumped 12% in the first quarter, but the financial system remains “shallow” at 75% of GDP in the words of the latest International Monetary Fund Article IV review. Bank corporate lending has pulled back amid new rules limiting foreign exchange exposure after offshore bond defaults, and fintech competition is a priority in Jokowi’s second turn to improve access and lower costs. Stock market heavyweight state-run Bank of Central Asia will invest heavily in technology and small business outreach, and rating agencies identified potential financial sector takeoff to mirror regional peers as a factor in a recent one-notch upgrade.

Malaysia’s central bank was the first in ASEAN to ease, but it has not boosted the popularity of Prime Minister Mahathir Mohamed’s Pakatan coalition one year after taking office. Public opinion approval is around 35%, as the economy feels the fallout of Asian semiconductor supply chain disruption and public investment retrenchment after a workout of China Belt and Road projects. The government avoided a $5 billion penalty with renegotiation of the East Coast rail link, as growth was pared to the 4% range with goods and services tax rebates saved for other mounting contingencies.

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