The Depth Charge

Keen to become a sharia banking hub, Indonesia is fine tuning its financial universe for greater depth and participation.

Indonesia’s December 2016 earthquake undoubtedly flashed an insurance-related question mark. Yet the archipelago nation is undergoing other seismic changes to reshape the entire economic and financial landscape. The central bank, Bank Indonesia (BI), is confident that a more vibrant financial intermediation is around the corner, reflecting not just macro-prudential policy easing, but also prospective banking and corporate sector consolidation.

2018 sees an end to state funding of the economically dominant public sector enterprises—118 firms with combined sales of USD133 billion must pay their own way. Toll-road operator PT Jasa Marga has pioneered Indonesia’s first rupiah-denominated global notes, known colloquially as Komodo bonds. And with housing development added to state-owned enterprises, scheduled 2018 capital spend of USD46 billion, mortgage-backed securities, additional Komodo bonds, and strategic healthcare sales will diversify the capital market, wooing retail and institutional investors. This is promising given the disparity between Indonesia’s local-currency bond market, in September 2017 worth USD180 billion, versus Malaysia’s USD299 billion bond market. Tellingly, stock market capitalization of around USD482 billion remains short of the USD507 billion of Thailand, which has half of its economy.
Pursuing Depth
Today, the total transaction value at Indonesia’s bourse is just 45.2% of GDP, problematically low when compared with the 104% and 156% of Thailand and Malaysia, respectively. Targeting SMEs, the Financial Services Authority (OJK) has eased listing requirements to spur liquidity and economic activity. SMEs now require minimum assets of IDR50 billion, halved from previous level, to enter the game, and may raise maximum funds of IDR40 billion.
The Indonesia Stock Exchange is working to facilitate wider investment options that include the sharia route, and May 2011 saw the launch of the Indonesia Sharia Stock Index (ISSI).
YtD as of June 2, 2017 the investible stable of 544 Indonesian stocks had gained 2.5%, with the Jakarta Composite Index (JCI) up 8.2%. This was south of ASEAN markets Singapore, up 15.7%, and the Philippines, up 15.1%. The bourse plans to narrow this gap by deepening its local retail investor base among savings-oriented millennials to compensate for fluctuations in the institution-heavy investor pool of pension funds and the like. Foreign investors YtD as of September had been record net sellers. Domestic equities held by local retail investors reached 8.2% as of September 2017, from 5.9% at end-2014, while foreign ownership slipped to 52.2% from 64.3%.
Obstacles to growth of the banking sector, which dominates the financial market, are low financial literacy and curbed penetration; the World Bank indicates that 36.1% of Indonesia’s adult population owned a bank account in 2014. As at 2016 the sector housed 120 commercial players; four state or partially state-owned players, 10 foreign players, 16 JVs, 13 Islamic banks, and around 32 Islamic windows. Banking’s contribution to GDP was 2.87% in 2016. Sector stability prevails, and as of August 2017, Indonesia posted a high capital adequacy ratio of 23.1% and liquidity ratio of 23.4%. Non-performing loans were at 3%. Among other recent metrics, credit growth of 8.3% was flat YoY, while deposit growth declined to 9.6% YoY.
The real story of potential growth is sharia finance, which the Organization of Islamic Cooperation (OIC) foresees printing total global assets of USD3.5 trillion by 2018. Yet, despite having the world’s biggest Muslim population, Indonesia is overshadowed by Malaysia and the Middle East’s Islamic financial markets. As of 2015, Islamic finance accounted for just 5% of total banking assets; Malaysia, with 61% of Indonesia’s population, printed at 20%. Government incentives in recent years to transform Indonesia into an Islamic financial hub reflected in an asset climb from USD8 billion in 2010 to USD22 billion in 2014 on a CAGR of 29.2%. In 2015, Indonesia’s National Sharia Board approved sharia-compliant currency hedging tools and a fixed contract template for sharia-compliant repurchase agreements. This ushered in the use of government-issued sukuk as collateral. OJK’s current five-year roadmap aims to triple Islamic banks’ market share to 15% by 2023. Local player Bank Syariah Muamalat was named among best Islamic institutions in the 2017 World Finance Islamic Finance Award.
Insurance—Honing the Rules
Since OJK became the insurance watchdog in 2013, the sector, with national penetration of 1.1% as of 2015, has been subject to the New Insurance Law, effective October 23, 2014. A total of 55 players include local entities and multinationals, some sharia compliant. The latter seems set to experience the fastest growth, at 26% CAGR (2014-2020), reaching penetration of 15% by then. Bancassurance is a major route to market for local insurers, with anticipated CAGR growth to 2020 of 23%.
The stipulated ceding of non-life premiums to domestic reinsurers “as far as possible” in a low-capacity domestic reinsurance market will dent premiums. Meanwhile, offshore reinsurers must purchase a local business to operate. The single presence (business line) policy will precipitate M&A activity across the value chain. Sector research indicates sustained growth to 2020 at a CAGR of 13%, with growth factors including consumption by a middle class rising from 55 million people in 2013 to roughly 86 million by 2020. Indonesia’s working population is projected to reach 200 million by 2035. The January 2014 introduction of mandatory universal healthcare coverage (JKN) aims at full enrollment by 2019. Partially funded by mandatory corporate contributions, private corporate healthcare coverage will be dented. That said, foreign ownership of said firms will be capped at 80% with surplus stakes to be relinquished.
The coordinated landscaping of Indonesia’s financial universe will, then, tap into improving demographics and aid the pursuit for liquidity and depth.

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