Not long prior to his widely mourned passed away in 2019, Indonesian third President Bacharuddin Jusuf Habibie presented an intellectual legacy not many of his people aware of. The renowned technocrat introduced Pancasila Market Economy (PME), a concept that, as he saw, was urgently needed by the country to make it through the current and future multidimensional challenges.
Socioeconomic model based on Pancasila values is virtually not a new thing in Indonesia. Many scholars and economists have formulated their own interpretations of the republic’s five ideological tenets like those of Emil Salim, Mubyarto, and Arif Budimanta more recently. However, looking at Habibie’s point of view on the subject as historical actor who laid the foundation of Indonesia’s reform era, offers a special angle.
During his presidency, Habibie led the agenda of democratization, cemented freedom of the press, brought independency to central bank from executive influence and many more. Thanks to the successful inter-sectoral reform, he has been dubbed as Indonesia’s father of democracy. But two decades later, he himself proposed the PME instead. Did he feel that the reform had not worked as expected?
At his first public introduction of PME in Bogor Palace, December 2017, Habibie indicated that Pancasila is not yet ideally implemented, if not abandoned by the people. It was even sometime used as an instrument by interest groups to legitimize their cause. The diminishing understanding of Pancasila is a real internal problem for Indonesia to carry out the vision of the founding fathers.
Externally, global economic landscape has been changing over time. As a reputable technologist, Habibie was fully aware that technology has been and keeps reshaping every aspect of human way of life. Just as described by Solow equation in which A (knowledge) is a constant to the production function, technology allows capital, population, consumption, and output to grow at a constant rate. As such, public policies either legislations, executive orders or other forms of regulation and directive must be constantly reviewed and revised in line with technological development.
In a delicate manner, technology has triggered the trend of socioeconomic polarization around the world. In some industries, for example, there has been a war between Big Tech multinational corporations aiming for centralization of everything and tech-savvy communities promoting decentralization powered by blockchain technology. Stiglitz (2012) suggested that technology has made middle-skill job to disappear, causing polarization in labor market. This could lead to widening economic inequality that could further result in divided social cohesion and political polarization.
Regarding this polarization trend, PME comes to remind Indonesia to remain in the middle as a third way or mixed economy as mandated by the constitution.
Indonesia must avoid any temptation to lean into one extreme; neither planned socialist nor laissez-faire liberal economy. PME emphasizes that market as the most effective allocation mechanism should be the epicenter of the economy guided by sound Pancasila-oriented macroeconomic management.
Evaluating dual banking system
One of main sectors having greatest exposure from technological development is the services particularly finance and banking industry. Financial market disruption has recently become top issues among authorities and business executives. On this issue, PME views the need of harmony and synthesis between Islamic or sharia economy and conventional one as Habibie said that conventional and sharia banking must benefit and complement each other.
Habibie’s explication might remind us back to his presidential tenure when he led Indonesia monetary reform. Through Bank Indonesia Act 23/1999, he founded the dual banking system in which central bank may conduct monetary management through sharia principle as mandated in Article 10 paragraph (2). The paragraph (3) later states that the implementation of aforementioned monetary management to be formulated by Bank Indonesia Regulation, meaning that the central bank would play the key role in interpreting the system establishment.
Dual banking system was designed, as per the act considerations, to support sustainable economic growth through financial stability. Sharia banks that operate with profit sharing principle were expected to counterbalance the more vulnerable interest-based conventional banks. The coexistence of sharia and conventional banks would presumably better guarantee the stability of financial system.
Nevertheless, after more than two decades of the system implementation, almost all the assumptions have not been met yet. Ichsan (2012) tried to examine dual banking system stability in Indonesia. Using data from 2005-2011, he found that sharia banks were not more stable than conventional ones where sharia banks stability were more prone to inflation (18,56%) than conventional (8,56%). Zahra, Ascarya, & Huda (2018) outlined that the average Banking Stability Index of conventional banks (0,299) were greater than sharia ones (0,278).
In term of economic impact, dual banking system has so far failed to optimally stimulate economic growth. Both conventional and sharia banks have failed to support monetary expansion through credit and financing. This can be seen by broad money (M2) to GDP ratio that tends to shrink from 58,4% in 1999 to 38,7% in 2019, positioning Indonesia among the bottom of the list globally. This has caused some problematic phenomenon such as premature deindustrialization and the lack of financial depth.
Best possible answer to explain the problem is the generalization of fractional reserve banking system. Khan (1986) stated that the principal difference between conventional and sharia banking is not that the former allows interest and the latter does not. Many Islamic scholars view that the underlying principle
of sharia banking is full reserve system, therefore it does not fit with fractional one. Under fractional regime, sharia banks would simply lose its competitive advantages against conventional counterparts either in stability or profitability standpoints.
Imposing fractional regime for both sharia and conventional banks has also been a contributing factor to the ineffectiveness of monetary policy transmission. Bank Indonesia often loses its grip to money supply management since private banks become the main source of money creation. When banks hold credit and financing, Bank Indonesia does not have effective instruments to money expansion. Adjusting discount policy often does not help banks’ credit interest rate to change since government’s treasury bonds as risk-free assets offer significant higher returns.
Potential future model
Central bank digital currency (CBDC) is among the latest technological development that could become a game changer in financial sector. CBDC would enable central banks to facilitate retail transaction where citizen would have their personal account in its system. This could boost financial inclusion and allow an unprecedented transparency in financial practices. The side effect, in one extreme, CBDC could eliminate the need for financial intermediaries or banking services.
Some central banks like those of Sweden and Euro Area are reportedly considering the use of CBDC to adopt full reserve system. This would grant them full control over money supply by limiting private banks the access to credit money creation. This is also known as nationalization of money (not banks)
where central banks and governments take a more active role in real sector financing in combating credit crunch. Otherwise, at boom period, central banks can better manage money expansion to avoid bubbles in the economy.
Retaining fractional or shifting to full reserve system would have significant economic impact in the CBDC era. Which one should Indonesia choose? Here is the beauty of PME. Instead of choosing one, PME allows the synthesis or coexistence of both using dual banking system. Central bank could separate the system for one whom best fit into, fractional for conventional and full reserve system for sharia banking. Thus, conventional and sharia banking could better counterbalance and complement each other.
Central bank and government could then compensate sharia banking’s limited leverage and lack of money creation capacity with a new kind of monetary expansion mechanism. This could be in the form of founding the national halal fund using non interest-bearing CBDC issuance. Sharia banks may access the fund to leverage its financing portfolio and take only fees for revenue while
central bank takes the seigniorage. This mechanism could significantly lower the financing cost to support Indonesia’s vision to become the center of global Islamic finance and economy.
To mitigate risk, sharia banks must equip themselves with reliable and unbiased creditworthiness assessments using latest big data and artificial intelligence technology. In the other hand, thanks to CBDC high-level transparency, central bank and government can trace, oversee and even block the unscheduled spending of the fund by borrowers to prevent moral hazard. This advanced risk management should provide a greater financing access for unbanked small and medium enterprises or big corporations in prioritized and export-oriented sectors.
More interestingly, central bank could utilize full reserve regime to promote social lending practices. Many financial platforms such as Kiva have successfully done this type of zero interest loans in a multibillion dollars ecosystem. With some modifications and coordination with central bank and government, full reserve sharia banks could create similar ecosystem while making revenues and delivering substantial socioeconomic benefits in the process.
In a nutshell, adopting full reserve as part of dual banking system will provide central banks additional tools to manage stability and stimulate economic growth. This corresponds with Habibie statement in many post-presidency interviews that monetary reform he did was to boost predictability and strengthen the role of Bank Indonesia in the economy as an independent institution.
Bank Indonesia’s plan to issue its own CBDC, the digital rupiah, could become a great momentum to reinterpret the dual banking system. Full reserve incorporation in the system would maintain Indonesia as mixed economy in the middle of future possible CBDC extreme arrangements; Soviet style of one bank for all or liberal privately controlled monetary system.
