The development of an Islamic capital market in Ningxia could be the start of a new financial relationship between China and the Islamic world. For this to flourish, however, Islamic finance must not only be open to non-Muslims but it most also be adopted by those outside the Muslim faith so that it can gain a larger foothold in the country.
Perceived by many in China as being for Muslims only, Islamic finance has struggled to take off. The initial focus in Ningxia should therefore be on developing a wholesale Islamic capital market, including Islamic bonds, equities and funds and making sure it is seen as a real alternative to the conventional market.
A large Muslim population and growing wealth provide a readily available retail Islamic banking market in China. The US$1.4 trillion Islamic finance industry is targeting rapidly growing Asian economies such as China and India and new markets such Kazakhstan and Sri Lanka. This is to help offset slow growth in the traditional Islamic finance markets in the Gulf Arab states.
Islamic banks are touting wheat- based deposit products and metal-based funds as ethical investments to appeal to investors burnt by the recent conventional banking crisis. The industry is also marketed as socially responsible investing in non-Muslim countries such as France and India to avoid fanning religious sensitivities.
“China is like Indonesia, a sleeping giant,” said Zulkifli Ishak, Sharia investment director with Prudential Fund Management Bhd which manages about US$4.03 billion. Kuala Lumpur is Prudential’s Islamic finance hub. “If Islamic finance can tap Muslims, especially in Xinjiang, then there will be a huge potential for the Islamic space in China,” he said. China has a Muslim population of about 37 million.
Islamic law requires investments to be based on a specific asset and it bans excessive speculation, interest-based lending and gambling, alcohol and pornography-related activities. Zulkifli said the Sharia’s screening criteria weeds out assets with excessive debt, helping them to deliver returns comparable to those of conventional instruments. “The discipline in the Sharia helps because you cannot invest in highly leveraged companies.”
Non-Muslims make up more than half of the investors of most of Prudential’s Islamic retail funds in Malaysia. Prudential’s RM42 million China equity fund rose 46 percent in the half year to August 31, about the same as some conventional China equity funds run by ING and OSK-UOB.
But China has to amend its tax laws. Currently Islamic financial transactions are costlier there than conventional deals, Zulkifli said. He believes that regulators in China need to look at the taxation issue. “Once they do that, then the opportunity for Islamic finance to grow in China would be much greater.”
Sharia finance typically involves the sale and purchase of assets, which attracts tax at every level thus increasing transaction costs. Indonesia’s parliament passed a law recently that will come into effect next April, which will scrap double taxation on Islamic financial transactions.
Bahrain’s Shamil Bank launched a US$51 million Islamic fund in 2006 targeting investments in China’s real estate sector. China’s economy this year grew at an annual rate of 7.9 percent in the second quarter, picking up from 6.1 percent in the first quarter and on track to hit its full-year growth target of eight percent. This makes the country a fertile ground for Islamic financial markets to do well.