Transition to riba free economy by Mohamed Rahumathulla Mohamed

Ç \þ-

é¿,,f¿,!,*

eYti"lt C¿¿UIl åI, W. Allah deprives interest of all blessing, whereas He blesses charity with gowth (al-Baqarah 2:21 6)

Transition to

a Riba Free

Economy

Transition to aRiba Free Economy

STIAQARMASOOD KFIAN

International lrr*irute of islamic Thought and Islarnic Research Institute

First Publishedul2002 by The Internâtional Insritute of Islamic Thought, (Pakistan) 28 Main Double Road, F -lO/ 2,Islamabad, Pakistan. Facsisrile 92-57-2280489; Email: üit@comsats.net.pk; and Islamic Research Institute, International Islamic University P.O. Box 1035, Islamabad, Pakistan. Facsimile: 92-51-2281289; Email: anaa555@apollo.net.pk @2002byThe International Institute of Islamic Thought (Pakistan), Islamabad.

Catatoguing-in-Publication Data Khan, \üflaqar Masood, 1952Transition to

a Riba Free Economy (Islamization of Knowledge)

Includes bibliography and index

1. Islam: Islamic thought. 2. Islamic Economic System.

3. Islamic Finance. 4. Islamic Banking. 5. Interest-free Banhing. 6. Interest-free Finance. 7. Interest-free Economy. 8. Economics. Islamic Economics. 10. Indexation. 11. Ribã. 12. Inrerest. 13. Vaqar Masood Khen. tr. Tide: Transition to a Riba Free Economy

III.

Series:

ISBN L-56564-099-3HB ISBN L-s6564-100-0PB Printed in Pakistan by Islamic Reæarch Institute Press Islamabad

Dedicated to my hrotber Mashkoor Abmed Kban

Contents xru

Foreword

1 .

Introduction

Elements of Islamic Finance Lending andBorrowing Trade and Investment Financing The Scope of the Prohibition

TransitiontotheNewsysæm

Private Domestic Transactions

Liabilities Side

Assets Side

Foreþ

Government Finances Ttansactions

Problems of Tra¡sition

Private Domestic Transactions Settlement of Existing

I r¿nsacttons Reserves Requirement

for

Current Accounts Profit and Loss Sharing as the Main Alternative Increased Documentation Contingent Liabilities Government Finances Size of Government Finances

27 30 3L 33 35

Nature and Ownership Structure of Governrnent Obligations Settlement of Obligations and Required Resources Obligations of the State Bank of Pakistan Obligations of Banks and Financjal Institutions Obligations of the General Public Development Role of the Governrnent Government Borrowings for Current Expenditure Availability of a Safe Investmenr Avenue Foreign Transactions Monetary Policy under the New System

Constin¡tionalProvisions

Legal Framework for Government Borrowings Implications of the Legal Framework

EfËcacy of Judicial Poç'er toBhmlrrrate Ribã

ConcludingRemarks

Annexures

A Note on Infl¿tion and Index¿tion Money Evolution of Money Falasin the Islamic Monetary System Inflation Quantity Theory of Money Is Inflation a Modern Phenomenon? Gresham's larv .Evidence from Europe: Views of Adam Smith Evidence from Greek andRoman Empires

47 49 50 53 55

57 58

78 78 79 81

86 93

95 96 97 98 99

Evidence from Spanish

History

Indexation Indexation in an Islamic Setting Følas andlndexation Peculiarities of. Falas The Cause of Vari¿tion in the Pnce of Falfrs

100 100

L04 105 105 107

Falas andThamani.yyah Main Lessons Ftegar: dtng Fala s

TLL

Fulus and Paper Currency

118

Comparative Satement of Constitr¡tional Provisions on Debts/Borrowinç

124

List of Lav¡s not Ex¿mined by the Federal Shariat Court

134

LL6

Appendix

tsø

Bibliography

138

Ind€x

t42

Foreword Interest has been characterized as the very backbone of modern, capitalist economy; the linchpin of virtually all economic institutions and activities of our time. The v¡eb of interest encompasses banking and finance, business and coslmerce, industry and agriculture. Interest has gradually and surreptitiously crept into all asPects of modern life so much so that one is often reminded of the aPtness of the Prophet's when þeace be on him) saying: "A time will come over people and ri'ba, devour not a single pèrson will remain who does not

if there be any who refrains from it, still its vapour will

overtake him". (Abo Dã'üd, Sønan, Kitab al-Buyu', Bãb fi Ijtinãb a1-Shubuhat).

On the one hand is this sordid reality of the Present-day life and on the other is the vehement denunciation of ribã in the Qur'an and in the traditions of the Prophet þeace be on him). The intensely vitriolic tenor of the Qur'anic castþation of. ri,ba cannot be lost on ânyone v¡ho has gone through the Qur'ãn: J'Those v¡ho devour ribø shall not rise [on the Day of Judgmentl except as one whom Satan.has driven by his touch to insanity. That is because they say: 'Buying and selling is like ribã whercas Allah has permitted buying and selling and has forbidden ri.bã) " Qz75). FIow can this reality of the contemPorary, interest-based economy be reconciled v¡ith the teachings of Islam which are categorical in their condemnation of ri'bã'? This question has been troubling Muslim conscience for about a century and a half. Some Muslims attempted to come to terms v¡ith the

xtv

TRANSITION TO A RIBA FREE ECONOMY

reality of modern economy by having recourse to a nev¡ interpretation of riba. They sought to restricr the meaning of riba to usury (meaning thereby interest charged at exorbitant rates). They contended that interest should be treated as unlawful only if irs rate was excessive, but permissible if the rate was reasonably lov¡. Likewise, sorne Muslims also attempted to resrricr the prohibition of interest ro rhose transactions alone v¡herein the loaned funds were devoted to consumption, suggesring thereby that if they were directed to productive purposes, the interest paid on them should not be deemed forbidden. During the last three or four decades, after a period of protracted debates Muslim scholars have reached a fair degree of agreement regarding ribã.. The point of agreement is ihat ribã signifíes the stipulated excess over and above the principal that a loanee is required to pay to rhe lender. Regardless of whether the stipulated excess over rhe principal is negligible or substantial, and whether the loan is spent on consumption or is devoted to profit-yielding venrures, every sripulated excess over principal is riba, and is prohibited. In fact, as Rodney 'SØilson has stated, abolition of ribã. has become one of the most visible defining characreristics of an Islamic economic system. (Economics, Etltics and Reli.gion: Jertisb, Cltristian and Møslim Economi.c Thought, Nev¡ York Nev¡ york University Press, L997).

The consciousness that ribã is flagrantly violative of the Qur'ãnic injunctions and that it is incumbenr upon Muslims to purge their economies of it grew rapidly in the last half of the 20th century as Muslims shooh off imperialist domination and regained political independence. In pakistan, with the achievement of a consensus abour the Islamic character of the state in the form of the objectives Resolution (rg49), artenrion inevitably turned to the process of Islamization of the

FOREIüTORD

economy.

was generally felt that one of the first steps

in this

direction was to eliminate interest (riba) from the economy. This is reflected in all the three constirutions of Pakistan wherein it was laid dov¡n that riba should be done away with over a short period of time. Religious scholars, economisrs, bankers, ffaders, industrialists, legal experts and people from across the entire spectrum of society joined in voicing the need to free the country's economy of interest. This growing enthusiasm also stimulated intellectual exertion. Soon scholarly works on the Islamic econornic and financial sysrems started coming out. Books, papers and articles on the feasibility of interest-free economy, presenting tåeoretical models of Islamic banking and espousing monetary policies and modes of financing consisrent with the teachings of Islam started being published with ever-grearer frequency. Also reflective of popular opinion was the 1980 Report of the Council of Islamic Ideology advocating elimination of ri.ba from the economy. In L991 the Federal Shariat Court of Pakistan gave its verdict declaring that ribã in all its forms was repugnant to the Qur'an and the Sunnah and hence should be struck off the legal codes of Pakistan. This was followed by the report of the Commission on the Islamization of Economy in L992, which upheld all such previous pronouncements regarding the prohibition of ri.ba.In L999 the Shariat Appellate Bench of the Supreme Court of Pakistan pronounced its judgement declaring, again, that any amounr over the princþal in a contract of loan or debt is riba regardless of whether that is claimed by individual or a financial institution such as a ^ this falls under the ambit bank, and that of the Qur'anic prohibition. Not only that, the Appellate Bench also indicated some features of an alternative economic system free of. ri.bø that should replace the present one.

xvl

TRANSITION TO A RIBA FREE ECONOMY

In the late sixties and earþ seventies, in other Muslim countries too the desire to eliminate ri.bã manif.ested itself. This is evident from the establishment of a growing number of ribafree institutions of banking and finance in severd Arab countries. But perhaps the crowning event was the establishment of the Islamic Development Bank (IDB) in 1925 with the avowed purpose to "foster economic development and social progress of the member countries and Muslim communities individually as well as jointly in accordance with the principles oÍ. Shan'ah".Itwas for the first time in modern Muslim history that an international financial institution had taken upon itself to conduct its activities in conformity with the Sbarl'ab. The establishment of IDB not only signalled the increasing Muslim desire to do away with rí.ba, but also gave further impetus to the Islamic banking movement. Since then several dozen Islamic financial institutions have sprung up all over the world, including in non-Muslim countries. These include commercial, development and specialized þanks, investment companies and insurance and reinsurance companies. In Pakistan, where interest-free banking counters were opened in commercial banks in 1984, as well as in Iran and Sudan, assiduous efforts were made to reorganize the entire banking system along the Islamic lines. Even international financial institutions like the International Monetary Fund have taken notice of these developments. (fhe IMF published an Occasional Paper on Islamic Banking way back in L987). Western universities have been holding seminars and conducting research on various aspects of the Islamic banking and monetary systems for quite sometime.

It is important to note that at least in Pakistan the purpose of the ongoing effort has been not simply þ prove that interest-free banking and finance institutions are viable. SØhat is sought to bé achieved is a switch-over to Islamic

FORE'TORD

xvll

monetary, financial, banking and commercial policies and practices to pave the way for a smooth transition to a fullfledged ri.ba-free economy, one that precludes violation of all canons of the Islamic Sharl'ab.

ïØaqar Masood Khan, the author of the present work,

was aurong a panel of legal èxperts, economists, 'ulamã,' and policy-makers who were asked by the Shariat Appellate Bench of the Supreme Court of Pakistan to appear before it as an amicus curiae. The book is based on his submissions before the Supreme Court of Pakistan. Apart from his sound grounding in economics and his grip on the relevant Islamic sources, he has the distinction of being very closely engaged in running the economy of Pakistan for many years. He thus combines in himself an intimate knowledge of both the theoretical and practical aspects of the subject. The work hopefully displays both his theoretical rigour and his ability to come to grips with the practicalities of the present economy, combined with his capacity to address the nitty-gritty of business and finance in a manner that would contribute to developing an effective road-plan for a smooth transition to a ribã-free economy.

The author has referred extensively to the economic conditions of Pakistan while enunciating his ideas and suggestions. This was useful, perhaps even necessary, to drive across the points that he was making. It is evidenr, however, that the relevance of much of v¡hat the author has said, and the suggestions that he has made, is not confined to Pakistan. For obviously while the economic conditions of the different Muslinn countries vary, there is considerable similarity in the problems they will encounter in their drive to build a ri.ba-free economy. I feel confident that while the author's might nor be the last word on the subject, a great deal of what he says will bel¡¡ell $¡ofth serious consideration both in Pakistan and other

xvllt

TRANSITION TO A RIBA FREE ECONOMY

countries commited

building

riba-free economic

structure.

The International Institute of Islamic Thought and Islamic Research Institute are deeply grateful to Dr. rü(/aqar Masood Khaq for revising his submissions to the Supreme Court and kindly permitting us to publish them in the form of this monograph. My thanks are also due to my colleague, Muhammad Modassir Ali, for his sharing v¡ith me the burden of editing this work, md for doing it v¡ith remarkable diligence and competence. Islamabad

lune2002

Zafar

hlaq Ansari

Introduction

The Supreme Court of Pakistan is seized with a mater that has no parallel in history, not just in Pakistan but anywhere else in the world. The questions relating to usury have been deliberated at length by the Parliament in England, while formulating lavrs on the subject, bur no court of equal significance has ever proceeded on this matrer. It would thus be fair to say that the Court v¡ill be giving a historic judgement vrhich would throw light on a mater rhar, at least for the Muslims, represents a burning issue. By the same token, it would be no exaggeration ro say that the eyes of the world are fixed on the deliberations of the Court. The primary questions relating to ribathat the Court may wish to resolve are neither easy nor raised for the first time in history. The issue has agitated the minds of people, at least of those possessing Revêaled Books, throughout their history. More recentþ, before the'lü(/'est gradually overcame its age-old revulsion against usur/r the 16th century witnessed social turmoil in which the question of usury occupied rhe centrestage. A renowned historian, depicting the situation has thus written:

If he [a schooLnan] had been asked why r¡sury v¡as wrong, he would probably have answered with a quotarion fronr Scrþture. If he had been asked to define usury, he would have been puzzled, and would have replied in the v¡ords of'a member

of Parliament who spoke on the Bill introduced in lS77: "It

TRANSITION TO A RIBA FREE ECONOMY

srandeth doubtful what usury is; we have of it."l

no tnre definition

Although we have no dearth of such doubters, we are placed in a far superior position with respect to the theological understanding of what ri.bø means. Nevertheless, the task of the Court remains daunting, as it hæ to steer a course that would meet the ends not only of the Shart'ah but of the efficient functioning of the economy as well. \Øithin the scope of the Federal Shariat Court's (FSC) jurisdiction to examine lav¡s to determine their repugnancy to the tenets of the Sban'ah, this case is unique. No other law, containing provisions repugnant to Islam, could claim to have such pervasive application in the country, with vast implications for the working of its economy, as the provisions relating to rí.ba. For instance, laws that sanctioned gambling (qimã,r) v/ere a few at best, and striking them down did not affect anything except the small activity of gambling in the country. Unlike this, as it will be seen, ri.bais sanctioned under numerous laws and has come to occupy a pivotal position in the functioning of all modern economies. Its elimination, in an effective and efficient manner, may require a slightþ different approach than that adopted hitherto in declaring as un-Islamic the relevant provisions of larvs under consideration. Consequently, the Court would not want to limit its investigation simply to the laws examined by the Federal Shariat Court, as the normal procedure would demand, but may wish to examine how its decision will impact other lav¡s that have been left out by the impugned judgment. It seems obvious that the answers to the questions raised before the Court will have profound implications for the lR. H. Tawne¡

Religi.on and Penguin Books, 1926), p. 159.

the Riæ of Caphalism (ÉIarmondswonh:

INTRODUCTION

working of the economy and the relations of the country with the outside world..It v¡ill be our endeavour to establish that, given the implications that will ensue from the prohibition in its truest and widest meaning, it v¡ill be uncalled for to initiate the process entirely from the judgment of the Court; rather, the desirable course would be to urge and obligate the Government to undertake the necessary legislation which alone would guarantee a smooth transition. The focus of our submissions is non-theological in the sense that they do not concern themselves with the questions of the definition of. riba, its rationale, and other related aspects. It is assumed that the present day interest, in all its manifestations, is covered under the definition oI ri.ba which is to be prohibited. More precisely, no exception is taken to the conclusions reached in the impugned judgment on this issue, though on occasions, such as on the consideration of indexation, stronger arguments in favour of the judgment have been expounded. Further, no effort is made to give details of the specific forms of the financing methods that will replace the existing ones, but only broad principles, which underpin the Islamic system of finance, have been outlined. Such details might be covered by other scholars. The primary focus of our submissions is the practical aspeçts of the elimination of. riba within the context of the modern banking and financial system. The basic objective is to give confidence to the Court that even when the widest and purest meaning of. riba is taken, the alternative arrangements are capable of supporting and sustaining the needs of the modern banking and financial system. The submissions are organised as follov¡s: '\üØe first describe, as pârt of 'Introduction', the elements. of Islamic finance followed by * exposition of the scope of prohibition within the modern system of finance. The manner in which transition to the new system can be effected is discussed in

TR,C,NSITION TO A RIBA FREE ECONOMY

chapter 2. The problems likely to be encountered during the process of transition, and their solutions, are discussed in chapter 3. In view of its significance, â separate chapter 4 has been devoted to a discussion of the constitutional provisions which possibly have a bearing on Government finances likely to be affected by the prohibition. In chapter 5, we give our views regarding the efficacy of the judicial action to eliminate ribø. An extensive Annexure has been added to discuss the issues connected with inflation and indexation. Here we havc also touched upon a highly controversial issue: whether rulings given by the faqaha'in respect of a special currency of the

early Islamic era, følas, can be applied

modern paper

currency.

Finally, although we have not followed the pattern on which the Questionnaire of the Court was framed, hopefully 'we have addressed all the questions raised therein.

Elements of Islamic Finance

At the very outset, it must be clarified that the prohibition on riba does not mean that money and capital would not earn a reward for their legitimate uses. Alternatively, interest-free system does not mean that money and capital would have to be provided free of charge. Essentially, all what is meant is that

form in which such arrangements are possible will no longer No one could have explained this better than how Allah Himself has stated in His book: a

be available.

That is because they say: "Trade is like usury," but Allah hath permitted trade and forbidden usury (Quy'ant

2z275).

This verse has profound implications for the alternate $ystem that is envisaged in place of the current one. The plain meanirig of the verse is that all exchanges (tr"d.) are admitted in Islam except ribã, whích is prohibited. More importantþ,

INTRODUCTION

riba is contrasted v¡ith trade. tü(/hat is it that makes ribã lose its character as trade? To appreciate this, we might note that all wealth is created through exchange, v¡hich invariably takes place between dissimilar commodities, including those in which money is used às a medium of exchange. Now it is only ri.ba-intercst-that involves trade of money with money, i.e., trading in the same commodity, with only the difference that monies at tr¡o different time periods, present and future, are exchanged. Allah has not accepted the monies of two different time periods as dissimilar commodities admissible under trade. The famous tradition of the Prophet þeace be on him) prohibiting trade in similar commodities þi.bã. al-fadl) has further fortified this.2 Given the scope of admissible transactions relating to üade, a natural question is whether the admissible set is sufficiently large to accommodate the needs of the modern financial system. It will be our endeavour to give an affirmative ansv/er to this question.. A system of finance is known by. the variety of arrangements it allows for lending and borrowing of money and capital or, in general, for their use to enhance their values. An Islamic system also affords a great variety of arrangements for this purpose.

Lending and Borrowing Let us first explain the position of lending and borrowing in Islam. Undoubtedly, such activities are prohibited when they involve the element of. ribã. The only permissible form in which lending and borrowing may be undertaken is the one in which no reward is sought, i.e. voluntary without seeking any 2

See

al-Bukhan, $aþiþ,Kitab al-Buyu', Bãb Bay' al-Dhahab bi al-Dhahab; See

Muslim, gaþiþ,Ktab al-Musãqât, Bãb al-RibE Kirab al-Buyt', Bãb f¡ al-Sarf also

See

also al-Nasa'7, Sanan,

TRANSITIONTO A RIBA FREE ECONOMY

return. Far from allowing aîy monetary consideration, the Sharl'ab prohibits the seeking of even implicit and non-pecuniary comPensation, such as gift, from the borrowers. On the other hand, it encourâges the believers to help their brethren in need by financial assistance whenever it is possible for them to do so. However, the above does not mean that all lending is of a non-business character. Indeed, lending as Part of business transactions is equally possible, but with the same restrictions. Thus it is possible to sell goods on credit or accept short payments and treat the balance as credit. It is also permissible, both in business and non-business transactions, to ask for collateral against loans. The collateral need not be the thing created out of the borrov¡ed funds, though there is no bar on this arrangement either. Let us also clarify that while permitting lending and borrov/ing,Islam has placed rights and obligations on both parties. \Øhile exhorting the believers to extend the scheduled time to their debtors for payment when the latter are in financial difficulty (al-Baqarah, 2:280), the delay in payment when the debtor has the means to discharge his obligation is strongly condemned.3 Permission to seek

benefit

3It is reported tl¡at the Prophet þeace be on him) said: "Delay (in repayment of a load by a ghøni (a person of means) is z.ubn (njusticQ, so if soheone

from among you undertakes to (repay within a stipulated) time period, he must abide by it" [al-Bukhãn, $dblh, Kitãb al-$awãlet, Bãb idha aþda ila mali' fa laysa l¿h¡ raddl. In another tradition it is reponed that the Prophet þeace be on him) said: "The one who delays repayment (despite capacity) may be humiliated and puaished" (al-Nasã'i, Sønan, Ki¡ãb al-Buyú', Bãb Matl al-Ghanr). In an even stronger reaction, as reported in a large number of sound traditions, the debtor will be deried entrr¡ into Paradise unless the debts were discharged. The Prophet þeace be on him) also declined to lead the funeral prayers of people unless their debts were discharged by their heirs. [Abü Dl-'Ûld, Sønan, Kitâb al-Buyü', Beb f¡ al-T¿shd¡d fi al-Dayn].

Although there is some difference

of opinion

among the fuqaha', the

preponderant view is that a delinquent debtor is indeed liable to punishment, including ¿rrest. Imam Abü Taû¡fah makes no disdnction betweeo the poor

INTRODUCTION

collateral further strengthens the security package available to the creditors. Flence, within the business related transactions, no fears need be entertained that Islamic Practices vrould induce delinquent tendencies.

Trade and Investment Financing scoPe of financial arrangements other than those based on lending and borrowing. As v¡e said earlier, there is absolutely no prohibition in Islam on using one's surplus resources for further enhancement in their value.a Indeed, the vocation of business, within the limits prescribed by the Sharl'ah, is given an exalted position in the hierarcþ of Islamic values. The Prophet þeace be on him) himself engaged in trading, and so did a large number of his illustrious Companions. \7hi1e encouraging the institution of trade and allowing a wide spectrum of transactions with all their ever-emerging new forms, Islam has prohibited only a limited number of transactions . Ri,b}-based transactions are one of them. Apart from the above prohibition, there are two other notable forms of transactions which are prohibited in Islam, namely those involving an element of gambling (qi'mar) and those having an

Let us nov/ move to

discuss

the

uncertain nature (gharar).5

and rich in this regard, whereas others confine this only in regard to those to repay. [See'Mujib Allãh Nadvi, Islãtn'| Fi.qh, (Lahore Progressive Books, 1991), Vol. 2, pp.435-436]. All this goes to show that Islam has fully safeguarded the interests of the creditors.

v¡ho have the capacity

aSee

'f5

above.

sGharar arises

transactions when they involve any of the one of the following elements: ignorance, uncertainty. or gambling. The selling of a

crop with the condition that the buyer will get the crop only if the producdon exceeds some minimum size is one instance of gbatar anå is prohibited in Islam (Mujib Allãh Nadvi, Islzøi Fiqb,Yol. 2, pp.365-6).

TRANSITION TO A RIBA FREE ECONOMY

The above is a general statement about the permissibility of all arrangements that lie outside the three major prohibitions. It needs to be stressed that the set of permissible arrangements relative to the present day finance is not restrictive and should pose no insurmountable problem for the smooth functioning of a modern sysrem of money and capital. To this end, let us explain the fundamental principle that guides the Islamic financial arrangements. This principle is that only assets earn â return, because of their intrinsic utility and productivity.' Money in itself is not an asset and mere holding of money or its tradingr over time, would nor be qualified to earrr a return. This is a powerful principle which opens a wide range of possibilities for earning a return on surplus resources. Let us explain some financing arrangements that are based on the above principle.i First, a person taking advantage of the marker opportunities may use his surplus resources to purchase goods at lower prices and sell them at higher prices with an element of profit. This is called trading and it is perfectly permissible. It is equally permissible if he finances the purchases of another person through spor buying and sells rhem on credit to rhar person with a margin of profit for himself. This is called financing on deferred paymenr þay'ma'ajjal), or with some modifications, such as rnørabaþaþ (sale at cost plus a srated mark-up). Second, the surplus resources may be used for buying a capital good such as machine or a house and giving on rentlleasing (ijaralt). The rental income is permissible provided

the contract meets cerrain conditions laid down by 6See

the

Muh¿mmad Taqi Usmani, An Introdaction to Ishmic Finance (Karachi: Idaratul Ma'arif, 1998), pp. L8-22, TThe treatment of financing metlods here is only explanatory and does not cover all tl'e conditions required to be fulfilled by the Shdnøh, For e cootemporary trearment of these modes see ibid., p.27 ff.

INTRODUCTION

Sbarl'ah, such as continued ownership during the flow' of renﾃｾl income and the assumption of the attendant risks. Third, it is also possible that the surplus resources are given to a farmer as an advance payment of his crop, which may subsequently be sold at a profit in the market. This is called bay' salam, and represents an exception to the general rule that prohibits the sale of non-existent commodities or forward sales. Some strict conditions govern the contract to ensure that it complies with the requirements of the Shan'ah. An analogous arrangement is the one in which the surplus resources are given to a manufacturer to manufadure some specified products. The products can then be sold in the market with a certain margin of profit. Finally, giving such resﾃ置rces to someone with a business proposition on the basis of participation in the profit and loss (masharakah or madarabab) of the business is also permissible. Here the earnings will accrue in the form of profits which will be shared between the parties to the agreement. Losses will be shared by the capital exclusively in the same proportion that they bear to the total capital of the enterprise. In each of the above financing arrangements, the common feature is the conversion into, or creﾃ｢tion of, assets from surplus resources and seeking return thereupon. The logic behind this principle, other than the fact that assets earn return, is the assumption of certain risks by the holder of surplus resources before he is allowed to earn any return. In the last example the exposure to risks is direct, as return is based on profit, which is not known in advance. In other examples, assumption of ownership and possession of the trading goods are critical reguirements of legitimate trading leasing contracts, all of vﾂ｡hich entail'some risk. "nd To summarise, in an Islamic setting, financing for the purpose of earning return has to be related to certain assets, whereas lending is either voluntary or against the mortgage of

TRANSITION TO A RIBA FREE ECONOMY

certain securities, not necessarily created out of the funds lent. ÍIence, alargenumber of financing instruments v¡hich attempt to meet the financing needs of the business within these constraints have been developed in Fiqb literature. A critical feature of these instruments, other than masbaraþab and maQarabah, v¡hich provide for direct risk exposure of invested funds, is th¿t they require some risk exposure, though indirectþ, before the investment qualifies for an enhancement in value. For instance, in the case of trade related modes, a cost plus price is allowed in lieu of acquisition of ownership and possession-which would obviously entail some risks - of the goods by the financier before the same are sold to the client. Siqrilarly, under i.jãrah, the ownership remains with the financier until the termination of the lease period, with risk of damages remaining with the lessor.

The Scope of the Prohibition Having explained the elements of Islamic finance, let us point out the main areas that would require transformation when hit by the prohibition of. ri.ba. There are basically three groups of transactions v¡hich will be affected by this prohibition, namely:

(1)

(3)

privatedomestictransactions, governmentfinances, foreigntransactions

The first set of transactions are those v¡hich are commonly trânsacted between the private parties. The bulk of sThe fect that such risks cag be covered by insurance is imm¿terial as the cost of such insurance is required to be borne by the owner/possessor. More importantly, it does not coffrovert the fact that risk dóes exist and belongs to the owner/possessor.

INTRODUCTION

them, on both borrowing and lending sides, are between the banks and individuals and orgartizations in the formal sector. All these transactions will be hit by the prohibition as they are clearly interest-based.

The second set of transactions are those transaded berween the Government (all tyPes) and the private parties. On the borrowing side, a variety of arrangements such as

deposits, accounts, certificates, bonds and bills have been devised to raise resources from individuals, organizations and banks. There is also a lending side but it is relatively modest. The lending side includes loans and guarantees generally given by the government to the provincial governments and its own alrtonomous organizations.

The third set of transactions ate those which ^re transacted with the foreign entities and in foreign currency. These include all the borrowings that the government undertakes from official sources and from the commercial market. Although limited, some such borrowings are also undertaken directly by the private sector. In addition, until recently, a huge liability of this tyPe was created by the Government in the form of Foreign Currency Accounts. A related kind of transactions are those v¡here foreign resources have been mobilized by the Government through the issue of bonds generally issued to residents. These, then, are the target sets of transactions which v¡ill require conformity with the requirements of the Sbarl'ab,both '\üØe may also clarify at this in their present and future forms. keeping in been determined has above scope stage that the view that ri.bã.wtll- be prohibited in all its forms. The Court, on the other hand, is dealing with a slightly restricted question, in the sense that after it has reached a decision on the definition of. riba, the immediate impact of its decision will be limited only to those lawq ¡¡hich have been challenged and impugned in the judgment of the Federal Shariat Court. Given

TRA}ISInONTO A RIBA FREE ECONOMY

the sensitivity of the subject, it is hoped that a way would be found to cover the prohibirion across all laws. Ve will address this question in some detail again at a later stage.

Transition to the New System

Keeping in view the basic elements of the Islamic finance, we may proceed to examine each of the above transactions and see whether the Shan'ab-compliant methods will afford a smooth transformation that avoids any majot disruptions in the working of the financial system. Our approach is to broadly specify the nature of these transactions and then indicate whether they would be amenable to reform in the light of the principles elaborated above.

Private Domestic Transactions

There is a unanimity of views amongst those who have worked in this area, that this segment of the market is the easiest to admit a smooth transition. The scope of Islamic financing methods is broad enough to meet the entire needs of this segment, at least so far as the focus of such transactions is on the productive side of business.

Liabilities

Si.d,e

To start off, consider the elements of a typical balance sheet of a bank or financial institution given in the following table.

TRANSITIONTO A RIBA FREE ECONOMY

Table

Structure of Assets and Liabilities of Bank Assets

Liabilities

Balances

Eqity

Cash in hand

Paid up Capital

with SBP Money at Call

Resen¡es

Reserves

Otåer Liabilities Foreign Currency Demand Deposits Time Deposits

Advances/Loans

Borrowings

Bills

General

Purchæed

Discounæd

Investments

SBP

Foreign Money at Call

Deposits with Banks

Government, Securities

Equity Investments

Fixed Assets The liabilities side of the banks and financial institutions broadly comprises three main categories, viz. equity, deposits and borrowings. Equity poses no.problem as it does not earn a fixed return; rather it receives the residual income þrofit) after

TRANSITION TO THE NE\T' SYSTEM

meeting all the costs. Hence as such no reform or adjustment would be required for this source of banks funds. Both deposits and borrowings, on the other hand, are interest-based and would require adjustment. In principle, such an adjustment is not difficult, as the providers of funds, either as deposits or loans, would be given a new contract which would stipulate a profit and loss sharing (PLS) arrangement with the bank, as opposed to a fixed return. Since banks are commercial institutions, the focus of their business is to earn profit through the acquisition of income earning assets out'of the funds geneiated from deposits and loans, and hence the design of alternative arrangements on a profit and loss sharing basis would be viable. It is generally held by experts in Islamic economics that under a profit and loss sharing (PLS) system, banks will have only two broad types of liabilities, besides their equity current account or demand deposits, as amãnab (trust) accounts, and investment, or muS.arabab accounts. The former, as the word suggests, would be due on demand, irrespective of the size of withdrawal. The funds from this source, though not formally required, would not be available for investment. On the other hand, the funds generated through investment accounts would be available for the pr¡rpose of investment in income-earning assets through the methods v¡hich are based on, or are at least not inconsistent with, the principles of the Sban'øh. ' In the next chapter we will examine whether there are any operational problems with regard to the transformation of liabilities side of banks and financial institutions. Assets Side

Turning now to the assets side, we find that the incomeearning assets are broadly comprised of three categories, viz. advances, investments and trade bills which are purchased/

TRA,NSITION TO ARIBA FREE ECONOMY

discounted. Two other categories of assets, viz. cash and bank balances and fixed assets, are generally not income-generâting assets. \Øe have to see whether these assets can be brought in

line with the methods of financing which are Sbari'øb compliant.

Both advances and bills represent investments in real assets, hence given the Islamic principle of assets-based financing, they will be amenable to transformation into Sharl'ah-compliant financing methods. Indeed, experts have found that since these bills are connected with real exports and imports, even møsharaþab-hke arrangements are possible.e A formidable problem will, however, be faced in the case of investment in the Government securities. No real assets are available against such investments. This problem can be solved only in the broader context of reforms in the Government finances, a subject which v¡e will take up shortly. Although not distinctly reflected in the balance sheet items, there is also a small portion of lending by these instituticns which may come under the category of what is called consumption loans, v¡hich may or may not be covered by corresponding assets. One should distinguish be¡ween two types of consumption loans, namely, those against which some durable consumer goods are purchæed and those where even such assets do not exist. In the former case, a desirable asset is available and Sharl'al¡compliant arrangements can be devised. The other category is purely of lending and borrowing which v¡ill be regulated as per the discussion given on the subject in chapter 1. It must be cl¿rified that what is stated above is that new transactions should also be required to be underaken according to the modes of financing which are in conformity eSee

Commission for Islamisation of Economy, "Report of Experts' Group

on Banks and Financial Institutions' (Islamabad: 1991).

TRANSITION TO THE NE\ø'SYSTEM

with the requirements of the Shari'ah. Thus it is possible, and also advisable, not only to reform the future transactions but also to convert the existing contracts in such manner that they become consistent with the Sban'ah. Government Finances

Undoubtedly, the mest difficult adjustment problems will be posed by the requirement of reforming the Government finances, not because of their inherent complexity, but because of rampant fiscal indiscipline that has become the hallmark of the country's fiscal management, particularly during the last one decade or so. Nothing short of a basic restructuring of the country's fiscal system will be needed in order to be effective. This is required arly way, and not simply as a part of the process of eliminatingribã, from the economy. The Government finances, in their present form, will not be amenable to adjustment in the Shan'ah-compliant form. The state of fiscal affairs obtaining in the cóuntry is such that very little of the Government's borrowings can be covered under this principle. At a time when the Government's income fiom ta:r and non-tax revenues is barely sufficieht to meet non-interest expendiftre, almost the entire borrowings are undertaken to make the interest payments.lo Obviously, no loThis is the definition of primary deficit, which is the difference between Government revenues and non-interest expenditure (i.e., expenditure othei than interest payments). Economists use this measure !o ascertain whether the level of public debt, and the consequent servicing liabilities, are sustainable or ûot. As'long as the primary deficit is positive (i.e., the reve¡ues are greeter tåan non-interest expenditure), then the excess can be used to defray pan of the iaterest payment and all of them v¡ill not be translated in additional borrowings. In the alternative, tåe entire interest payments vill have to be financed through borrowings, which would unleash an explosive cycle of debt accumulation as interest payments would continuousþ be rising requiring greâter borrowing, which in turn will further raise the required payments, with another round of sdll higher

TRANSITION TO A RIBA FREE ECONOMY

assets are created when borrowings are made for making interest payments. Consequently, there is no instrument that can be used to fund such operations and remain within the bounds of Islamic fina4ce. The principle enunciated above would call for resrriction of Government borrowings only for such purposes that lead to creation of income-earning assets, which may be shared or distributed to the contributors of funds. This means rhat borrowings will have to be restricted for the purpose of the development projects that yield a rerurn sufficient ro compensate the providers of funds. Undoubtedly, this ¡¡¡ill be very restrictive on the Government's fiscal operations. But there are sound economic reasons why it will be in the best interests of the economy that such restrictions are imposed on the fiscal management of the Government. In reaction to such limitations, proponents of continuing the Government fiscal operations along the present lines, have expounded a number of alternatives in a bid to satisfy the requirements of the Sbarl'ah. These include payment of a return on Government deposits linked to the growth rate of the economy, evidently on rhe belief that since the growrh rare is not known in advance it should satisfy the conclition of variability thought to be the key requirement under the Sban'ah.

borrowings and so on. See Rudiger Dornbusch and Stanley Fischer, Mactosixth edirion (New York McGraw-Hill Inc., 1994), pp. 579-580. In,1997-1998, based on rhe Revised Estimares, the consolidated revenues of the federal and provincial governments were Rs.452 billion and rhe noninterest expenditure was Rs.410 billion. Thus a small amoutrt of Rs.42 billion was available, out of the revenues, to finance the interest payments r¡hich amoun¡ed to Rs.189 billion. The rest, of course, were financed through additional borrowings. (Pdkistan Economic saroey 1997-98: statistical Sapplement, pp. 153-159) Econornics,

TRANSITION TO THE

NE\üø SYSTEM

A second alternative, supported not only on account of its variability but also on account of concern to prorect the value of savings, is to index the rerurn on deposits with a welldefined price index. Other alternatives include (1) denomination of savings in a foreign but stable currency; (2) fixing the value of deposits ro rhe price of a stable commodity; and (3) devising a new and stable fixed value denomination which would protect currency depreciation against exchange rates and price fluctuations.

Clearly, the above proposals revolve around the objective

to protect the fiscal operations in their presenr form, while introducing elements which may give them a form of variability thought to be the central condition of Islamic finance. Appeal to the need for protecrion of small depositors

savers

made

to draw grearer sympathy for

these

proposals. Proposals relating to indexation are largely made on this account. All these alternatives have been considered in the relevant literature at considerable length, both by Islamic economisrs and the 'ulama'associared with the process. The idea that it is

the variability or uncertainty of rerurn which is the crucial requirement in Islamic finance is highly erroneous, for in that case one may even âttempt to make a case to legitimise gambling. As elaborated at length earlier, the key ro earn a legitimate return on money is to stake a claim in the ownership of an asset whose income will constitute the said return. Risk is a by-product of ownership, not a requirement of the Sharl'ab. Not surprisingly, none of the proposals has found favour with any of the two groups.11 There is, thus, 11

Reporr of the \(¡orking Grgup on Fiqance (First Draft Report, pans I of Economy" (Islamabad: February 1992); "Report of the !íorkiog Group on Government Budgetary Deficit Financing, Commission on Islamisation of Economy, Islamabad (February 1995); and, Financing of Government Budgetary Deficit in the Lighr of "See

*d il), Commission on Islamisation

TRANSITION TO A RIBA FREE ECONOMY

unanimity of views that any attemPt to disguise interest on Government transactions would fail the test of permissibility in Islamic finance. As for the concern for protecting savers from inflation, we have discussed the relevant issues both from the economic and the Shan'ab points of vieu¡ in Annexure I. The only feasible alternative in this case is to restructure the Government's fiscal operations so that no borrowing is made for the purpose of consumption. All consumption expenditures or current expenditures will have to be restricted to the level of revenue (to and non-tax) receipts and seigniorage.l2 Development expenditures leading to the creation of assets may be undertaken provided sufficient returns are entailed which may be used to ðompensate those who provide the funds on the basis of Islamic system of finances as explained above. In case some develoPment projects entail less attractive commercial returns, these will have to be financed out of the savings from the current account. Foreign Transactions Finally, we would like to discuss the last grouP of transactions, namely the foreign or foreign currency transactions. Here, again, it is contended that no peculiar problem is posed by the task of eliminating interest from foreign transactions. Indeed, almost an overwhelming part of such transactions is assets based, involving trading of goods and services or flows of capital for investment in specific assets. As explained above, all such transactions are amenable to conversion under the Islamic system of finance.

Dr Sayyid Tahir, International Institute of Islamic Economics, Intern¿tional Islamic University, Islamabad, Study for the

Sbañ'ah Principles by

Commission on Islamisation of Economy. r2This is the safe printing of money required rc support the oormel growtl of the economy. It will be discussed more fully later.

TRANSMON TO THE

NEIüI' SYSTEM

At best a problem will be posed by such loans which are taken for what is known as the balance of payments support. In view of the general nature of such financing, not specifying the underlying goods, its immediate conversion to a new basis may pose sôme difficulties. However, this will not be an insurmountable problem so.long as it is used for financing of

imports and not

for

meeting

the budgetary Baps, a

phenomenon that has recently acquired currency in the fiscal administration of the country. In the latter case we will be faced ¡¡¡ith.the same considerations as enumerated in the case of Government finances.

Problems of

Transition

Having established the principles that would guide the transition, let us also point out the difficulties that will have to be faced during the process of transition and the ways to overcome them.

Private Domestic Transactions Some

of the problems which are often highlighted by

the

economists in this class of Ăşansactions are:

l. 2.

Settlement of existing transactions; Lfnnecessary requirement of maintaining 100o/o reserves against the current accounts, which are treated as amĂŁnah (trust);

Near impossibility of. carrying out the entire banking business on the basis of profit and loss sharing (PLS); Increased and cumbersome documentation that ate required for other modes of Islamic finance; and Lack of suitable alternatives for undertaking the business

4. 5.

of contingent liabilities (i.e. issuance of guarantees).

Each

sections.

these problems

discussed

in the following

sub-

PROBLEMS OF TRA,NSITION

Settlement of Existing Transactions

Let us first ask if there would be any problems in the in accordance with the new principles. As v¡e have pointed out in the previous chapter, the liabilities side poses little problems even at the present. For as far as the seftlement of liabilities

rupee-based liabilities are concerned, these are already in an acceptable form ever qince their conversion into the profit and

loss sharing (PLS) basis

1985.

best, there would be the

requirement of converting the foreign currency liabilities into a profit and loss sharing (PLS) basis. Technically, no problems v¡ill be faced during the process of such conversion. If banks have the opportunities to invest foreign funds and earn adequate returns on them, there is no reason why the PLS system v¡ould not work here. Indeed, before their conversion to the PLS basis, even the rupee liabilities were on a similar basis as the foreign currency accounts are. llence, a move to convert FCY accounts to profit and loss sharing (PLS) basis will be as smooth as v/as experienced in the case of rupee accounts. '$Øe may also point out that there are no requirements in the Shari'ah which would disallov¡ pooling of resources. The conditions of. mudãrabah and musbaraþal¡ are very clear regarding the conduct of managing partners. If properly stipulated, there would be no bar on these persons to manage the affairs of the business in the manner they think fit. Indeed, such flexibility is highly desirable and encouraged. Thus the PLS depositors v¡ill be treated as partners with the banks and the latter will be free to invest these resources as they think fit for the profit of the partnership. Turning noq¡ to the assets side, many economists have suggested that existing transactions (loans and credits facilities, etc.) may be left to mature and the change roward the new system be made applicable prospectively. Although this may

TRANSITION TO A RIBA FREE ECONOMY

if the change is made applicable on the existing transactions as well. There may definitely be certain advantages of doing so. It has already been pointed out that almost the entire portfolio of banks and other financial institutions is based on financing against assets, and v¡herever assets exist, in principle, an Islamic mode of finaricing can be devised to make it Shart'ah-compliant. For this reason there is no justification for allowing the transactions to mâture, once ri.bã has been recognised as an institution repugnant to Islam. There are other reasons why this may be a better strategy. First, this step will be closer to the spirit with which the institution was first introduced during the times of the Prophet þeace'be on him). Secon{ the change will be nondiscriminatory thereby avoiding creation of distortions in the system. Finally, the change may provide an opportunity to introduce changes in civil laws that would help in the seftlement of contracts that continue to linger for v¡ant of a speedier judicial recourse. Some of these matters will be discussed later on. 'What will then be required is to declare the interest-based obligations, i.e. interest and principal,l3 from a given date of effectiveness, as due and payable. The parties to all such contrâcts may be given an opportunity, if they so desire, to convert those contracts into a Sbari'ah-compliant form. Needless to say that certain concessions from the required conditions of the Shart'ah compliance will have to be allowed, on a one time basis, so that this process is complçted without posing serious operationâl problems. IØhat is meant by these concessions is that since the transactions have already been be acceptable, there are no serious impediments

l3Although it will be objectionable ro prorecr the accruèd inreresr, yet will it be desirable to do so in view of tle peculiar social conditions obtaining in the country, particularþ because of the widespread abuse to which the ba:rking sector has been subjected.

PROBLEMS OF TRANSITION

it vยกill have to be assumed that the initial conditions required of a contract were indeed concluded, while converting them,

met so that the converted contract is fully Shart'ab-compliant. It is often argued that in the presence of. a large nonperforming portfolio in the commercial banks, the conversion would be of little consequence. This is a valid point if one is concerned for the earnings from this portfolio under the new system. Obviously, the change vยกill have little impact as far as the earning potential of the portfolio is concerned. The focus, instead, is on the conversion of the liability, from an interestbased one to one without it. For this purpose, it does not

matter what is the quality of the assets in terms of their earnings potential. The benefit of such conversion will be a simpler recourse to foreclosure and realisation of securities, provided" the changes 'required by the Shan'ah are also simultaneously introduced in the legal system. The benefit will be further ensured by avoiding the meaningless accrual of income and consequent build-up of liabilities of the borrowers on such assets when it is well-known that such accrued income has no existence except under the terms of the contract. Resentes Requirement

for Carrent Accounts

is generally argued that since current accounts or demand deposits (which are not remunerated) are payable on demand these are hke amanah (trust), which cannot be used by the amln (trastee) unless he has been explicitly permitted to do so and, in the case of any benefits, he would be required to share them uยกith the depositors. Flowรงver, since no one vยกould be willing to allow the use of such deposits by banks for the purpose of earning some benefit, depositors would like to ensure the safety of their deposits. This would only be possible in case banks are required to provide 100o/o reseffes against such liabilities.

TRANSITION TO A RIBA FREE ECONOMY

This is not a particularly acute problem, rarher, it is a result of some misconceptions about the working of banks and the requirements for the enforcement of amãnab conúact. First,. let us point out that the concepr oÍ. amanab does not preclude the use of the thing(s) given in rrust ro rhe amln, provided a prior understanding ro rhis effect has been reached. Similarþ, there is no bar if the amln seeks a charge or is remnnerated by the owner of the amanah for the services he renders in the process of keeping the antanah. Therefore, the amanah contract is no bar in allowing the banks either to use the funds or ask for a remunerarion for this service. In fact, if the implicit condition is that no remuneration v¡ill be sought by the banks provided that they are allowed ro use the funds, it would be quite reasonable and legitimate.la Now so far as the security of the amanah is concerned, it is not necessary that this be accomplished through the requirement of providing reserves of an equivalent amount, for that would impose enormous hardship on banks, and will leave them no incentive to provide such a service without any cost. It may also be kept in mind that banks carry sufficient liquidity in order ro meer the overall reserves requirements and other statutory regulations so that there is no need to provide separately for the currenr accounr liabilities. Also, since money is fungible, i.e. it is not distinguishable by source, hence, so long as the overall liquidity position of the banks is sufficient to cater for the currenr accounr liabilities, this should be enough to allay any apprehensions about the security of current accounr liabilities. Indeed, the PLS sysrem presently in vogue in pakistan, is based largely on rhe above reasoning and no serious objection has been raised by the 'ulama' as regards its sbarl'ah validity. laFer a detailed discussion on the subject see the chapter on Amanab in

Mujib Allãh N^dvi,Islami Fiqb,Yol.2, pp. 473-493.

PROBLEMS OFTRANSITION

There is, however, a group of economists that insists on such provisions, but that is based rnore on an economic reasoning rather than on any requirement of the Sban'ab.rs Profi.t and

Loss

Sharingas the Main Abernative

There is a strong view held by many that the widespread use of profit and loss sharing arrangements may lead to a virtual collapse of the banking system. The arguments given in this regard generally depend on the inability of the banks to appreciate the true benefit of the business projects, the incentive for borrowers to abuse the funds or misrepresent the performance of the project (moral hazard and asymmetrical information), high cost of monitoring the performance of the projects and the abysmally low standards of propriety in business transactions prevalent in the society.l6 \üü'e are not concerned here with arguing that the profit-

sharing arrangements are superior

interest-based

transactions. Such discussions are extensively available in the existing literature on the subject which may be consulted for this purpose.lt 'What is, however, of concern to us is the

15For a discussion

of these issues see M. Umer Chapra, "Monetary Policy in in Ziauddtn Ahmad, Munawwar Iqbal and M. Fahim Klran, eds. Money and Banki.ng in Islarn (Islamabad: Institute of Polþ Studies, 1983), pp. 27-68 andMa'bid Ali al-Jarhi, "A Monetary and Financial Structure for an Interest-Free Economy: Institutions, Mech¿nism and Policy inZiauddin Ahmad, ef al, Money and Banking in klam, pp. 69-101. an Islamic Economy"

r6See Abbas

Mirakhor, "Shon-rerm Asset Concentration and Islamic B"¡kingo, in Mohsin S. K-han, and Abbas Mirakhor, eds., Theoretical Studies i.n Iskmic Banking and Fi.nance (Flousrof: The Institute for Research and Islamic Studies, 1987) pp. 185-192. 17See, for instance, the various papers collected in Mohsin S. Khan et al, eds., Theoretical Studics in Islamic Banking and Finance,It will be seen that a great deal of research has been done to esrablish rhar even if PLS were to be the only choice, no such apprehension as the possible collapse of the banking system would be justified.

TRANSITION TO A RIBA FREE ECONOMY

position of profit and loss sharing (PLS) within the overall scheme of Islamic finance. In particular, there is a need to dispel the impression that profit and loss sharing (PLS) is the only alternative to interest-based system. As we have explained in our discussion on the scope of Islamic finance, the crucial requirement of the Sharl'ah is the existence of certain assets which can yield return either in trading (boy), or in use (ijarab); or creation of certain assets which would ens-ure a flow of income þrofit) that may be shared among the providers of capital. So long as these three classes of arrangements are concluded in accordance with the requirements of the Sharl'ab, all arrangements are equally good and acceptable from the Islamic point of view. Indeed, it must be our endeavour to keep our problems simple and tractable. \Øhat the Qur'an has asked us is to refrain ftom ri.ba, without constraining our alternative choices. It would not be prudent if v¡e were to self-impose an added requirement of limiting our choice to profit and loss sharing (PLS). At this stage, one cannot help but take note of the fact that this point has not been fully appreciated by the Federal Shariat Court in its discourse on mark-up based transactions. \Øhile no exception can be taken to the Court's conclusion (vide. Para-262 of the Judgement) that mark-up based transactions, in their present form, were nothing else but interest and nothing has changed except the name, and thus they are repugnant to Islam. There are no reasons, however, to discard the instrument provided it is applied with proper care, for the financing of asset-based transactions. In our opinion, the following observations of the Court are nor fully consistent with the views held by a large body of the 'ølarna' experts working for the Islamic Banks: 255: Thefact of the matter is that "Mark-up" is a crude trading practice which has been permitted by cerrain religious

PROBLEMS OF TRANSITION

scholars under specifieil conditions. Its permissibiliry is case, it is a device questioned by other scholars. In between transactions contract of relevant in the which is

a seller and buyer of

goods. Banhs are

not trading

organisations. They are essendally financial institutions which mobilise funds from the general public and make should, them available to productive undertakings. therefore, be abundantþ clear that if the banking system

is to be Islamised, "Mark-up" is no solution and some way has to be found which preserves the financial character of

the banking institutions and steers clear of interest which is prohibited by Islam. 26lz

prominent Muslim economist, Dr M. Nejatullah Siddiqui, while commenting on the "mark-up" system

writes

under:

I would prefer that Bøi Muajjalis removed from the list of permissible methods altogether. Even if we concede its permissibiliry in legal form we have the over-riding legal maxim that anything leading to something prohibited stands prohibited.It will be advisable to apply this maxim to Bdi Muajjøl in order to save interest-free banking from being sabotaged from vrithin.'l8

These statements v¡ould give an extremely restrictive viev¡ of what the Islamic banking would be like, i.e. one based only on profit and sharing (PLS) arrangements on both sides of the balance sheet. This is how the Court has remarked in its subsequent discussion. For instance, while acknowledging that leasing (ijarah)is an approved mode of financing, under a given set of conditions, the Court has remarked that:

See

Nejatullah Siddiqi, "Comments" inZiauddin Ahmad et al, Monq ønd

Banking i.n Iskm, p. 227 .

TRANSMON TO A RIBA FREE ECONOMY

264: Although 'the leasing' is permissible in Shari'ah, we may advise its minimum use in banking system because the best modes in Islamic system as alternate to the present system, are Mudarabah and Musharakah, on the basis of the ratio of profit and loss sharing seæled between the parties according to Shari'ah.

A similar advice is contained inPara-369: 369¡ So far as the banking system in Pakistan is concerned, it has to undergo a change on the bæis of profit-loss sharing in its several forms like Mudarabah and Musharakah, etc.

In fact PLS cannot be the only alternative, as not all financing opportunities are such that definitive PLS nor would the entrepreneur be always interested to seek financing on such basis. For all these occasions there have to be ways so that business needs are met, all parties arej reasonably remunerated and the requisite conditions laid down by the Shart'ab are met. A variety ol bay'-hke arrangements are possible which may fulfil these requirements. There is no need to accord such instruments weaker legitimacy as long as the conditions required under the Shan'ab are strictly enforced. assessments can be readily made

In c r e as e d D o c arn ent ã.ti o n

There are quite a few who concede that there are acceptable alternatives to the ri.ba-based system. F{owever, even rhey are not willing to impose burdensome monitoring and supervisory

responsibilities on the financiers, on grounds that the documentation required to put these alternatives into operation is cumbersome and would lead to inefficiencies in banking operations. There can be no two options about the fact that the requirement of documentation would indeed

PROBLEMS OFTRANSITION

increase with the adoption of trade-related financing instruments of Islamic finance. It would, however, be an exaggeration ro say that this would, in any significant way, undermine the efficiency of banking operarions. Every change entails certain costs thar have to be incurred if we wish to move to a new economic system. Increased documentarion may indeed be treated as rhe .ost of the change-over ro the new sysrem. It would appear burdensome and complicating in the beginning. But ànce adopted, it would become part of the routine and cease to be a source of. any discomfort. This is exacdy the experience of a very large number of Islamic banks which are operating in almost all imponant business centres of the v¡orld. I'r fact, there are ways thar may lead to significant reduction in the required documentation once the Islamic financing insrrumenrs are widely adopted. If the financiers enter into long-term conrracts with the suppliers of goods, with stipulations which may lead to consrructive possession of goods on the part of the financiers, it would greatly reduce the level of documenration. Indeed, the large suppliers such as big departmental srores v¡ho extend credit facilities, would noi require more documentation than required under the simple credit documentation, since they possess the goods that are sold on credit. Thus if banks can evolve such arrangements wilh suppliers they may also take advantage of the simple documentation. Contin gen t Liabi litie s

A significant class of banking transacrions is known as contingenr liabilities. The most notable of contingent liabilities are the guaranrees issued by the banks to their clients. Normally, a fixed fee, based on a percentage of the amount of guarantee, is charged by banks to provide such a facility.

TRANSITION TO A RIBA FREE ECONOMY

Obviously, this is an unfunded liability, but can become funded in case the guarantee is called for payment. In such a case the liability turns into a formal loan obligation. The question arises as to hov¡ this arrangement would be covered under an Islamic setting. This is clearly a difficult area where authoritative answers are still awaited. As Usmanile has pointed out, the classical literature on the subject of guarantee is unanimous on the inadmissibility of charging any fee for providing such a sen¡ice. This position is a direct consequence of likening the process of guarantee with that of lending and borrowing. It v¡as thought that when a reward is not allowed on thè provision of money, how could this be allowed on a promise to make money available in case the guarantee was called. Flowever, this position is not based on any explicit prohibition laid down either in the Qur'an or in the traditions of the Prophet þeace be on him).

For these reasons, scholars are of the view that serious thinking is required on the subject particularþ in view of the fact that the context in which the classical Islamic legal thinking on the subject was developed has completely changed. The process of guaranteeing is no longer a voluntary

aÍfur, but has become a purely business matter. Given the benefits that accrue to the beneficiary of a guarantee, it is reasonable to expect some compensation to the guarantor for v¡hatever .ort, À. may have incurred during the process of' issuing the guarantee.

Thus, although at the present answers are not readily available on this subject, it can be expected that scholars and practical people with experience in business and finance will work out satisfactory solutions of the problem. It is, however, leSee

3L.

Muhammad Taqi Usmani, An Introducti.on to Ishmic Fi'nance, pp. I29'

PROBLEMS OF TRANSITION

for the experts of the Sbarl'ab to give their opinion whether in the transitional phase the existing arrangements should be allowed to continue or some other ad. boc arrangernents should be worked out.

\(/e close this section by noting that no

significant

problems of transition are posed in this class of transactions. The problems encountered are tractable, and arise, inevitably, during the process of a major change. Gooernment Finances The real problems of transition, however, are associated with the reforms in the Government finances. Indeed, in our view, it is the Government finances in their present state which constitute the real obstacle in the elimination of. ri.ba. There are several reasons for this.

First, the Government alone, in terms of the scale of its financial operations, is bigger than the entire financial market. This unusual size poses formidable adjustment problems, not merely in itself but also in terms of its impact on orher units of the economy that deal with the Government. In particular, its debt is owned by a diverse class of domestic and foreign entities and hence one must fully understand how they will be affected by the change and what arrangernents will have to be put in place to ensure that the change does not lead to disruption of economic activities in the counrry. Second, the Government enjoys vast lending and borrowing powers which are nor available to individuals. In particular, the Government's control over money supply puts it in a unique position to c rry the lending and borrowing operations without much consideration for the prodĂ¸ctioity of the underĂžing uses. For this reason, it provides, 'what is known in the financial jargon, at least in the denomination of

TRANSITION TO A RIBA FREE ECONOMY

country's own currency, a risk-free security in the form of its bonds or other saving schemes. Such a security is considered to be a critical element of financial sector's stability as well as a strong motive for savings. a

Third, the Government securities play a vital role in the conduct of monetary policy and the regulation of banking operations, not just in Pakistan, but elsewhere as well. For instance, banks are typically required to invest in Government securities as part of their obligations to maintain a certain type of mix between risky and risk-free securities. Invariably, these securities are fixed income securities, covered under the definition of. ri.ba. Accordingly, institutional and regulatory problems will have to be faced when extending the scope of prohibition to Government finances Given the above considerations, it will be useful to point out the questions which are normally asked while discussing the problem of Government finances in the context of the elimination of. riba. 1..

'Sühat

is the size of Government finances compared to the rest of the economy, which will be affected by the prohibition of. riba?

is the nature and ownership structure of Government obligations, both domestic and foreign?

\Øhat

\Øhat will be the status of the existing Government obligations?

\üØill

it be practical to imagine that the Government

can discharge these liabilities, and the resources come from?

so, where would

PROBLEMS OF TR.A.NSITION

Given the significant role of Government investment in development; how will the process continue in the absence of Government borrowings?

\Ă&#x2DC;ill

be feasible for the Government to stop borrowings for current expenditures when such expenditures involve salaries of its employeesl

How would the ordinary savers find an avenue of safe return for their savings-so critically needed for development-after the Government stops borrowings to which it has recourse at the present?

How would the monetary policy of the State Bank be conducted once fixed income securities are

eliminated from the market?

Are there any constitutional provisions which have a bearing on the conduct of the Government finances?

Undoubtedly, the above is not an exhaustive list of problems in this area that will be posed by the prohibition of riba. However, the articulation of a response to the above problems, while outlining the approach for their resolution, would hopefully provide some broader guidelines for determining how other problems, once identified, may be resolved. Size of Goaernrnent Finances

There is no single indicator that can settle the question of how big is the size of the Government finances compared to the rest of the economy. \Ăźe, therefore, will have to consider several indicators which may reflect the relative size.

TRANSITION TO A RIBA FREE ECONOMY

Specifically, three indicators have been considered. First, we have compared the total outstanding public debt with the debt that is outstanding with the private sector. The former is

clear as it is published regularþ by the Government and the State Bank of Pakistan. For the latter, we have used the outstanding advances owed by,the public to rhe Scheduled Banks. Obviously, one cân add to this figure some more advances, such as those made by the development finance institutions, but since those figures are nor readily available, we have not included them. However, this would not nullify the result we have arrived at.

After the stock of outstanding loans, v¡e look at the annual flows of credit. Here the comparison is somewhat straightforward. For the Government, the correct measure is to look at the annual increment in the outstanding public debt, because that represents the additional borrowings during the year. A three-year average has been taken to ensure that analyses are not distorted by * unusual year. Similar figures for private borrowings have been taken from the annual credit plan allocation for the year. Here again a three-year average is tahen to guard against unusual obsen¡ations.

To highlight the all-pervasive presence of the Government in the financial sector, we have considered yet another indicator of relative size, namely the investments made in the Government Sponsored Savings Schemes versus those offered by the scheduled banks. Here again three-year averages are taken to ensure consistency in the data. The resulting information is contained in the following tabLe2.

PROBLEMSOFTRANSMON

Table2 Structure of Financial Sector in Pakistan (Rs.

in millions)

Indicator

Value

Public Debt (Stock on 30-6-98)

2s18

Domestic

Ltsl

rorergn

t367

Scheduled Banks' Advances (Stock on 30-6-98)

644

Ratio of Public Debt to Bank Advances (1:2)*

4zL

Annual Credit by Banking Sector

Annual Government Borrowings

(3 year Average)

year Average)

Ratio of Government Borrowing To Banking

3tr 5:1

Credit (4:5) Deposits in Government Schemes plus resident 738 deposits in FCY Accounts (Stock on 30-6-98) Demand/Time Deposits of Banks (Stock on 30-6-

1072

1ee8)

Ratio of Government Deposia to Banlr Deposits

0.721

(7zB)

Source: State Bønþ, of Pabisun Annual Report, I99Z-99 *Measared impliciþ hy

annaal increment in oatstønd.ingpablir d.ebt

TRANSITION TO A RIBA FREE ECONOMY

Though

may be surprising,

but evidentĂž

the Government alone is bigger than the entire private banking system in terms of the size of. its outstanding debt (4 times that of the total private sector advances), as well as the annual borrowings it undertakes (4 times the credit flowing in the private sector). It was almost equal to the private sector in terms of the size of deposits in Government schemes. Under the circumstances, it is the Government which largely shapes the forces of demand and supply in the capital and money markets. Hence, the real challenge of elimination of. ri.bĂŁ lies in cleansing the government finances of this element.

Nature and Ownership Structure of Government Obligations There are several dimensions of a country's debt profile. The basic classification is between domestic and foreign components. In each of these, there are several important categories which point out important features of the kind of obligations attached to them. In the following table 3 we will try to capture some information about Pakistan's debt profile:

PROBLEMS OF TRANSITION

Table 3

Profile of Public Debt As on 3S6-98

DebtProfileAs on Components of Domestic Debt Permanent Market Loans Federal Government Bonds

þillion

rupees)

Special Government Bonds for SLIC Bearer National Fund Bonds (BI'ffB) Federal Investrnent Bonds (FIBs)

290 77 10 10

22 147 9

Foreign Exchange Bearer Certificates (fEBCÐ

Foreign Currency Bearer Certificates (FCBCÐ

Prize Bonds

Others Floating

t 474 62

Ad hoc Treasury Bills 6 Months Treasury Bills (Auction)

6 Months Treasury Bills (SBP)

6 Months Treasury Bills

Short Term Federal Bonds (STFB)

105

STFB for replenishment

247

Un-fi¡nded

388

Defence Savings Cerdficates Special Savings Cerdficates Regular Income Certificates Special Savings Accounts Mahana Savings Accounts

163

Savings Accounts

Others Components of Foreign Debt (million dollars) Long Term (Project related)

Short E¿ Medir¡m Term (Commercial and BOP Suooort) Source: Sute Bønk of PaÞisun Annual Report, 1997-98

L76 73 26

2 7 1

29,7t5 22,838 6,877

TR¡,NSITION TO A RIBA FREE ECONOMY

It will be useful to briefly comment on various entries in the above table. First, the domestic debt has three main components. The permanenr debt refers to somewhat longterm obligations of the Governmenr. Almost all of them are operated through the State Bank of pakistan or authorised scheduled banks. It includes such famous schemes as the prize Bonds, FEBCs and FCBCs. A recently introduced scheme was the Federal Investmenr Bonds, which were the long term bonds sold through open auction. llowever, because of their high cost, they are no longer an important insrrurnent. As on 30-6-L998, the oursranding value of permanenr debr ll¡as Rs. 290 billion, which represenred 25o/o oÍ. the total domestic debt.

The main borrowing insrrumenrs, frorn the point of view of open market operations and short-term borrowings, are grouped in v¡hat is called floating debt. Various kinds of treasury bills. of the Governmenr, issued both to the State Bank of Pakistan and scheduled banks, are included in this group. These are sold in open auction conducted every rwo weelçs by the State Bank of Pakistan. As on 30-6-199g, the outstanding value of floating debt was Rs.4Z4 billion, which represented 4to/o of. the total domestic debt.2o rü(¡ith the exception of PÅze Bonds, FEBCs and FCBCs, the instruments used to collect savings from the common people are grouped in the category of un-funded debt. These schemes are marketed through various national savings centres and ordinary savers invest in these schemes. These are, thus, the direct insrrumenrs of borrowing from the general public. As on 30-6-L998, rhe outstanding value of un-funded debt was

2.Proceeds

from these schemes are deposited in the public Account of tåe

Federation while o¡her borrowings are deposiæd

in Federal consolidated

Funds. See the discussion in Section-V regarding rhese accounts.

PROBLEMS OF TRANSITION

Rs. 38S billion, which represented 34o/o of. the total domestic debt. On the foreign debt side, the most prominent form of borrowing has been the long-term project financing from consortium2l countries. Traditionally, this has been the only

form of foreign borrowings. llowever, in recent years,

particularly after the Pressler Amendment, the net transfers (new loans minus debt servicing) from this form of financing declined sharply and have almost become negligible. As on 306-98, the outstanding long term loans amounted to $22,838 million, equivalent to Rs.1051 billion, at an exchange rate of Rs.46:US$1. The other component of foreign debt comprises medium and short térm loans. This is the new form of borrowings that emerged only in the 1990s, and in response to the curbs placed by USA and other countries on lending to Pakistan. There are a number of ways in which such loans are contracted. The most simple types are the ordinary loans fror:n the foreign commercial banks, which carry maturities of uP to one year. Then there is one issue of Eurobond listed in Luxembourg and traded in the Eurobond market. This is the five year issue. A third type is the institutional placement of Pakistan bonds for up to three years with renewal features. All of these borrowings are carried out for what is known as the balance of payments support; that is the deficit in the current account of bal¿rnce of payments is met from such borrowings. There has been a significant rise in this type of foreign borrowing, which 2lConsortium signifies the

Aid to

Pakistan Consortium,

a forum of

developed countries providing loans to less developed countries. Recently, it has been renamed as the Pakistan Development Forum. The rü(iorld Bank is the main catalyst that arranges the meetings and leads the negotiations oo tåe

forum. Each development project prepared by Pakistan is offered to this forum, where the lenders decide whether they would like to finance the foreign exchange requirements of such projects.

TRANSITION TO A RIBA FREE ECONOMY

is, besides being short term in narure, quite expensive. In the wake of poor economic growth, this new element in the country's external indebtedness has exposed it to the risk of default. As on 30-6-1998, rhe outstanding short and medium term loans amounted to $6,877 million, equivalent to about Rs.316 billion at the eichange rare of Rs.46 : US $1.. It will also be useful to look at the ownership strucrure of the public debt. There are rwo ways in which this may be done. First, we may simply indicate, from among the above table, the qualified/implicit lenders behind each of the instruments of borrowing. Second we may also consider the ownership structure of the Federal Government debt, v¡hich is published by the State Bank of Pakistan in its annual rcpoft.z2 Table 4 Ownership of Public Debt Instrument

Held by

Permanent

Market Loans

Banks

Federal Governmenr Bonds Special Governmenr Bonds for SLIC

Institutions State Life fnsurance Individuals and

E¿

(Financial)

organisations Bearer Nadonal Fund Bonds (BI.ffB) Federal fnvestmenr Bonds (FIB$

-do-

This was the rate obtaining at the time when the submissions were made.

nThe exact distinction between public and Federal Governmenr debr is oot clear. Very likeþ the public debr includes the provincial Government debts also, but exact figures are nor ¿vailable. Since here we are only concerned about the shares in ownership by various types of debt holders, this distinction is not critical.

PROBLEMS OF TRANSITION

(FEBCÐ/(FCBCÐ

-do-

Prize Bonds

-do-

Floating Ad hoc Treasury Bills 6 Months Treasury Bills (Auction) 6 Months Treasury Bills (SBP) Short Term Federal Bonds (STFB) Un-ñ¡nded Defence Savings Certificates

State Bank of Pakistan

Banks State Bank of Pakistan

Banks

Individuals and Organisations

Special Savings Cenificates

-do-

Regular Income Certificates

-do-

Special Savings Accounts Mahana Savings Accounts

-do-

Savings Accounts

-do-

Components of Foreign Debt (million dollars)

Long Term (Project related)

Governments/\(rBlA

DB/IMF Short E¿ Medium Term (Commercial

Foreign Commercial

and BOP Support

Banks/

IMF/Institutional Investors

Let us nov¡ examine the extent of ov¡nership of each of the above debt holders within the debt of the Federal Government:

TRANSITION TO A RIBA FREE ECONOMY

Table 5

Ownership of Federal Government Debt (As on 30.6.1998) (Rs. in billiong

Held By

1- State Bank of Pakistan 2- Banks and Financial Institutions Banks

Financial Institutions

Value

o/oShare

272

14.60

362

19.43

310

t6.64

02.79

Foreignlnstitutions International Institutions

813

43.64

435

23.35

Governments and Banks General Public

378

20.29

4t6

22.33

Total

t863

There are basically four classes of debt-holders, namely (1) the state Bank of Pakistan, Q) the domestic commercial b"nks and financial institutions, (3) foreign governments, commercial bariks and multilateral financial institutions, and (4) the general public, including both individuals and organisationr. fl. foreigners comprise the largest single class of debt-holders, followed by general public, domestic banks and the State Bank of Pakistan. \Øhile approaching the problem of eliminating riba, we have to keep in view how each of these classe, *oolã react to the change and v¡hat special needs of each group will have to be taken inro account while formulating pi* to give " effect to the new regime. Settlement of Obltga,tions and Required, Resources

The foremost problem to be faced here is rhe status of the existing obligations, which are, as seen in table 2, quite huge.

PROBLEMS OFTRANSITION

The issues to be addressed in this regard are: v¡hether these obligations will continue to remain; whether they will be allowed to mature; whether they will be settled either through conversion or retirement. And in case such a possibiliry exists, whether the conversion would be acceptable to debt-holders and in the case of retirement, where will the resources come from? '\üØe address these questions, which correspond to guestions (3) and (a) page 34 above, in the following

pamgraph. Regarding the status of the existing financial obligations, no expert has proposed that they be reneged. Many have

proposed that they may be allowed to run through their stipulated maturities. However, this proposal is not feasible, for the simple reason that the entire process of government borrowings has been locked in a vicious cycle, where to service the existing liabilities, resort will have to be made to further borrowings, and hence no solution will emerge if an attempt to setde them is not made. An appreciation of this position is absolutely essential. As we have explained in the footnote 10 the primary deficit is close to being zero or slightly positive; meaning very little revenues are available to finance interest payments, which aÍe largely financed from additional borrowings. Accordingll, the extension of prohibition to Government finances could only be possible when, besides discontinuing the future interest-based transactions, the existing obligations are either retired or converted to a Sbarl'ah-compliant form. The proposal to allow these obligations to mature is thus not feasible. This would entail continued borrowings, and such borrowings v¡ould only be possible on the basis of interest which would mean that effectively the prohibition v¡ould not be applicable to Government finances. Indeed, it is for this reason that the elimination of. riba from the Government

TRÁ,NSITION TO A RIBA FREE ECONOMY

finances is most problematic and would require extraordinary efforts.23

' In view of the above considerations, the experts have

that these obligations, at an appropriate date, may be declared as due and payable and ways be devised to either retire them or convert them into other forms v¡hich are Shari'ah-compliant. This brings us directly to the next problem, whether it will be practical to imagine that a settlement of these obligations can be made. Undoubtedly, the settlement of these obligations will be a formidable problem, but not something that is insoluble. The problems of settlement stem primarily due to the peculiar nature of the Government borrowings as opposed to private borrowings. At a later stage, we will deal extensively with the process of Government borrowing and explain this peculiarity. Put succinctly, the Government, at least on the domestic side of its operations, need not be bothered with the underlying uses of the borrowed funds. Its monopoly over fiat money gives people confidence that it will not renege on its promise to repay the principal with interest. Consequently, the Government is neither constrained to build a portfolio of profitable assets to ensure servicing of ensuing obligations nor does it care to distinguish between borrowed resources and the revenues that it receives from taxes ând non-tax sources. But not having a corresponding portfolio of assers, ro account for against the borrowings does not mean that the Government has no assets except its ability to borrow or print more money. There are assets that the Government has built over a long period of time other than those against which proposed2a

23Not surprisingly,

in the so-c¿lled Islamisation efforts of rhe 1980s, Government finances were completeþ excluded from the measures taken to eliminate interest from the financial sector. 2aSee the Repon of Prime Minisrer's Committee on Self Reliance Finance Division, Islamabad (April,

1991).

PROBLEMS OF TR,C,NSITION

specific loan obligations are clearly identifiable. IüØe will identify these assets in a moment, but first it will be important to understand the size of the obligations required to be retired or converted into Shari'ab-compliant forms and the feasible manner in which this process can be approached. In this sub-section, we will restrict our attention to domestic obligations, which are largely rupee-based. Using the information provided in tables 3 to 5, the following obligations are required to be adjusted: Table 6 Size and Ownership of Domestic Debt (Rs.

in billions) As on 30-6-98

Component State Bank of Pakistan

299

Banks and Financial Institutions

392

General Public

460

I otel

LTsL

On the side of the domestic debt, we need to adjust an obligation of Rs.1,151 billion, whose ownership is given in the above table. .Let us identify what possibilities exist to accomplish this goal.

Obligations of tbe State Banþ of Pakistan As on 30-6-L998, Rs.299 billion were outstanding on account of borrowings from the State Bank of Pakistan. These obligations are basically book-keeping entries as the State Bank of Pakistan is essentially a Government-owned body. There is

no need for

^ny

adjustment

on this account. Indeed,

TRANSITION TO A RIBA FREE ECONOMY

,+8

borrowings from the State Bank of Pakistan, which ate notional, would continue ro remain available to the Government in the future as well, with the only difference that no interest cost will be attached to such borrowings.25 The notional charactçr of such borrowings is reflected in the fact that in the modern monetary system, monef6 creation state function. However, seldom this accomplished through actual rransfers of printed money ro the Government. Rather, the mechanism is to borrow from the central bank, which does the actual printing of money, and

is virtually a

book

it as an asset of the central bank. Even the interest

payments, notionally booked

income of the central bank on

such borrowings, are transferred back to the Federal Government through remittance of profits of the central bank.z7 So long as this expansion is reasonable, roughly defined as equivalenr ro rhe rate of growth in real GDP, there is no problem in treating them as revenues of the state. Beyond

such limits they would be more akin to what is called as negative tax or inflation tax,28 which is highly regressive. In fact about the same considerations apply to what is known as inter-Governmental debt, which is largely between the Federal Government and Provincial Governments. These are, in the first place, not regulated on market and economic principles. More importantly, in the aggregate fiscal system of 2s

Such borrowings are notåing butBeigniorage, as defined earlier. (see p. 20).

"Ooly High Power money (rupees and coins) is meant here. The money created by banks through fractional reserve system (through checking account and otåer facilities) is included in a broader definition of money. 21n Pakistan these transfers have remained much less than the interest income of the State Bank of Pekisl¿a, simply because t}.e foreign exchange accounts were subsidisedby æ charging a much smaller fee for forex risk covèr compared ¡o the actual devaluation, with losses offset against interesr income. 28

See Rudiger Dornbusch and Sanley Fischer, Møuo-Economics, 6ú ed. (New York: McGraw-Hill Inc., !994),pp. 554-5.

PROBLEMS OF TRANSITION

the country, these are internal transactions ôf the State and as such they are merely book-keepin&rransactions. In both the above cases, for future transactions, a question of efficiency of use of scarce resources will be raised, which the interest rate is supposed to regulate. In response, it may be stated that questions of efficiency arise so long as the use of resources is determined by producdvity considerations. Since largely productive considerations have been missing in these transactions, questions of efficiency aÍe nor involved. \Øherever such considerations are relevant, Islamic insrruments of finance that can regulate the use of resources in the desired form can be found. Otherwise, the only oprion is to adopt a system of rationing whose paramerers will largely be determined by political and social considerations. Obligations of Banks and Financial Institutions As on 30.06.L9g8,Rs.392 billion v¡ere outstanding on accounr of borrov¡ings from the banks and financial institutions. These

obligations are largely the Treasury Bills and Federal Investment Bonds of the Federal Government held by these institutions. Partly these are due to some lnvestment requirements v¡hich these institurions have to make under Prudential Regulations. There are a number of ways in which these obligations can be adjusted. First, the Government will have ,o -obilir. extraordinary resources, such as through privatisation of public sector assets, ro rerire such obligations. \üØe will discuss this subject more fully in the nexr sub-section. (See pp. 50-53 below). Second, such obligations may be converred into a nonearning paper of the Government which would be redeemed over a period of time (say, in five years), but which can be used for the purpose of reserve requirements and other srarutory requirements, such as liquidity ratio and credit deposit ratio.

TRANSITION TO A RIBA FREE ECONOMY

Third, the State Bank of Pakistan may assume Part of these liabilities and remunerarc them on rhe basis of its own profit and loss position.

This last proposal is .significant and needs further elaboration. In an Islamic financial sysrem, there would be no bar on the central bank to play an active role in market stabilisation by taking positions in the capital and money markets. Obviously, its motivation would be market stabilisation as opposed to profit earning. Its control over monĂ¨y supply makes it a unique player in terms of the exercise in the functioning of the market' influence it "* Thus, the central bank will have an active investment-cumregulatory role which would provide it enough leverage to inluence the market. Its own securities, which would not be interest-based, and its investments in capital and money market would generate significant returns which it can share with its'security holders. If Governmenr's obligations to Banks are paftly transformed in such obligations of the State Bank of pakistan then the banks can hope to eĂ˘fn some positive return on such obligations, as opposed to the non-earning PaPer' Obviously, a suitable combination of these three methods will have to be used to adjust the obligations. This will ensure that no one solution is imposed which may not be the best for everyone involved in the process.

Obligations of the General Public As on 30-6-1998, Rs.459 billion were outstanding on account of borrowings from the general public. As already explained, these are the investments made by the individuals and organisations in various savings schemes of the Government. In terms of its risk bearing capacity, this is the most sensitive group that holds the Government debt. Special care needs to

PROBLEMS OFTRANSITION

be exercised in devising a plan to adjust the obligations of this group to a Sbari'ah-compliant form. The most desirable form in which the adjustment can be accomplished provided appropriate resources are available, is to replace these liabilities by the equity of the Government in its economic projects. This is a form of privatisation and we will explain the mechanism through which this can be accomplished.

adustmerit of interest-based should be noted that either the Government

Given the need

for

obligations, it may print the money and return the same to the people or else generate the necessary resources by selling its assets. The first option is obviously highly undesirable, as it would trigger massive inflation, which besides substantially eroding the value of savings would also be harmful for those who have nothing to do with these obligations, i.e. the general economy. Therefore, an alternative course has to be explored. Let us leave aside, for a moment, th; adequacy of the Government's âssets, assuming that these assets exist. Vould it be desirable to sell them and use the proceeds to retire these obligations, or trade these obligations against the value of the Government's equity in such assets? Ideally, a combination of the ¡q¡o will be required, but largely it should be the second form that should be used. This is because the economic assets of the Government, having the capaöity to meet such huge obligations, are of a strategic nature. The sums involved in their outright sale may not be easily forthcoming from the local market. Inevitabll, one will have to search for foreign investors to bring the required resources. Flowever, considering the sensitive nature of such assets, the nation may not v¡ant to see them go in the hands of the foreign investors. Accordingll, the option of outright sale may not even be feasible. This leaves us v¡ith the trading option, that is, to buy

TRANSITION TO A RIBA FREE ECONOMY

the obligations against the transfer of Government ownership of such assets. Experts have suggested that the best way to accomplish this conversion is to form a grand mutual fund of all Government equities in its economic projects, and after proper valuation the certificates of such a fund may be given in lieu of the obligations. Two questions are fundamental to the success of this scheme. First, does the Government have adequate assets that it might transfer to such a mutual fund so that it would be able to meet the obligations? Second, how would the fund be managed? Regarding the adequacy of the Government resources, no published data is available to satisfactorily determine this question. However, it is possible to identify the nature of these assets and reflect on their commercial nature. At present, by and large, all infrastructure projects aÍe owned by the Government. Projects belonging to Power, \(/ater, Highways, Telecommunications, ports and shipping, aviation, dams, oil and gas sectors are in the ownership of the Government. In

terms of specific commercial entities,

Pakistan

Telecommunication Corporation Ltd. (PTCL), \íater and Power Development Authority (\ü(IAPDA), Karachi Electric Supply Corporation (KESC), Oil and Gas Development Corporation (OGDC), Karachi Port Trust (KPÐ, Pakistan

National Shipping Corporation (PNSC), Pakistan International Airlines (PIA), etc. are owned by the Government. Besides infrastructure, a number of banks and financial institutions are still operating in the public sector. In mid-L997, according to a news item, while briefing the Prime Minister of Pakistan on the potential of privatisation, a figure of $30 billion was indicated as the value of the assets that would be up for privatisation. However, it is the Government alone that can undertake a reliable exercise on this account and determine the adequacy of this scheme. Many of these

PROBLEMS OFTRANSITION

corporations may nor be profitable bodies at the presenr, but their potential to become so is beyond all doubt. It would, therefore, be fair ro assume that the overall fund wourd indeed generate a reasonable return to the certificate holders. Regarding the managemenr of the proposed fund, it has to be professional and independent of the Governmenr influences' Indeed, this v¡ould be required ro ensure that the benefits typically associated with privatisation will be coming by transfer of ownership to the Murual Fund. This would only be possible if the fund is managed by those who could also monitor the performance of management of the underlying units. For an interim period, rhe managers of the Fund may be made ansv¡erable to a Parliamentary Committee, which will judge the performance of the manâgers. Before we conclude this section let us make an important observation. The Mutual Fund would comprise of shares of a large number of profitable assers. This would ensure considerable spreading of risk for the certificate horders. Accordingly, the scheme of mutual fund would provide nearly the same safety of investment as v¡as available under Government guaranteed savings schemes. So far our atenrion has been confined to domestic debt. The question of the manner of adjustment of foreign obligations will be discussed in the Section on Foreiin Transactions. Der.telopment Role of tbe Governrnent

Let us now address the question regarding the continued role of the Governrnent in the economic development of the country. Clearly, under the new fiscal system, the availability of resources will be constrained and hence ir would appear rh;t the overall economic development of the would "orrrrtry suffer.

TRANSITION TO ARIBA FREE ECONOMY

It must be pointed out at the outset that there is no

to supporr that the Government's development role in relation to the liabilities it has accumulated, had been .were ro be the case, rhe over¿ll burden of debt positive. If this servicing would have been tolerable, as significant grorn/th in ..orro*y would have led to higher revenues for the Governmenq rhus enabling it to service such liabilities.2e'lü(/h¿t evidence

is evident is the fact that no linkage existed betv¡een borrowing

it is not clear to what extent role of the Governrirent vzas in fact

Accordingly, and productivity. -development

the

productive, at least compared to the size of the borrowings to which it resorted. Leaving this aside, let us point out to what extent the development role of the Government will become restricted by the proposed change. The prohibition of riba would deny the Government its pr€sent flexibility of borrowing without caring for the productivity of the underþirig uses"In fact, as we saw earlier, the Government is borrowing to make interest payments and even to Pay the salaries of its employees' Such indeed would not be possible. But if there are "r"t development projects where commercial considerations justify outside financing, this may be accor¡rplished through one of the several modes which are Sbari'ah-compliant' For projects where commercial considerations are weak, such as health, education and other social sectors' the Government will have no oprion but to generate savings from irs current budget and use them for financing these projects. It should, however, be noted that the Governrnent's resources would not be restricted to only tax and non;tax revenues. Borrowings from the State Bank of Pakistan, to the extent 2eAll indicators of debt burden, such as debt servicing as Percentage of GDP' foreign debt servicing as Perceotage of expons and,exports earnings, hav-e been"continuourty d.ãIil"g. See SBP Report t997-98: Table VII.2 and Table

VII.3, pp. I03 ar.dl07.

PROBLEMS OF TRANSITION

justified by inflation targets in the economy, would also be available for this purpose, i.e. the seigniorage. Accordingly, what v¡ill be denied to the Government, after the prohibition of ri.bã. comes into force, is interest-based borrowings and nothing else.3o It should also be noted that if the GovLrnment's development role is restricted, it does not necessarily mean less development in the economy. Many of the sectórs from which the Government may have to withdraw, such as infrastructure, will be those where market considerations would enable the private sector to fill in the gap. Indeed there is no economic justification for the Government to allow its energiei to fritter away in commercial management. Its role is regulatory and should remain confined to that. Government Bonowings for Cunent Expenditare Given the fact that increasingly larger amount of borrowings are made to meet the current expenditures, including payment of salaries, it is feared that massive retrenchment will have to

3oSpace

will not permit

us but

it will

imponant rc briefly point out that

from general public is a manifesadon of {ailure of administration to generate the resources required for running borrowings

tax the

Gover¡ment. It is said that what Government câûnot get through kxation, gets through bciriowing. Are the two methods equivalent? Some econo-ists believe that these are (since future tax liabilities are incurred by loaning today), but the majority view, which is also supponed by empirical evidence, is that they are not (as those loaning rcday may not be ¡he s¿me prying higher taxes tomorrow, if ever this was to happen). See Rudiger Dornbusch and Stanley Fischer, Maro-Economlcs, pp. 587-8. Iû a system of taxation which is characterised by widespread evasion and distortions, as in

Pakistan, Government borrowings would lead

to hig¡rly adverse

for income distribution and inflation. The

reason being that prospective tax payers not only escape tâx liability but are rewarded by safe investment opponunities (for evadpd resources) in Government savings consequences

schemes.

TRANSITION TO A RIBA FREE ECONOMY

to enforce the new regime on Government finances. Since this will have a mqor impact on overall employment, extension of prohibition of. ri.bĂŁ on Government finances is opposed by a number of people. be required

This is,

however,

misplaced argument.

Since

expenditures are not marked to specific sources of funding, it is

difficult to say which of the expenditures are met from borrowings and which from revenues. Ffence, to say that salaries are paid out of borrowings may not be entirely true. The bottom line is indeed that expenditures are far in excess of revenues, and therefore, resort is made to borrowing. Thus, when attempts will be made to cut down expenditures, all types of expenditures will have to be treated as candidates, depending on the priorities that the Government may like to develop. Indeed, the sacrifice will have to come from many sources, including perhaps from reduction in the Government's wage bill. More importantly, even if it is granted that wages are paid

from

borrowings,

the

question

whether such

employment is desirable or contributes anything positively to the society? Moreover, who pays the cost of creating such

employment? Obviously, the productivity of such employment is highly suspect. As for the cost, the entire economy picks up the bill as the rising debt servicing burden is undermining the efficiency of the rest of the economy, by appropriating a disproportionately higher share of investment resources for non-productive uses in the Government sector. This process has to stop somewhere, even without any bonsideration of the elimination of. ri.bĂŁ.It is contended that approaching this problem through the elimination of. ri.ba would be less painful than the adjustments which vÂĄould be required otherwise, for those could be quite chaotic.

PROBLEMS OF TRANSITION

Availabiliry of a Safe Inoestm'ent Anenue regard to the elimination of. riba from the Government finances is the loss

An important apprehension expressed with

of a

safe avenue

investment. Once interest-based

Government securities are excluded from the financial martet, the so-called risk-free assets will no longer exist. For small and risk-averse investors this is considered an undesirable situation. '\üØithout being apologetic about the loss of such an asset,

let us point out that there would still remain avenues which could be nearþ as safe as those offered by the interest-based Government securities. In the discussion on adjustment of general public obligations, we had pointed out the formation of a mutual'fund based on those highly profitable projects which are presently operating in the Government sector. It was noted there that such a mutual fund would lead to significant spreading out of risk across profitable projects and the certificates based on such assets would be as risk-free as they can be within the parameters of the Shart''ab. But these would not promise any fixed return, though practically their expected return would be materialised.

The special mutual fund noted above is not the only relatively risk-free asset that will be available in the market. Banks and other financial institutions can dévise equally riskfree funds and schemes for depositors by pooling their deposits and investing them in a variety of uses, which may not enhil the same PLS stipulations as between such institutions and depositors. Rather, as'we have seen in the discussion on Islamic instruments, they may engage in trade related modes, where there is some risk, but not as much *s in mu(Arabab and møsbaraþah.

It is our view that the difference

between risk-free

assets

and the assets obtained through the pooling of risk across a large portfolio of assets would not tantamount to arLy

TRANSITION TOARIBA FREE ECONOMY

significant dilution in the utility of depositors forcing them to reduce the level of savings. There is considerable literature in economics that deals with the morives behind the savings behaviour. No one doubts that interesr rate plays a role in determining the level of savings but, equally, no one considers it to be the only variable affecting the saving behaviour. Income, for instance, is considered to be an equally important determinant of savings. Accordingl)¡, rhere arebo valid reasons to suspect that elimination of the so-called risk-free assets would adversely affect the level of savings in the counrry.

questions relating ro monetary policy and constitutional provisions will be discussed after we have considered the problems associated with foreign transactions,

The

to which we shall nov¡ rurn. Foreign

Transactions

The reasons that made the Government finances a peculiar in the context of foreign transactions. Investment and borrowings from the foreigners

problem are largely absenr

are essentially assets-based and hence the considerarions noted case of domestic pîivate transacrions would apply here

in the also.

As reflected in table 3 the total foreign obligations as orL 3O-6-Lgg8 amounted to Rs.1,367 billion or $ 29,71i million. Of this the long term debt is $ 22,833 million and short term debt is $ 6,877 million. The former is largely project related, and hence, in principle, specific assets were created against them. Even in the case of short-term debts some assets were created, though a ready identification of such assets may nor be possible.3l

srAs we had earlier indicated (see pp. 2ù2t above), in recenr years foreign borrowings have been made ro meet budgetary gaps also. This means that foreign borrowings have been put to sâme non-productive uses as domestic

PROBLEMS OF TRANSITION

tüüherever assets are available, a conversion of foreign liability into a shørl'ab-compliant form would be possible and

re-sp-onse should not pose much difficulty, excePt perhaps the of the for"lgoers, which we will discuss separateþ \Øhe¡e in the assets cannoi b. identified, the methods discussed have t9 context of settlement of Government obligations will be offered be resorted to. In particular, the foreigners may also fund mutual fund certificates. Alternatively, a portion of the proceeds the and ;t;it" be offered in the foreign markets,

may be used to retire such obligations' no Regarding the response of the foreigners, there is as they âre reason å U"Uã"" that ii would be adverse, as long their future assured that their investments are secure and that based on be to transactions would continue to be allowed

corrrse' commercially viable principles of financing which' of will have rc te withio the parameters of the Sban'ah' \Øhat is required is to properþ educate the foreigners' It the needs to b. *"d. clear thar by eliminating interest' country is not restricting the scope of_ business transactions; rather it is only eliminating a method of such transactions' Throughout the world, Islamic banks and financial institutions op-"r"ting on profitable basis' A large number of well "r. krro*o financial institutions have opened special counters and Islamic departments that deal exclusiv"ly ot the basis of the be not frio.ipl., of finance. llence, the country would is the restrictions often borrowings. The reason behind this phenomenos borrowings' To domestic of extent thã on prograllmes imposed Ëy IMF is orrår..-. ,rr.h ,.rtri.ìions, foreign borrowings h¿ve been made' \ühat to borrowings p"ri"pt -*n dangerous is the treod to use short-ærm foreign '-.", ,1" debt servicing obligations of long-term loans' This effectiveþ ãouo* to trading io.*p.oti* debt for more expensive debt' Since project ch"rp, servi"ing it by borrowing high-cost short-5rm-

iliA"s ¡ ur,tdlyåry JJ, iJtn *or., for-

of dJt probleÃ a country can f¿ce' Pakistan Repon t99697' P. 95.

See State

B¿nk of

TRANSITION TO A RIBA FREE ECONOMY

embarking on a venrure which is unknov¡n or untested. As long as the foreigners believe that our move is nor motivated by a desire to evade obligations to them, there is no reason to suspect that their reacrion would be anything but favourabre.32 However, it would still be prudent to allov¡ a longer period for requiring the foreign rransacrions ro be broughiin conformity with the new sysrem. A period of rwo y."r, should be allowed so that the foreigners become duly acquainted with the new sysrem before it is made applicabre on transactions with them.

Monetary Policy under the New System

In modern economies, money supply is a major concern of economic management. The basic aim of monetary policy is to control the supply of money so that it not onl). stimulates growth but also maintains price stability. In the conremporary institutions of monetary management, interest plays a pivotal role. Besides being an instrumenr of monerary policy itself, the

interest-based securities are the most important tool of controlling money supply. A question arises as to hoù, the monetary policy would be conducted in the absence of interest, both as a tool of monetary policy and as the basis of securities used for open market operations.33 32For

a more detailed discussion on Foreign Transactions see Report of the cornmittee on self Reliance and Repon òf n.," zafarur Haq commission (Lee\. 'open Market operations (oMS) refer ro rhe process by which the overall money supply in the economy is affected. The basic insrrumenr of such policy is the set of securities þonds) of either the Government or the Central Bank. By buying and selling such securities the cenrral bank increases or decreases the money supply. For instance, if the central bank wants to increase the money supply, it would be vzilling to purchase these securities and make money available there of.

on the other

hand

if ir

v¡ants

to contracr the money supply ir will sell these securities so that against their cash balaoces banks will acquire these securities. In the foi..,

"rr",

PROBLEMS OF TRANSITION

Experts have held that prohibition of interest would not lead to any dilution in the effectiveness of monetary policy to achieve its objectives.'o It is contented that under the new system the central bank will have sufficient instruments to conduct the monetary policy in the same manner as it does at present. If some instruments of the Present system are excluded, others will be added leaving the scoPe and effectiveness of the policy unchanged. To see this let us consider the position of instruments under the two sysiems, as given in the following table: TableT Instruments of Monetary Policy

Traditional Svstem Open Market Operations Reserve Requirements

Discount/Bank Rate Interest Rate Selective Credit Controls Moral Suasion

Islamic System Open Market Operatlons Reserve Requirements Bank Sharing Ratio

Bank/Depositor/Investor PLS Sharing Ratio Selective Credit Controls Moral Suasion

Open Market Operations (OMO$ will continue to be available under the new system. Obviously the securities v¡ill not be interest-based, but both the State Bank of Pakistan and as well as the Government can devise PLS sharing securities. purchasing of securities by the central bank injects money in the economy, case, money is sucked in by the central bank by selling the securities. See Rudiger Dornbusch and Stanley Fischer, Macro'Economics, pp.

whle in the latter 123260. 3aSee

Mohsin S. Khen and Abbas Mirakhor, Theoretical Stødies in hhmi'c

Banbing and Finance, pÞ. 185-t92.

TRANSITION TO A RIBA FREE ECONOMY

The State Bank of Pakistan can do so because it is a well defined commercial organisation, though it is not concerned with profitability in the same mann., th. private secror ", Bank of Pakistan institutions. But there is no bar on rhe State undertaking profitable operations and sharing the same with its shareholders or with the holders of its special securities. The Government can also devise securities based on some special projects. Undoubtedly, the scope of Governmenr securities would be .limited compared ro rhe State Bank. Flowever, this will nor be a consrraint, as the State Bank of Pakistan securities may be sufficient ro meet the needs of OMOs.

The instrument of

reserves requirements3s would continue to be available to the central bank, as there is no bar on its powers to require banks to keep a porrion of their deposits as reserves with the central bank. However, under the new system, the motivation for requiring reserves would be quite different. V'hereas under the present system reserves are a cushion against the possibility of banks failing ro meer their fixed liabilities to the depositors, under rhe new system banks will not be issuing any such liabilities, and hence rhe reserves would not be a cushion against possible failure. Rather, banks may be required, simply out of prudence, to even out the variations in banks'earnings which may lead to fluctuations in the returns to depositors. Accordingly, there are no objections to continuing with the instrument of r茅serves requirements under the new system.

35This

refers to the portion of the banks' deposits which they are required to deposit with the cenrral bank. In a fractional reserve sysrem, where the banking system has the ability to creare more credir than the acrual mo没ey (currency and coins), the reserve requirement is an imponant instrumetrt of regulating money supply

PROBLEMS OFTRANSITION

Discount Rate or Bank Rate36 obviously would no longer be available as an instrument of monetary policy. However, its replacement would be the profit and loss sharing ratio bet'u¡een banks and the central bank. As q¡e have noted earlier, there is no bar on the central bank to undertake certain oPerations with the motive to earn profit, as it does even today. The central b¿nk will continue to play the role of the lender-of-lastresort. Ii has to remunerate banks on their reserves also. For all these reasons the central bânk m y devise PLS arrangements.

As for the interest rate,37 the alternative instrument is to regulate the profit and loss sharing ratios both between the depositors and banks, on the one hand, and between the banks and the investors, on the other. Such a procedure is equivalent to controlling the rates of return to these different grouPs, v¡hich would have the same impact on the money supply just as changes in the interest rate. The 'ul4'rna', however, have warned that such a policy v¡ould be valid only when the changes in sharing ratios are prospective and have no effect on the existing contrâcts. As for the selective credit controls,3s no bar is placed on these instruments and depending on needs any one or their combination can be adopted to regulate credit expansion. The point is that as far as the regulation of money supply is concerned, Islam does not require that it be done in a

36This is the rate of interest at which banks

borrow from the central bank rc

mee! temporary shonages in their liquidity.

37Altåough direct control of lending and borrowing rates of banks is not considered a good policy, yet in Pakistan this is of¡en resoned to by the specification of minimum and maximum rates for various types of lending and borrowing. 38This refers to a set of miscellaoeo us ad. hoc instruments, like credit/deposit rado, liquidity ratio, sectoral credit targets, etc-, which are not included in the list of standard instruments.

TRANSITION TO A RIBA FREE ECONOMY

particular manner. So long as inrerest is absent, all other arrangements for this purpose may be adopted depending on the exigencies of economic managemenr. By the o*. ,olk.o, the instrument of moral suasion - an informal channel of advising banks to pursue active or passive credit expansion policy - is also available under the new system. Y/'e would like to conclude by noting that the insrruments of monetary policy will be fully intact in the new system and the ability of the central bank to regulate the banking system and control the supply of money vยกould not be compromised by the elimination of interest from the sysrem.

Constitutional Provisions

It will

be important at this stage to ask whether the process of transition would, in any way, be affected by certain provisions of law, particularly the constitutional provisions. The reason for asking this question is that no effort has so far been made to review- the provisions of the Constitution from the perspective of the borrowing powers of the Federation or Provinces and the restrictions, if. any,imposed on such powers, and the protection, .if. any, offered to the lenders to the Governments. Even in general, one has to be mindful of the overall legal framework provided for protecting the financial contracts likely to be hit by the prohibition. In our view, the above questions will have far-reaching implications for the proceedings of the Court. It will be seen that there are constitutional provisions which may have the forĂ§e to insulate the Government finances from the purview of the Court. For this reason, it is nĂ¨cessary that we deliberate on these provisions in some detail.

Legal Framework for Government Borrowings The following piovisions of thÂż Constitution of Pakistan have a bearing on the process of borrowings by the Federal Government:39 3h4ore or less similar provisions exist for the management finances.

of provincial

TRANSITION TO A RIBA FREE ECONOMY

Article-78:

(1) All revenues

received by the Federal Government and all

.loans raised by that Government, and all moneys received

it in repayment of. any loan, shall form part of the

Federal Consolidated Fund.

Q) All othermoneys(") received by or deposited on behdf of the Federal Government; or

(b)

received by or deposited with the Supreme Coun or any other court established under the authority of the Federation;

shall be credited to the Public Account of the Federation. Article-792

The custody of the Federal Consolidated Fund, the payment of moneys into that Fund, the withdrawal of moneys there from, the custody of other moneys received by or on behalf of the Federal Govemment, their payment into, and v¡ithdrawal from, the Public Account of the Federation, and all metters connectd with or ancillary to the metters aforesaid shall be regulated by Act of Majlise-Shoora (Parliament) or until the provision in that behalf is so made, by rules made by the President.

Anicle-81:

The follov¡ing expenditure shall be expenditure charged upon the Federal Consolidated Fund¡

(") (Ð (ü) (-) (t") (")

The remuneretion payable to the President and other office, and the expenditure relating remuneration payable theJudges of the Supreme Court; the Chief Election Commissioner; the Chairman and Depury Chairman; the Speaker and Deputy Speaker of the National Assembly; the Auditor General

to his to-

CONSTITUTIONAL PROVISIONS

(b)

(d) G)

The administrative expenses, including the remuneration payable to officers and servants, of the Supreme Court, the department of the Auditor General and the Office of the Chief Election Commissioner and of the Election Commission and the Secretaries of the Senate and the National Assembly; All debt charges for which the Federal Government is liable, including interest, sinking fund charges, the repayment of amortisation of capital, and other expenditure in connection with the raising of loans, and the service and rederirption of debt on the security of the Federal Consolidated Fund; Any sums required to sedsfy any judgment, decree or award against Pakistan by court or tribunal; and ^ny Any other sums declared by the Constitution or by Act of Majlis-e-Shoora (Parliament) to be so charged.

Ardcle-82:

(1) So much of Annual Budget

Statement as relates to expenditure charged upon the Federal Consolidated Fund may be discussed in, but shall not be submiรฆed to vote, of the National Assembly. So much of the Annual Budget Statement as relates to other expenditure shall be submitted to the National Assembly in the form of demands for grants, and the Assembly shall have povยกer to assent to, or to refuse to assent

to, any demand, or to

assent

a:ay

demand subject

reduction of the amount specified there inr Provided...

(3) No demand for grant shall be made except on

the

recommendation of the Federal Government. Ardcle-166:

The

executive authority

of the Federation extends

borrowing upon the security of the Federal Consolidated Fund vยกithin such limits, if any, as may from time to time be fixed by Act of Majlis-e-Shoora, and to the giving of guarantees within such limits, i{. any.

TRANSITIONTOARIBAFREEECONOMY

Evidently, the Federal Government has the authorþ, under the Constitution, to borrow and issue guarantees on the security of the Federal Consolidated Fund (FCF), under such limits as may be fixed by * Act of the Padiament. However, to this day no such law has been framed by the Parliament and as such the Government enjoys unrestrained power to borrovr against the security of the FCF.40 ÏØhat is equally important is that no law'has been framed to regulate the custody of FCF or PA of the Federation, as provided in Article-79. However, in this case a variety of Rules have been framed by the President, such as Treasury Rules, which essentially give full freedom to the Federal Government to regulate these accounts. As for the borrowings, since in the absence of specific laws, the executrve authority is exercised through Rules made by the President, one needs to find if specific rules exist which allov¡ the Federation to regulate the process of borrov¡ing.No such specific rules on the subject exist. Thus resort has to be made to the Rules of Business which regulate the business of Federal Government, in the absence of any specific laws and rules.

specified in Rule 3(3), indicates, at the entry '13 Finance Division', the functions assigned to the said division. There at sub-entries 6 and 7 we find the following items:

In the Rules of Business,

tr,

Public debt of the Federation both internal and external;

borrowing money

Schedule

on the. security of the

Federal

Consolidated Fund; Loans and advances by the Federal Government.

Thus the lending and borrowing operations

the

æAlthough space will not permit us to explain this point in detail, it is quite clear that this unrestrained authority þas played i key role in the,creation of poor fiscal discipline and in the coûsequeff accumulation of public debt in tle country.

CONSTITUTIONAL PROVISIONS

Federation are performed by the Ministry of Finance u¡ithin the framework provided in the Rules of Business. Indeed, the rules are silent in requiring specific steps by the Ministry of Finance while performing such functions. This means the Secretary Finance, or at best the Minister for Finance, are free to decide on these subjects, though if these are considered to be important policy matters, prior consultation with the Prime Minister is necessary. The Cabinet, apparentþ, is not required to be taken into confidence, as can be seen from Rule 16 that specifies the cases required tô be brought before the Cabinet. The list does not contain borrowing proposals. In the aþsmce of any legi.slatiae resnictions, tbe bonoai.ngs are lørgeþ determined by the expedi.mq of tbe situation. In particalar, borroaings øre not resti.ctedfor specif,c ases. From this oery flaci.bili.ty, the Goaernment acqaires this aniqøe pouer tbdt it can bonou uithoat at all beingbothered about the prodøuioity of the ases to ubi.cb tbe borrowed resonrces dre applied.

Indeed, since all moneys from revenues and loans are credited to FCF (and some to Public Account), expenditures are inçurred without regard to the sources of funds. More importantþ, as we havr shown in previous sections, no accounting is done for identifying the liabilities created by certain expenditures. Reuenaes are mixed ap ui,tb proceeds of loans, and both are treated at pd.r.

should also be noted that no distinction is made in rupee or in foreign exchange, or from local or foreign markets. Thus the Government can decide freely ttre mix between foreign and local borrowings or in nrpee or in foreign exchange. Under the Federal Legislative List, at entries 9 and 10, the subjects of foreign loans and foreign aid are federal subjects. Accordingly, the foreign obligations of Pakistan are by and large the obligatio¡rs of the between borrowing

Federal Government, assumed on the security of FCF.

TRANSITION TO A RIBA FREE ECONOMY

These constitutional provisions have not attracted much judicial review. There are no authorities on the subject dealing with the scope of financial powers enjoyed by the Federal Government under these provisions. Hence, the true scope of such powers remains undetermined. Before we close this section, let us also point out that the above legal framework was evolved at least 63 years ago, first

-in the Government of India Act, 1935 and, with slight modifications, later incorporated in various constitutions .of Pakistan. A comparative position of these provisions across different constitutions is given in Annexure-2 f.or reference.

Implications of the Legal Framework

There are some important implications of the above framework governing the process of Federal Government's finances. evident:

In particular, the following

(1) The Federal Government

observations are quite

enjoys borrowing powers

which are constitutionally sanctioned and on these powers no limits have been placed by any Act of the Parliament;

Ă&#x2DC; (3)

The borrowing transactions, i.e. payments of interest and principal, are protected by their inclusion within the list of expenditure charged to the Federal Consolidated Fund; Charged Expenditure enjoys the protection of complete insulation from parliamerLtary oversight. Although such expenditure can be debated but would not be put to vote, and hence no cut motions can be moved in respect of such expenditure. More impoftaĂŽt|y, since these are charged expenditure, they take prebedence over all other

CONSTITUTIONAL PROVISIONS

(4)

expenditures. Apparently, such obligations will have to be discharged prior to incurring any other expenditure. Together with the absence of any Act to regulate the custody of the FCF and PA, the Federal Government has manage the finances of the complete freedom

Federation.

Before we deliberate any further on this subject, it is important to point out that at the present Government Finances are not directþ hit by the decision of the Federal Shariat Court, except marginally. This could be the result of the fact that the FSC has not examined all the lav¡s which would be hit by the prohibition of. ribã, as we shall have the occasion to point out in the next section. But, in view of the framework explained above, the real reason is that the Government's borrowing po\¡¡ers emanate directþ from the constitution and hence there is no law that can be struck disabling the Government from borrowing on the basis of interest.

Given the above constitutional provisions, it is clear that Government Finances are effectively outside the purview of Federal Shariat Court¡ because it is not competent to examine the proyisions of the Constitution. Since borrowing powers are protected under the Constitution, together v,tith the transactions c¿rried out in pursuance of such powers, apparentþ tbe process of probibition cdnnot be extended to tbe Gooemmentf.nances ander the existing scheme of judici.øl rasi.eut of ldus øitb regard n tlteir consistency uith the i.njønctions of ßlam. 'W'e are thus led to the inevitable conclusion that within the existing constitutional framework, the prohibition can at best be applied tó the private transâctions and not to the

RANSTTTONTOARIBAFREEECONOMY

Government finances, unless of course the Constitution is amended.*1 'W'e

must warn, hoúever, that this should not be any basis

for any complacency on the part of the Government. For those who would lend to the Government would have been barred, through other laws, to invest in Government bonds. For instance the FSC has already struck Section 22(l) of, the SBP'Act, L956 that enabled the bank to purchase bills and other commercial instruments of discount (see para-328 of the Judgment) and similar provisions of the Banking Companies Ordinance, 1963 (see para-340 to 342). Hence, there would be no one to purchase the Government bonds or securities.

al Stricdy speaking, whatever is stated above is applicable

only to the extent that no la¡v exists that enables the Government to borrow. But the Rules made by the President (see Constitution of Pakistan, Art. 79 on pp. 69-70) for keeping the custody of Federal Consolidated Fund and the Public Account, may still be challenged, for they allow deposit and payment of mooies relating to loans and i¿terests. Similad¡ provisions of Rules of Business that allow the Federal Governmenr ro borrow þata-L63) may also be challenged. Hence, effectively it may still be possible to challenge aay of tle instruments used by the Government to exercise its constitutional power to borrow.

Efficacy ofJudicial Power To Eliminate Riba

'We

in a position to deliberate the important question of how far the judicial recourse is the desirable method to are now

ehmínate riba.

There are no two views on the fact that the iudicial Power examine laws with respect to their consistency with the

Islamic injunctions is an indispensable tool to meet the objective of bringing the country's legal code in line with the Sbøti.'ah. F{owever, there may be occasions where this method

will not be the answer in rooting out the undèsirable provisions of lav¡s. In our view, the problem of the alone

elimination

riba is one such area. Before we elaborate this point, let us briefly descri'be the of.

methodology of judicial reviev¡. Under the Constitution (Articles 2O3A to 203IÐ, the Federal Shariat Court has been empowered, either on its own motion, or on the petition of a citizen of Pakistan, or of the Federal Government or a Provincial Government, to examine and decide the question whether or not a law or a provision of lav¡ is repugnant to the injunctions of Islam. Once examined and decided, the respective Governments will be given a specific time to amend the lav¡ or provision of lavr to bring it in conformiry with Islam, after which the said law or provision of lav¡ to the extent it was held to be repugnant to Islam will cease to have effect. Under certain conditions, an appeal from the decision of the Federal Shariat Court lies to the Shariat Appellate

TRANSITION TO A RIBA FREE ECONOMY

Bench of the Supreme Court, v¡hich may yary from or uphold the decision of the Federal Shariat Court. This methodology would be highly effective under two conditions. First, when the law or the provision of a lav¡ has a limited application, which means that it does not have wide application in practice. For instance, gambling v¡as sanctioned under a specific provision of Pakistan Penal Code and it was not practiced at awide scale. Second, *h"o oo .rr".Lrr* would be created in case an alternative legislation was not framed.

Thus in the case of gambling, no alternative legislation was required neither was it made. Once the law ceased to have effect, the matter ended there. In the absence of the above two conditions, the above methodology would have to be modified to avoid undesirable implications. The subject o[. ribã. is undoubredly one in which the above conditions are missing. First, there are numerous laws that sanction riba and prorecr the transactions based on riba.Unless each and every law is reviewed and the provisions to this effect are held repugnant, the issue would nor remain fully examined and decided. Second, even when this is done, 'the matter would not be resolved unless alternative legislation is put in place. For riba is a pivotal element of the modern

A dangerous void will be creared if alternative arrangements are not put in place to substitute the riba-based transactions. Undoubtedly, this is not the problem of the Court, but the peculiarities of the situation are such that they cannot be ignored altogether. 'What we have stated above is exactþ the situation in hand. The Federal Shariat Court has examined some 20 laws, and the rules made therein, and has held various of their provisions as repugnant to Islam. These lav¡s were examined both on the basis of petitions moved by a number of parties as well as on sr,to rnoto notices issued by the Court. IJnfortunately, these are not the only laws that dealwith ribã, financial system.

EFFICACY oF JUDICIAL POTTER TO ELIMINATE

NBÃ

There is a much larger body of laws (see Annexure-Ill for some such laws) which has been left out from the ex¿mination of the Court. These are not unimportant laws. They include some of the most important economic lav¡s in our statute books, such as the Income Tax Ordinance, L979, the Companies Ordinance 1984 and the laws relating to the establishment of some banks and financial institutions. \Øe thus have an awkv¡ard situation. From a purely legal point of view, even if the Federal Shariat Court judgment is upheld by the Supreme Appellate Bench, these lav¡s would remain effective, unless of course these are either examined by the Federal Shariat Court in the same manner as it examined the lav¡s covered in its judgment or the Government voluntarily amends them after the judgment of the Supreme Court. Under the circumstances, we are faced with an extremely delicate situation. The Court is obviously constrained by its jurisdiction which requires it . to examine and decide repugnancy or otherq¡ise of a lav¡ and nothing more. But if a decision is given v¡ithout having the necessary assurance for alternative arrangements, the country may be pushed into a void that would be harmful to the smooth functioning of its financial system. In our view the following strategy deserves the consideration of the Court:

(1)

The Federal Shariat Court may be asked to take sao moto action regarding the laws left out from its examination and decide the same days;

within

short period of time, say 90

The Government may be asked to undertake this exercise at its own and take corrective steps just as it u¡ill have to do in the case of laws that have been declared as repugnant to Islam;

TRANSITION TO A RIBA FREE ECONOMY

As for the overall straregy for a smooth transition, passage of a legislation by the Parliamenr is rhe only answer. A time frame may be allowed for the actual passage of the legislation.

Beyond that, the Court may specify a time interval for the applicability of prohibition u¡ith respecr to different classes of transactions, domestic, Government and foreign. This time will be allov¡ed keeping in viev¡ the relative difficulties of transition in different classes of transactions. The same law should provide the framework for the settlement of existing obligations, particularly of the Governmenr, and such other m¿tters as the prwatization of assets and-establishment of a mutual fund. A draft law along the above lines was also recommended in the Report of the Zaf.ar-ú-HaqCommission.

Concluding Remarks

these submissions, our focus has been to argue that an alternative system not based on ribø does exist, that can smoothly substitute for the ri.ba-based system. Our approach has been general, in the sense that we have addressed all sectors of the economy which will be affected in case the prohibition of. ribã is implemented without any exceptions. The problems that will be encountered in the process have been identified together v¡ith some suggestions for their resolution. Furthermore, it is contended that none of the problems is such that its presence could create doubts about the viability of the alternative system. More importantly, it has been highlighted that the faqaba'throughout Islamic history have been giving rulings keeping in viev¡ the genuine needs of the market and the imperatives of changing times. Flence, there need not be any apprehension that the system will be tied to a straitjacket of dogma. Ffowever, we have also shown that in the present case it will not be desirable that the institution of. ribø be eliminated through a judicial action. This is because of the pivotal position occupied by this element in the structure of our economy. It would not be sufficient that we simply declare ri.bã. as repugnant to the injunction of Islam. \üØe must do everything possible in motivating and requiring the Government to undertake the necessary legislation for this purpose. It is only after an alternative framework for continued working of the financial system is put in place that the prohibition can be desirable and consistent with the larger objective of a peaceful and prosperous economy.

Annexure-1" A Note on Inflation and Indexation

The twin issues of inflation and indexation have come to occupy a greât deal of space and attention in the discussion on ribã.Thekey question is whether it is permissible to make any allowance of inflation in lending and borrowing transactions. The Federal Shariat Court was seized with this matter when the Court included the subject in its questionnaire sent out to er,ninent scholars for their views, and then the judgment itself devoted significant space in deliberating on the question of permissibility of. any compensation to lenders on account of inflation or indexation of loans [see paras 153 to 23t of. the judgmentl. Undoubtedly, the discussion in the judgment is fairþ extensive and covers nearly all that is needed to draw a conclusion. However, we would like to approach the problem from a different perspective so that inflation is not seetr as a problem peculiar to the question of the elimination of ri.ba. Also, we would like to develop stronger arguments for refuting the case for indexation. To these purposes this note is devoted.

It is not uncommon that the discussion of inflation and indexation is carried without clearly spelling out the issues that require a resolution. At the outset, therefore, it is imperative that we must develop a clear focus on the nature of inquiry in this area. In our vievr the following questions may help develop the right focus:

ANNEXURE

At the time of prohibition on ri.ba, money was comprised of gold and silver coins and fulas. How does the present paper money differ from such monies and what implications will it have for the meaning and prohibition of. riba?

2) 3)

Is inflation a modern phenomenon?

\Øhat is the role of money in the inflationary phenomenon?

What is indexæion and how does it work?

Under the present-day monetary system, in so much as it is believed to have been the primary reason behind the inflationary phenomenon, would it be desirable to evolve values of economic variables which are insulated from inflationary pressures? 'lüØhat

is the position oÍ faqaha' on indexation, particularly in the context of their rulings on fulas?

Let us answer each of these questions in the same order.

Money

There

is little doubt that money has evolved beyond

recognition from the days when it was comprised of gold and silver coins. This position has also been recognised by experts on Islamic fiqh. It is now a seltled position in fi.qb that the paper money now enjoys the same rights and obligations as v¡ere stipulated for the old monies (nøqÐd) Flowever, for the present we would confine our views on this subject from a purely economic and financial perspective.

TRANSITION TO A RIBA FREE ECONOMY

Money is known to perform the follov¡ing functions: (1) medium of exchange; (2) store of value; (3) unit of account and (4) standard of deferred Payments. In fact, for the fourth function, the debt transactions, (1) and (3) are combined, as not only debts are denominated in money but payments are required

as such.

Ever since the division of labour began to take roots and exchange was the necessary ;pecialisation became common, ingredient to support and sustain this process. But exchange would not be possible, or at least would be extremel¡i inefficient, unless it was facilitated by * efficient medium. Money, an evolving phenomenon even to this day, is indeed the continuing pursuit of this desire. Few subjects in economics are as controversial as money, in all its dimensions such as its definition, origin and the real causes of its existence. The sentiments about money are best summed up by John Stuart

Mill:

There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than.money; exc.ePt in the character of a contrivance for sparing time and labour. It is a machinery for doing quickly and commodiousþ, what v¡ould be'done, though less quickly and commodiousþ, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order.a2

For our discussion,

it is instructive to note that money

has passed through at least.three known stages: commodities, metals and paper. \Øithin these stages, the stâge when some

commodities sen¡ed as money is of little interest, though 42

Mill, John Stuart, Principlcs of Politi.cal Econorny añth sorne of thei.r Applications to Social Pbilonplty, ed. IüJ. Ashley (London: Longmans, Green andCo., 1909), p.488.

ANNEXURE

may have significance for other reasons. Indeed the recorded history tells us that the use of meral as money can be traced back to 2000 years BC. Even its standardizatioî as a medium of exchange (coinage) is traced to some 7OO BC. Thus Aristotle has written as follov¡s: The various necessities of life are not easily carried about, and hence man agreed to employ in their dealings with each other something which was intrinsically useful and easily applicable to the purposes of life, for example, iron, silver, and the like. Of this the value wâs ar firsr measured by size and weight, but in process of time they put a sramp upon ir, ro save the trouble of weighing and to mark the value.a3

Evolution of Money Let us briefly survey the main aspects of how the money has evolved to its present form. Our interest would be to understand the monetary system that existed at the time of the advent of Islam. As we shall see, the system that prevailed at the time of the advent of Islam had essentially evolved by the year 7OO BC and survived until the 19ú century. This system is largely the system of coins: gold, silver and copper. The main features of this system v¡ere:aa

(1) It dates back to Greece, v¡here the earliest coinage is attributed to King Croesus(560-546 BC) of Lydia (Asia Minor or Turkey), the earliest man known for his fabulous wealth. Gold (denarium), silver (drachm, rerradrachm (4 drachm), obol (1/6th of drachm) and bronze (chalcoi was denominated in obol) came successively in use.

See Friedman, Milton, "Money' ia Macropædia, The Nea Encyclopædi.a Britannicø,15ù edn. (Chicago: Encyclopædia g¡i¡¿nniça, Inc., 1985), vol.24,

p. 333. 44Ibid., pp.333-339.

TRANSITION TO A RIBA FREE ECONOMY

82 Q)

(3)

This system vrâs supported by an elaborate system of money changers and rates of exchanges across different types of coinage. The money changers were licensed by ciry states and they charged commission for their services. They performed two functions, nameþ (1) changing foreign coins into local coins, and (Z) from one metal þ another.

The work of money changer was made efficient and was regulated by another se¡vice provider, who was officiall/ appointed, and was called dokimastes or coin-validator, whose job was to verify the contents of various coins and to Prevent forgeries.

(4)

Hellenistic expansion brought large geographical area within its influence where coins were circulated and made it possible for other civilisations,. most notably lranians, to engage in coinage. The notion of Royal coinage emerged during this period.

Rome brought an end to the Greek coinage. Initially, the Romans, in their characteristic sryle of conquests' left the Greek coins continue to float but under their authoriry. After the establishment of monarchical power by Augustus, the first Roman Emperor (31 BC - 14 AD), the imperial portrait appeared on almost all the coinage produced

(5) The rise of

throughout the Roman empire. (6)

At the advent of Islam, it

(7)

This continued to remain so until 'Abd al-Mâlik ibn Marwan introduced the first Islamic coins. This marked a significant break from pictorial punches to calligraphic inscriptions.

was the Roman-Sassanian monetary system that prevailed in Arabia (Dracham came from Iran and Dinar and Bronze came from Rome).The Prophet þeace be on him) tacitþ allowed this system to continue.

ANNEXURE

(8)

It is said that of the two things a Muslim ruler used ro announce his sovereignry with were rhe mention of his name in the Friday sermon and striking of. coins-siþþab.

(9)

Orhan (r.1326-1360) was rhe first Ottoman ruler who engraved coins in his own name.

(10) The three coins that prevailed in the Isl*oi" world were dinar, dirham and fulas. The last one was made of copper, and was equivalent of bronze of the Greek sysrem.

The next stage in the process of money evolution came through the introduction of paper money. The following are the important features of this evolution:

(1) It started essenrially with a substiture of copper coins which were becoming unwieldy. Chinese were the firsr ones to invenr

pâper cuffency, simply because they invenred the paper. Ffowever, the modern developments in paper currency owe ro the traders of rhe \üfest who invented bills of exchange and goldsmiths who invented deposit receipts which eventuaily became currency notes.

Q)'

Four factors are imporrant in determining the acceptabiliry of notes: (i) inadequacy of their backing by coin; (ii) unreliabiliry of the institution or people issuing the notes; (iii) social, political and economic circumstances in which rhe nores were issued,

"nd

(rv) the risk of forgery.

(3)

More akin to copper coins, they were privately produced until very recentþ.

(4)

They were initially started with rhe backing of gold, but the Bank of England abandoned this process n t794 v¡hen Britain v¡ent to war against France. It did so in response to heavy v¡ithdrawal of gold. In 1820, the process wæ srarted agaínbv.t was again discontinued

(5)

TRANSITION TO A RIBA FREE ECONOMY

The so-called gold standard functioned on-and-off between 1800 to 1933.

It will be an over-simplification to claim that the Present money, in its paper form together with the present requisite institutional set-up, would cârry the same meaning as the metallic money. Þo, oo. - and this is perhaps the most significant of the differences - the latter was limited by the total ropply of the metal v¡hereas' at least theoretically, the former can be supplied in virtually unlimited quantities. The limits on the supply of coins gre tly constrained the potential of economic activities, which were made possible only after the evolution of paper mciney. This may alone be the most significant reason why, despite numerous mishaps in the process of its evolution to PaPer form, there was never a serious effort, whenever reforms were considered, to insist on backing the paper to a commodity like gold. As a medium of exchange it did away with the deficiencies of uncertainty of measure that survived the metal money even after the introduction of coinage. Similarly, as a store of value, the paper money affords enormous convenience not imagined with the metals except at a great cost. However, by the same token, such differences should not obscure the fact that in essencè tuo moni'es perforrned the same, fanctions, albei.t uitb oastly di.f*mt efrci'mcics and scales. Indeed, the statement is true by definition, for otherwise we may be considering t'q¡o different things. That the old metallic money played the first three roles, namely those of medium of exchange, store of value and unit of account' needs no proof. rü(/hat is not immediately clear, however, is whether it also acted as the unit of deferred payments. In fact it is this role of the money which must engage our attention as it has the most direct bearing on our discussion on indexation.

ANNEXURE

In its treatment of the History of Indian Civilisation in the period 150 BC and AD 300, under the heading 'Finance', the Enqclopaedia Britannica reports as follows: Increasing reliance on money in commerce greatly augmented the role of the financier and banker. Sometimes the wealthier

guilds offered financial services, but the more usual source of

money was the merchanr financier (Srtçthr").

Coinage

proliferated in the various kingdoms, and minting attained a high level of craftsmanship. The most wideþ used coins were the gold d.tnãrøs and sar¡ømal based on the Roman denarius (L24 grains); a range of silver coins, such as the earlier harsã.pana or pa.na4 (57.8 grains) and the fuurnana; an even wider range of copper coins, such as the ma¡a (9 grains), þaHø (2.25 grain$, and a variety of unspecified standards; and other coins issued in lead and potin, particularly in wesrern India. Usury was an accepted pan of the banker's trade, with 15 percent being the rypical interesr rare, although thir varied according to the enterprise for r¡¡hich the money was borrov¡ed. Expanding trade also introduced a multipliciry of weights and measures.a5

Under the term Pav¡nbroking, rhe Enqclopaed.ia Britannica also informs us that:

[Pawnbroking was the] business

customers

who have

advancing loans ro

pledged household goods or

personal effects as securiry on rhe loans. The trade of the pawnbroker is one of the oldest known ro humaniry; it existed in China 2,000 to 3,000 years ago. Ancient Greece

and Rome were familiar with its operation; they laid the legal foundadons on which modern srarurory regulation v¡as buiha6

See art. "India" in Macropædia, The Neu Enqtclopædia Britannka, 15ú edn. (Chicago: Encyclopædia Britannica, Inc., 1985), vol.2L, p. 41.

ß See "Pawnbroking" in Micropædia, Tbe Neu Enqtclopædia Brì.tannica, L5ú edn. (Chicago: Encyclopædia Britannica, Inc., 1985), vol.9, p. 217.

TRANSITION TO A RIBA FREE ECONOMY

This position is also endorsed in the literature on Fiqb, as we shall see in some detail in the next section. For the Present let us just point out that Fiqh is replete with examples as to how partnerships and muQ,arabab conttacts are formed. The capital has been defined as liquid cash, with the many jurists lolding that such arrangements cannot be formed by contribution in kind, unless of course converted in liquid cash'

\Øe are thus justified in concluding that although the money has greatly evolved since the time when prohibition of ri,bawas ordained, it continues to perform essentially the same roles as previously, though in a much more efficient manner and on a much wider scale.

Falasnthe Isla-ic Monetary System

\íithin the context of money, it is important to spend some time on the nature of. fulns, which formed part of the monetary system that prevailed in the Islamic world. The to single out this unit is motivated by the fact that some rulings of. fuqøba'in the context o[. falas have attracted considerable atteption of exPerts on the question of reason

indexation.

Before we proceed further, it will be useful to keep in view some of the modern terminologies regarding money which have a bearing on the following discussion. The following table describes them:

ANNEXURE

Table

Glossary of Some Useful ConceptsaT Term Full bodied money

ìtleanine Money whose metallic cotrteût hâd

value in

non-monetary uses (such as in making jewellery) equal to their value in exchange.

Commodity Sandard

monetary system that is based on full bodied moneys. The famous God Standard was an example of commodity standard.

Representative Full Bodied money

system of token moneys that have little intrinsic value but that is backed (can be converted into) a commodity such as gold

and silver. The tokens may or may not be metallic. The US and some otåer countries used tåis system undl the .middle of this

century, when gold and silver certificates by US Treasury which represented the value of undedying metal as

v¡ere issued

fixed by the Government. Fiat Money

FiduciaryMonetary

A System based on fiat money.

money that has little commodity value compared to its value in exchange. This mo¡rey is issued by Government, Central Bank and other financial iostitutions.

Svstem

As is well known, fpr the greater paft of Islamic history, the monetary system was comprised of three coins, nemely gold silver and copper. The copper coins v¡ere known asftuhrs. \íhereas the first two coins had intrinsic value equivalent to the content of their underþing metal, fulas were nor on the az

See

({.{ew

R.L. Miller and D.D:, Ven Floose, Modøn Monq and Banking 3d edn. York McGraw Hill, L9g3),pp. 13-15

TRANSITION TO A RIBA FREE ECONOMY

Their intrinsic value was only a fraction of their In this respect, while the silver and gold were, what is now called, full bodied monies, the fulas were a fiat money, having a face value in excess of their intrinsic value. Unlike the full-bodied moneys, fulus afforded great transâctional convenience. They were minted in abundance and were quite useful in small exchanges in v¡hich the use of gold and silver coins would have been a problem on account of divisibility. Their acceptability was not due to either their intrinsic value or their being a representative money. It was purely due to trust and confidence that these were acceptable in the market. Obviously, this must have come about after a long process which must have its pitfalls also. Some of the problems withfulns are v¡orth nodng: same foodng. face value.

(Ð Falns had a fairly limited geographical acceptability; a) There was no single standard regulating their size, shape, denomination or weight of the coin; (3) Many kinds of falas circulated side by side, with varying degrees of acceptability and values in exchange; (4) There was no control over the supplies of the coins; and (5) Fulus went out of circulation quite frequently, hence they cauSed considerable unóertainty about the value of

transactions, particularþ those based

on deferred

Payments.

It was due to such limitati ons oÍ. fuløs that one encounters significant differences in the views of fuqaba'regarding their treatment as money. Two such differences are wofth mentioning, as they have important bearing on our final discussion on the subject. First, it is well known that exchange of similar commodities is prohibited in Islam, for it may give rise to ri.ba al-fadl, unless in equal quantities and by spot exchange. Gold and silver are among the six commodities

ANNEXURE

enumerated in the famous ab-aú'th on the subject of riba al'fad). Thus any exchange between them would clearþ be violative of '\üØhether

this rule extends to falas is not immediately clear. For one thing' it is not covered in the six commodities. But more importantly, there is a very large variety of fulns circulating in the market and, as such, on the face of it, these are not similar things. Imam Ab¡ Hanifah ând Imam Abu Yúsuf are of the view that fulus can be particularise{ and in this respect these are like goods, which

this injunction.

can be traded. Accordingly, these føqaba'have allowed the sale

fals for two fulas. On the other hand,

Imam at currency, Mulrammad, considering them as absolute Par with gold and silver, would not approve of their exchange. Clearly, the former consídered falus rs non-money while the latter considered them as money, at par with gold and silver. Secondly, in the discussion on partnership and rnøQarabah, an important aspect is the composition of capital under these arrangements. There are no differences among the føqaba' regarding the use of liquid cash and the capital of such ârrangements. However, differences emerge whether goods can be the capital or not. Generally, goods are not considered suitable for capital, unless they are sold and are converted into cash. There is also no difference that gold and silver coins are cash and as such are suitable for the formation of partnership or madarabaå. However, strong differences exist whether falns are suitable for this purpose or not. More or less along the same line of reasoning, Imãm Ab¡ Hanifah and Imãm Abü Yusuf would not appiove of. falas as capital for partnership xtdmudatabah,while Imãm Muhammad approves this so long as the fulus in question are in circuladon. Ironically, despite these limitations, fulns had all the qualities that will be found in the modern paper currency. To see this point, consider the follov¡ing table:

one

TRANSITION TOARIBA FREE ECONOMY

Table 9 Comparison of Old and New Money Characte

Description

ristic

Mediumof

Acceptable in

Exchange

exchange

Unit of

Used

Account

expressiog values

Gold Coins

Silver Coins

Fulus

Hish

Medium

Hish

Medium

Hish

Low

Hish

High

Hish

Poor

High

Hish

Poor

Hish

High

Hish

Low

Hish

Low

Medium

Hish

Poor

Hish

Paper

Money

of goods and services

Store

Used

Velue Standard

in holding

v¡ealth

Deferred Peyment/ Caoital

Used

exPressmg

loanlinvestment/ credit transactions

Other desirable

nronerties

Portability

Ease

Durability

Abfityto

in carrying

endure physical uses/strains and Prevent wortr-out

Divisibility

Abiliryto divide itself in increasingly small units as per tåe .market needs

Standardis-

Abilityto

¿bilitv

standardise

in the

ANNEXURE

form of units of equal quality and indistinguishable physical aPPearance

Recogniz-

Abilityto

ability

recognised

Hish

Low

Hish

High

Hish

Poor

High

Hish

Poor

Loqยก

Low

Hish

quickly and distinguished

Intrinsic

from counterfeit Value in use, as

Value

opposed

value

in exchanee Predict-

Abilityto

ability

predict the value (exchange rare,/purchasing power) in the face of changing

of value

demand/supply conditions Extent of Supply

Adequacy of quantities to meet economic needs

Institutio-

ยกal

Setup

Control

Oversight

Gow./

Gow.

supplies

Pvt.

Bank

National Monitoring

None

Central

Sources

Banks

Agency

Multiple

Simultaneous

Standards

existence

several currencies

Yes

TRANSTIONTOARTBAFREEECONOMY

From the above table, the following

important

observations can immediately be noted: (1)

Evidently,

it is the falns

which can rightfully be form of paper money. In particular, rhe three critical features of modern money, namely its fiat character, designated as the one which has evolved in the

abundant supplies and uncerrain purchasing power/exchĂ˘nge rate, were shared only by fulns. Q)

In the process of evolution, the paper currency has shed all those defects that made the futas a somewhat imperfect money. In parricular, the problems of poor store of value, unsuitable mode for deferred payments or investments, lack of standardisation, difficulty in recognition and lack of durability were overcome by the paper *orr.y. More than overcoming these defecĂ&#x;, rhe biggest advance was made in the creation of an institutional framevÂĄork which was completely missing under the old system, but which is the single mosr imporranr reason behind giving the paper money its fiat

character

and

widespread acceptability and confidence for use in transactions. Although there continue to remain many institutions which supply paper currency, there is a national agency everywhere in the world called the Central Bank, which has been mandated to control and oversee the functioning of the monerary sysrem based on paper money. The existence of such an institution may alone explain the differences in the acceptability of falas andpaper money.

ANNEXURE

(3)

It will be noted that the paper currency is not simply fala.ç but it has embodied all those traits that made gold and silver more resPectable and accepted media in the realm of currencies. In fact, it has gone beyond them, freeing the exchange from the need of

such metals. Curiously, at the end of the evolution of paper currency, this position has been achieved with absolutely no reference to values of gold and

silver determining the value although it

not

paper currency,

was thought that paper currency would

sun¡ive unless

remains

to be

the

representative of a stable metal (4)

Although there was some misunderstanding in the beginning, it is now an established position of the

fuqaba' that paper currency falls within the definition of. nuqød, i.e. gold and silver, and falas over which zakatis leviable.

(5) More generally, all those principles

of. shøri'ah which are applicable on nuqud,will be applicable on paper currency. In particular, it will attr¿ct the injunctions relating to ri.bã.

lü[e leave this subject here at this and will revert to it after we have discussed the subjects of inflation and indexation.

Inflation Although there exist a number of definitions of inflation, but it essentially refers to the phenomenon of rising prices. In fact it has'come to mean a sustained increase in prices over a long '\üíe period of time, largely caused by a rising supply of money. have to be sure what type of inflation should be a matter of

TRANSITION TO.A RIBA FREE ECONOMY

concern for policy makers. Is all inflation bad, or only part, or it that is bad? This is an important question, ând must be settled before we proceed any further. It is a simple fact of economic life that prices of goods and some form of

services change

for a variety of reasons. These

changes would

not attract the attention of policy-makers unless they are systematically influenced by cenain individuals or groups. The markets have to be trusted for throwing up the best values of all goods and services, and unless there are reasons to believe that market forces are tampered with, no intervention is called for. It is also reported from the Prophet þeace be on him) that he once turned down the request of the people of Madinah for controlling the prices in the rnarket, on the ground that such

prices were determined by Allah and he þeace be on him) would not want to rise to his Lord when sorneone could have a claim against him þeace be on him).4 This clearþ means that unwanted intervention in the market is very likely to give rise to injustice to some parties. Thas it is not the i.ncrease in prices resu.hing from the fancti.oni.ng of normal market forces athi.ch i.s a matter of concern fo, polrry marþ,ers. Rather, the. concern is ai.th the rking prices caased by sustøined increase in rnonq silpp\. Since money is a control variable, excessive expansion in its supply would lead to greater increases in prices than would be warranted by any changes in other market forces. This extra inflation, caused by the increase in money supply, is v¡hat people attribute to be -monetaryy*.* the product of mod.rn based on paper currency. It is for this component for which compensarion schemes are being advocated and for which an answer within the Islamic setting is also required.

See

Abu Da'id, Sunan,Kitãb al-Buyu', Bãb fi al-Tas'ir.

ANNEXURE

Quantity Theory of Money Before we proceed any further, it will be useful to understand the linkage between the money supply and the general price level. The simplest way to establish this linkage is to describe, what is called by economists, the equation of exchange. This is

an identþ relationship, equating the f,wo sides of a transaction, nameþ the value of transaction (uses) and its financing (sources). The equation is

follows:

M*V:P*Q (M"".Ðo(Velocity) : (Prices)*(Quantit

This means that if velocity is constant (means no change) and or¡tput is at full employment (so Q is also constant), then changes in money supply translate, one to one, to changes in prices. rüØhat

this equation says is that the value of ,all goods and

sen¡ices (GDP or the right hand side of the equation) must be equal to the stock of money times the number of times a rupee

changes hand in a given year (the left hand side of the equation). Alternativeþ, if V is 1, M must be equal to GDP. If V i¡ 2, the required money stock would be hdf the GDP, and so on. Now this equation is true by definition. Since it involves

both prices and money, we can understand the relationship a\ühere

M is the total stock of money, V is the velocity of money (i.e. number.of times a dollar changes hends or finances transactions during tåe year) P an index of prices of all goods and services produced in an econom¡ Q an index of all physical quantities of such goods and services and * is the s¡'mbol for multiplication. lüe mry also write this equation in the form of rate of change in these variables. In tåis form theTo changes in tåese vari¿ble will obey the following relationship: o/oV + 7oM - o/oP + o/oQ

TRANSITION TO A RIBA FREE ECONOMY

if V and Q *. fixed, then changes have a directly proportional effect on P. The assumption.of V being fixed is typically accepted, particularly in the context of an economy like that of Pakistan where the financial sector is not much developed. As for Q, it will be fixed when there is the situation of full employment. Thus on less than full employment level, changes in M will also affect Q *d hence the relationship between M and P will not be one-to-one. This is where the trouble srarrs, because it is not possible to isolate the effect of money supply on prices and output separately. The relationship between money and prices, as described above, is known as the Quantity Theory of Money. Although there is considerable debate on the effícacy of monetary policy. based on this theory, it is almost a setded quesrion in economics that over a longer period the theory provides a much better understanding of how prices and money interact v¡ith each other than any other theory. between them. Specifically,

in M will

Is Inflation a Modern Phenomenon? 'We

no¡¡ in a position to answer the above quesrion: first in theory and then on the basis of historical evidence. Given the quantity of exchange-a relationship that is rrue by definition-there is no reason to believe that inflation is a modern phenomenon. \Øhatever has served as money, at whatever time in history, would neatþ fit in the above equation, and hence changes in its supply would have the same are

as the present day paper money will have. Indeed there is overwhelming evidence to suggesr that this has been rhe case throughout history, though rhe manner and methods of increasing the supply of money have varied considerably, some transpafent, some less so.

effect

ANNEXURE

support of our contention that inflation is not a modern phenomenon, we quote the following evidence: 'Seigniorage' has been defined

as:

The charge over and above the expenses of coinage (making into coins) that is deducted from the bullion brought to a mint to be coined. From eady times, coinage was the prerogative of kings, who prescribed the total charge and the part they weÍe ro receive as seigniorage. .Th. deducdon v¡as sometimes supplemented by replacing part of the bullion with base metal, resulting in debased coinage. Because the seigniorage and coinage charges ¡vere collected by with-holding part of the bullion brought for coinage, the currency value of the coins received in exchange was often less than the bullion's market value. Eventually, merchants stopped providing bullion for the mint, and the supply of coins became inadequate. In England all

for coinage were abolished in 1666. Because coins are as token money for domestic purposes, they no longer need possess a high inrinsic value, and low-standard silver or certain base-metal alloys provide all the qualities required. A substantial margin usually exists between the cost of producing a coin and its statutory currency value; this charges

now issued enly

margin, or profiq is known

as seigniorage.5o

Gresbam\ law Enunciates the law that "bad money drives out good.' If rwo coins have the same nominal value but are made from metals of unequal value, the cheaper will tend to drive the other out of

circulation. Sir Thomas Gresham, financial agent of Queen Elizabeth I, was not the first to recogrize this monetary principle, but his elucidation of it in L558 prompted the economist H.D. Macleod to suggest the tgrm "Gresham's law" in the 19th century. Money functions in ways other than as a

See "seigniorage"

in Micropædia,

The

Neu Encyclopædia Britønnica, L5ú

edn. (Chicago: Encyclopædia Britannica, Inc., 1985), vol. 10, p. 610.

TRANSITION TO A RIBA FREE ECONOMY

domestic medium of exchange; it also may be used for foreign exchange, as a commodit)2, or as a store of value. If a particular kind of money is wonh more in one of these other functions, it will be used to buy foreign exchange or will be hoarded rather than used for domestic transactions. For example, during the period from t792 to 7834 the United States maintained an exchange rado berween silver and gold of 15:1, while the ratios in European countries ranged from 15.5:1 to 16.06:L This made profitable for owners of gold to sell their gold in the

European market and take their silver to the United States mint. The effect v¡as that gold wæ withdrawn from domestic 51 circulation; the "inferioro money had driven iç out.

Eoidmcefrom Earope: Vieuts of Adarn Smith From the time of Charlemagne among the French, and from that of \Øilliam the Conqueror among the English, the proportion between the pound, the shilling, and the Penny, seems to have been uniformly the same as at present, though the value of each has been very different. For in ertery country of tbe uorld, I beliwe, tbe aaarice and injustice of princes and so,uereign sta.tes, a.busing tbe conf.dence of tbeir subjects, bøoe by degrees diminished. tlte real qttdntity of mea[ vbich had. been

originaþ contøined in tbeir coins. The Roman Aes, in the later ages of the Republic, was reduced to the twenty-fourth part of its original value, and, instead of weighing a pound, câme to weigh only half an ounce. The English pound and penny contain at present about a third only; the Scots pound and penny about a thirry sixth; and the French pound and penny about a sixty-sixth pan of their original value. By means of tbose operøtions tbe princes ønd soaereign sates uhich perþnned tbem anere øble, in appeørance, to pay their debts and to fulfi'l tbeir engagernents aitb a smøller qua,ntity of sih.ter tban uould otheruke their høae been requisite. It wøs indeed in appearønce only; creditors uere really defrøuded of ø pørt of wbat uas due to tbem.

þr

5l See "Gresham's

law" in Micropædia, TheNea Enqclopædia Britønni'ca,15ú edn. (Chicago: Encyclopædia Britannica, Inc., 1985), vol. 5, p.489.

ANNEXLIRE

All

otber debtors in the sate utere øllowed tbe sarne privilege, and rnight pay w¡itb the sørne nom.inal swrn of the new¡ and debøsed coin uba.tever tbq bad borroued in tbe old. Sucb operøtions, thereþre, haae aluøys proved faoourøble to tbe debtor, ønd ruinous to tbe

creditors ønd bøve sornetimes produced a. grea.ter and. m.ore uniaersal reoolution in tbe fortunes ofprh)ate persons, tban could baae been occøsioned. by auery grea.t pablic cøkmity.t2

Eoidmcefrom

Greeþ. and. Rornan

Empiræ

A mo{e

serious matter was the affempr by the sovereign to benefit from the monopoly of coinage. In this respecr, rhe Greek and Roman experiences offer an interesting contrast. Though Solon, on taking office in Athens in 594 BC, did institute a partial debasement of the currency for the nexr four centuries, until the absorption of Greece into the Roman Empire, the Athenian drachma had an almosr constant silver content (67 grains of fine silver undl Alexander, 65 grains thereafter) and became the standard coin of trade in Greece and

in much of Asia and Europe

as well. Even after the Roman conquest, the drachma continued to be minted and wideþ used.

The Roman experience was very different. Not long after the silver denarius, patterned after rhe Greek drachma, \üas introducèd in about 2t2 BC, the prior copper coinage (aes, or libra) began to be debased until, by the time rhe empire began, its weight had been reduced from one pound to half an ounce. The silver denarius and the gold aureus (introduced about 87 BC) suffered only minor debasement unril rhe rime of Nero (AD 54), when almost continuous tampering with rhe coinage began. The metal content of the gold and silver coins was reduced, and the proportion of alloy was increased to threefourths or more of its weight. Debasemént in Rome (as ever since) was a reflection of rhe srare's inability or unwillingness to

finance 52

its

expenditures through explicit raxes.

But

the

Adam Smith, An Inquiry into the Nature and Ciases of the Vlealth of Nations, ed., Edwiu Cannan (Chicago: The University of Chicago Press, 1976), pp.31-32.

TRANSITIONTO ARIBA FREE ECONOMY

100

worsened Rome's economic situation and to the collapse of the empire.53 contributed undoubtedly debasement

in turn

Eoidmce from Spani.sb Hi'story

New v¡orld supplies of gold and silver proved limited, but Spanish greed was not. The precious metals that flooded into Europe helped bring on a massive inflation, which historians

call the Price Revolution. By the year 1600, prices in Spain were nearly four times what they had been a hundred years before. The inflation that spread across Europe disrupted the economy of Spain and hastened the decline of Spanish Empire.sa

This is sufficient to prove our point that excessive money supply, either through tampering of metal, or new discoveries, have all along exerted the same kind of Pressure on prices as is done by the paper currency. Accordingly,'there is no need to give any extra attention to the problem of inflation on account of paper currency. Bur the problem should be addressed in its own right, as we have done here.

Indexation are now ready to take uP our main concern in this Annexure, namely indexation. Indexation refers to the mechanism by which ceftain economic variables are adjusted on account of changes in prices. It is essentially a compensation device, aimed at insulating the target variable from frequent changes in prices. Alternatively, indexation may rnean protecting the real value of the target variable from undesirable changes in prices. rü(/e

*Money"

Macropædia, Tbe Nau Enqclopædí'a Britannica, 15ú edn. (Chicago: Encyclopædia Britannica, Inc., 1985), vol' 24, 53

Friedman, Milton,

pp.333-339.

DJ. Boorstin,

The Dixoverers

: A History of Man\

Vodd. dnd Himself(New Yorh Random F,Iouse, 1983)' p. 653.

Knoat His

ANNEXURE

101

There are a varíety of ways to approach the subject of indexation. All economic variables v¡hich are fixed over a reasonably long period of time (3 months to L year and morQ are candidates for indexation. Notably, fixed interest rates, vrage rates and tax revenues of Government are candidates. The process of adustment may evolve both through private as well as Government arrangements. In the latter case, this is nothing more than a market response through which different contracting parties would attempt to safeguard their interest. For our discussion it is the latter category which is of interest. The Government sponsored/regulated schemes are primarily motivated on the assumption that it is the Government v¡hose monetary management is the basic cause of inflation. This is a popularþ held belief, and not entireþ unþstified. The greatest obstacle in devising an efficient system of indexation is not only the actual determination of the right index, but how much of inflation should be targeted. As we sav¡ in the last section, not all inflation is attributable to money changes, for then it will have the meaning of denying the role of demand-supply in the allocation of resources. This role of the market is reflected in the changes in the real values of the variables. If a misguided effort is made to stall even this desirable change, indexation would create serious problems of resource allocation by eliminating the required flexibility in real variables.

The most popular variable targeted for indexation is wages, with very little indexation of inreresr rates. The following methods are prevalent for the purpose of indexation of wagess5:

See A.E. Marinakis, "Wage Policy in High Inflarion Counrries" in. loarnal of Ecoìrcmics Studics,Vol.24,No. 6, pp. 356-78.

t02

TRANSITION TO A RIBA FREE ECONOMY

Types

Formal or Legal Indexation Informal Indexation

Full lndexation

Partial Indexation

Backwardlooking Indexation Pre-fixed Indexation

Fixed Periodicity

Descriotion Indexation is introduced and regulated by law. Indexation emerges as a result of high inflation, and its terms are agreed among the parties involved. Every adjustment takes into consideration 100 percent of past inflation. Indexation is based on partial adjustments to past inflation. Indexation is based on past inflation. Indexation is based on future inflation, estimates, and may or may not include ex-post facto revisions.

The period

between

adjustments known. Changes

in the frequency

adjustments might take place in the long term. Variable Periodicity

The period between adjustments is unknown,

being arbitrary or determined

by a trieeer clause. As for the practice of indexation of wages, we have three sets of experiences: in Europe of widespread but moderate indexation; in USA of little indexation; and in Latin America of widespread and extensive indexation.

The trade unions are strong in Europe and hence indexation is easily achieved. But it is kept at a moderate level,

ANNEXURE

i.e. only partial indexation is done. This could also be due to the State's larger role in European economies. On the other hand, in USA because of low demand variability, higher cost of administration of indexation schemes, existence of efficient social securþ and pension systems and provision for participatory features in labour contracts, there is virtually no indexation. However, there is considerable roorn for private contrâcts that stipulate compensation on account of changes in the cost of living index.56 The worst experience is that of Latin American countries where the indexation was rampant and fuIl, particularþ during the periods of hyperinflation, in countries like Brazil and Argentina. Such arrangements v¡ere considered one of the main reasons behind the hyperinflation and the consequent economic breakdown faced by these countries.sz

There has been search for alternative ways of protecting the small agents facing fixed prices; indexing to some measure of the performance of the employer, bonus plans, commission pay, andprofit sharing arrangements are also considered forms of indexation in the sense of protecting and supplementing the wages. The point is that inflation v¡ould not be bad so long as it is equitable. The problem comes from its iniquitous character. But to move to indexation is no solution to this. It is an accepted wisdom in economics that comprehensive indexation is a resignation to fight inflation. The best course is to fight it head on, through prudent economic management. The best comment on the subject is found in Samuelson and Nordhaus:

\lhy not completeþ s6See

index the enÍfe economy? In such

R.L. Miller and D.D. Van Hoose, Modern Money

ønd.

Banbing pp.590-

93. 57See

Maries-Ange Veganzones, Argmti.na i.n the 20th centary @arns: Development Cendre Studies, OECD, 1997), pp.235-41.

104

TRANSTTTON TO A RrBA FREE ECONOMY

world, inflation would not matter for anything 'real," and we

could ignore inflation and concentrate on

reducing

unemployment.5s

This sounds like a good idea, but in practice it has serious drav¡backs. Full indexation is impossible because it guarantees a certain level of real incomes that may simply not be producible. Moreover, the greater the indexation, the more an inflationary shock will rage through the economy like an epidemic. A high raæ of indexation is like a big multiplier-it amplifies outside price shocks. Full indexation is an invitation to galloping inflation. Adaptation to inflation thus contains a parado* The more a society insulates its members from inflation, the more unstable inflation is likely to becorne. Countries that have thoroughly indexed their economies (such as Brazil) found it extremely costly to eradicate inflation even through harsh measures.5e

Indexation in an Islamic Setting Indexation in an Islamic setting is relevant v¡ithin the lendingborrowing contexl As for wage indexation, there is apparently no injunction in Islam which could come into conflict with such a scheme. Accordingly, it may be decided within a broader context of economic policy, as opposed ro determination of ri.ba. As far as lending and borrowing is concerned, those who are advocating this scheme are not clear what they wânt. If the idea is to index the deposits with the banks, then it will be difficult to find merit in this proposal. The reason is that in an Islamic setring, deposits will be linked v¡ith the profits of the banks, which are nor fixed the way the

P.A. Samuelson and IØ.D. Nordhaus, Economics, 16ù edn. (New York: Irwin/McGraw Hill, 1998), p. 598. 5e

Ibid., pp. 598-9.

ANNEXT.IRE

105

wages are fixed. Flence, there is no reason why they should be

indexed. Similarly, the financing will be linked to the return on investments'or mark-up and rentals, none of which are fixed for long periods. So there also one does not find any justification for indexation. Falas and Indexation Before closing this Note, we would like to address an issue which, from the vantage'point of the shart,'ah,lies at the core of indexation question, i.e. what implications the ireatment of fulas in the sharT'ab, in relation to their various properties, has for the paper money. This is a controversial issue and one needs to develop a good understânding of some f.qbl concepts before a possible answer can be developed. Peculiariiies of Fulus There were some peculiar features oÍ følns that have given rise to not only the controversy but also considerable confusion in understanding their true character as money.In Fi.qh literature, a medium of exchange is typically designated as thaman.60 Since gold and silver coins were indisputable mediums of exchange, they were not only declared tltaman, but because of their innate value, were also declared as tbaman kbalE flatent) or tba.ftrdn þoqtq| (real). There is consensus that gold and silver are not alone in performing the functions of a thaman, In particular, faqøha'admit that people may accept anything as thaman and if that thing acquires wide acceptability, then it will be like. a thaman. This kind of. tbaman is called tham.an Iççilaþ| (conventional). The differences emerge when one @The formal definition of. thatnan

is as follows: Thøman is that which in return for purchases be it from silver coins or gold coins. See Abú Bakr Jaç¡a;, Aþkam al-Qar'an, ed., Muþammad al-$adiq Qambâwi @eiruu Dãr Iþyã' al-Turfth al-'Arabi, 1405 AfÐ, vol. 4; p. 384. becomes due

106

TRANSITION TO A RIBA FREE ECONOMY

considers whethertbaman l:tilãþr will attract that same as are applicable to thaman-khalqt. Unlike gold and silver coins, fuløs are not precious metals having an intrinsic value.62 Thus, to everyone, følas arc tbaman Istilãþ.Many føqaha'would not even fteat fulus as part of cash (nøqud). The uncertainty and ambiguity about fulas Iargely stems from three sources. First, there was frequent cancellation of such coins, as mints would either stop producing them or produce new ones. Second, there were occasions when they would be in short supply in the market. Finally, there were occasions when their prices, with respect to silver coins, were fluctuating. Under such circumstances, questions arose as to the status of transactions, like sale, loans, dowry, etc. which, before they were closed, faced any of the above three rulings6l

occurrences. It is important to consider the views these issues separately.

of. faqaha'on

each

Cancellati.on (Kasadah)

The most common view in this case is that the sale in such a case v¡ill be invalid. If sale was contracted and price was not paid, then the thing will have to be returned. In case of goods where likes (mithl) exist, replacement v¡ill have to be made if the purchased goods were used or consumed. \Øhere this is not possible, such as when some peculiar goods (q¡*ù like cows were involved, their price on the day when the purchase took place would be paid. This is by and large the view of Imãm 6rThe nrlings

which shall be the focus of our artention are (1) trading in gold and silver is not ¿llowed, excepr if it is in the same measure and is hand to hand; (2) violation of (1) gives rise to ribã; and that zakat wiIl be levied on them.

6$¡e have been assuming that føløs are made of copper, only for convenience. However, as a matter of fact many other metals, such as bronze and brass have alio been used to makefalns.

ANNEXI.IRE

107

Abu $anifah. llowever, both Imãm Abu Yùsuf and Imãm Muhammad have differed with this opinion. In their view, the sale will still remain valid, but price will be paid, according to former, as prevailing ôn the date of purchase in an acceptable currency, and according to latter, the day cancellation took place.

Shortage (nqi,ça): This is a simpler situation. Although opinions differ, but the majority view is that the sale will remain valid and the value of fulas in terms of gold and silver on the day of. purchase or the day shortage occurred should be paid. Variation in the Pri.ce of Fulut (Tagboyy"r): This is perhaps the most difficult case, and a source of much confusion. The position of Imam Abu Hanifah, and the initial position of Imam Abu Yusuf was that changes in the price of falas would

have no effect on the amount due from the purchaser. lfowever, Imam Abu Yùsuf subsequently changed his position and held that the purchaser will have ro pay the price in fulas as it prevailed on the day of the purchase or in silver coins on the day of payment. It is this last view of Imam Abü Yusuf which has given rise to the view among some scholars that it is an endorsement of the principle of indexation. Since this is an important area and the most widely used argument in attempting to provide indexatiori a basis drav¡n from the sharT'ah, it deserves to be studied in some detail. The Cause of Varíation

tbe Price of FulAs

At the outset, we need to clarify the context in which this discussion is taking place. This depends on a clear underst¿ndingof fulas. As we said earlier, fulnswerc a peculiar coin in a system that was primarily based on full-bodied

109

TRANSTTION TO A RIBA FREE ECONOMY

moneys, i.e. gold and silver. For a currency to occupy a position in such a system, it must acquire a representative status with respect to the full-bodied currencies, for otherwise it would have no meaning. Thus there was always a rate of exchange bewreen fula.s and dirham and dinar, although there 'was no authority, at least no formal authority, like a central bank or Government, which stood guarantee to such conversion. It was the market v¡hich independently performed this function.63 Now føløs, and even some type of silver coins, were subject to heavy wear and tear, which was, in the absence of cancellation and shortage, the primary reason for fluctuation in their values þrice$. It is abundantly clear from the following passage of Imam Shãml that the primary reason for price variation is the defects developed in fulns or low quality silver coins Then

should also be remembered, as evident from their

entireþ to fulas and over-defective silver coins. And this is also evident from the fact that on some occasions their focus is limired to fuløs and, on some other occasions, 'Adølihave been also been added with (faqøba's) discussion, that this discourse relates

63The

following passage from art. on "Fals" in The Encyclopaedid of ßkm (I" edition) supports this assertion: "The fals was nor considered by the Arabs as a standard coin but only as a token curreûcy; its coinage v/as not a prerogative of the sovereign but was left entirely to the discretion of governors and local authorities. The fals thus varies between great extremes from tou¡n to towû in weighr and value and also in rype, and could nor therefore like the dinãr and dirhem be currenr throughout the caliphate. It seems that no legal relationship berween silver and copper coins ever existed although there are some grounds for thinking that 48 fulus wete to be curreût to a legal dirhem; the relationship between the rwo metals must have been to be re-adjusted from time to time. The Egyptian glass weights for copper coins clearþ show that the fals could be any conceivable size; we have glass weights oL L, 21 3, 4 upro 30 þþanilba (þirãç) aú above, which were used for weighi"g a certain number of. fulas."

ANNEXURE

t09

følas.Thts is because according to Binayab, on the authorþ of øl-Baþf , 'Adah are those silver coins which are attributed to 'Adl wlttch seems to be the name of a King, to whom defective silver coins are attributed. Likewise, I have seen the words of overdefective n Gbayat'al'Bøyãn and similar words have also appeared in the Sbørb al'Tønrtlr. This fact is also evident from

the arg¡rments given to support the views of Imam Ab¡ Harufah, after pointing out the differences, that because of defects the value (tbømønfiryøb) of the coin vanishes, and since

more defective coins retain value only because of convention, once people stop their usage, this convention ceases and the sale becomes value-less and hence is invalid. Similarþ, their words relating to increase and decrease in the price of cgrrency also point to the same fact, because increase and decrease in the price is known only when the defect is large and it is valued in terms of other cuffency. Furthermore, their difference also points to

the same fact, that whether hke (mitbl) is to be returned or price, because where there is no defect there is no need for their difference, as in that case, to everyone, like is to be returned. in the . And this is the clear proof of our point. In al'Hidaydh, said that if it is silver coins, on over-defective discussion and someone purchases something from such coins subsequendy they become (even more) defective and people stop their usage then, for Imãm Abu Hanifah this purchase will be void and for Imam Abu Yusuf, the buyer will have to Pay the price that prevailed on the day of. the purchase and Imam Muþammad says that the buyer will have to pay the price that prevailed until the last day before the coins became defective and their circulation ceased.65

To further fortify the position that the context is entirely the defective coins, let us refer to the following subsequent

Refers to al-Baþr al-Ra'iq Sharþ Kanz al-Da4ã'iqby Z,ayn ibn Ibrãhrm (Ibn Nujaym). 65 See Muþammad Amin (Ibn 'Ãbidin), "Tanbih al-Ruqüd fi Masa'il alNuqüd" is Røsa'i.l lbn 'Ãb¿d¡n (Lahore: Suhail Academy , t976), pp. 6L-2.

110 passage

TRANSTTTON TO A RrBA FREE ECONOMY

from Imam Shami:

So far the position with regard to pure and less defective currency has not been ascertained. It seems that since chances of

their shonage and defection are rare the 'uløma' have not touched them. But in our times, since their prices are also fluctuating considerably, it is necessary to decide them. Although Allah knows better, but so far no writer in my knowledge has paid attention to this problem. But the fact that a limitation [in discourse of defective coins] was imposed points

to the fact this is not the position of pure silver coins or

less

defective silver coins . . . The more appealing view is that if the price of less defective or pure silver coins increases or decreases then the sale will not become void and whatever silver coins

in the âgreement only those will be required to be paid. This is because such silver coins are not only real value coins (tbdmdn khaþl) but also conyentional have been stipulated

(ktiloþl) and

less defective

will

be considered like non-defecdve.

And the variant view of Imam Ab¡ Yüsuf does not apply in the case of such coins. In fact, some 'alama'have opined that Imam Abu Yusufs variant view regarding increase or decrease in

limited only to falas, and for over-defective silver coins Imam Abu Yusuf does not hold a different view ... Our prices is

professor has said that once the position of over-defective silver coins is known, it is easier to find out the position regarding the lessdefecdve coins. For in that case if the price decreases the seller has no option, according to the consensual view, but to accept the same silver coins, and in cæe the price increases, the buyer has no option but to pay the same silver coins. Our professor says 'don'r think that Imãm Abù Yusuf 's variant view holds under all cases, so that it is applicable to silver and gold coins, such as al-Sbønfi., al-Bundaq\, al-Mubammadt, ølKalbl or al-Riyal. Rather in such cases, by consensus, anyone having a right in one of these will be entitled to get only that

one.

To think otherwise will be a

clear mistake, and this

Ltt

ANNEXURE

mistake arises because of the failure to.understand the difference bet:wr eenfaløs and

nuqød."

Falas andTharndniyyah

is not merely the fact that changes in the thamanlryab of. falashave led to differences in their treatment øi.s-a-ai.s gold and silver, even the very thatnanilryah of fulas has been a matter of dispute. Two major controversies, briefly mentioned on pages 105-106 are directly connected with this issue. In his discussion on the use of fuløs as capital for partnership, Udovitch writes: "Hanafi Law insists that some form of acceptable currenry be used in the conduct of all commercid transactions. Because of their intrinsic value, gold and silver coins are considered the most acceptable of currencies. Hanafi authorities are in unanimous agreement concerning the validity of dinars and dirhams in whatever shape or form, for all commercial operations, including the formation of partnership investment. as fulas (copper coins, sngalar: føl) are concemed. The fals was a token coin and was never recognized as legal tender comparable to gold and sfver currency. The wide margin between the intrinsic and face value

This is not the case, however, as far

of copper coins, and the fact that their value and

acceptance

varied widely from place to place, caused uneasiness among the

lawyers and cast doubt

on the validiry of their use for

pannership and other investments.

As for falus, if. they are non-circulating, then neither

pannership rLor a cornrnendø lMudørdbøhl can be formed r¡¡ith them, because they are in the same caÍegory as goods. According to a well knov¡n statement attributed to Abù tIarufa and Abu Yusuf, this holds true even if they are in circulation. According to Muhammad (i.e. Shaybani), it is permissible to use them for investment.

66lbid., pp.62-4.

,IRANSITION O A RIBA FREE ECONOMY

tt2

følns revolves around a basic issue. According to Abu Hanifa and Abü Yüsuf circulatingfalus arein no circumstances to be considered as currency. This is so, because they can, on the whole, be panicularized by specification. Fulas can be sold in ffansactions between tv¡o parties, so that according to the two above mentioned authorities, the sde of one fak for two would be permissible. Since fulcæ are objects which, on the whole, can be particularized in contracts of exchange and hence are not an absolute type of currency, they are, just like all other goods, unsuitable to form the capital of a partnership. According to Muhammad, the property of currency attaches to circulating falns, and they are to be considered as an absolute currency. For this reason, he refused to permit sale of one fals

The discussion concernin

for two. They are, in his view,

suitable

for

partnership

investment like all other absolute currencies, viz., dirhams and dinars.

Unlike gold and silver coinage, copper coinage was a completeþ fiduciary currency; that is, its acceptance and circulation as a means of exchange at a value greatly n excess of its intrinsic worth was based entireþ on the rust and confidence of those who used it. All three flanafi authorities agree that copper coins that were for some reason not acceptable, or not in use (hasrd) in a given locality are not eligible for partnership investment. At issue in this dispute is whether any circulating token currency - in this case, copper coins - can be considered a legal tender. Abu Hanifa and Abu Yùsufdeny copper coins the status of currency "because, on the whole, they can be panicularlized by specification"; that is, they are not completeþ interchangeable as are standard gold or silver coins, but resemble commodities in that each individual copper coin or type of coin may differ in value and acceptance from time to time and place to place. Specifically in relationship to partnership, these tsio authorities are concerned lest the fluctuation in value and unpredictable acceptabiliry of copper coins lead to uncertainry about the amount of each partner's

ANNEXTIRE

tt3

investment. This interpretation

of their view is given by

Sarakhsi:

Muharnmad (i.e. Shaybãni), may God have mercy on him, holds that as long as rhey (fulas) arc in circulation, they are in the category of currency. The other fwo (Abu $anifa and Abü Yusuf) hold that the circulation of. fulas is merely a convenrion âmong people, and that this changes from time to time. If we permit a partnership with them, this will lead ro uncertainty as to the amount of each parrner's capital at the time of division of

profit. This can come abour

if the panicular fulas become

unacceptable and people start using anorher type. For at the time of the divisions of the profit, the amount of each one's capital is determined by consideration of its monerary value and not by the consideration of the nusrber of coins; and monetary value of. fula.r flucruares in relation ro their acceprance and nonaccePtance.

Abù Hanifa's and Abu Yusufs opposition to rhe use of copper coins in pannership was probably bæed on an observable fact of monetary life of the eighth and ninrh centuries. The mintiag of copper coins was highly decentralized and was enrrusred ro local authorities. The¡e was no single standard governing their size, shape, or weighr of the coins: This proliferation had two

main results: first, the geographic in which the copper ^rea coins of a particular mint were accepted as a means of exchange was fairþ small; and second, there was no effective control of the quantiry of the petty coins, in circulation. An oversupply of petty coins, or a change in their weight or metallic contenr, could easily lead to the situation envisaged by Abu flanifa and Abù Yüsuf. The copper coins used to form a partnership one day could be wonhless, or close to it, the veÐ/ next day. The transfer of such partnership capital from one localiry to another- an action often dictated by the needs of cortmercecould have the sanre effect. Shaybani, undoubtedly aware

of the difficulties tó which the free circulation of copper coins were" subject, nevenheless considered them "in the category of currency as long as they are

circulation," and permitted their use

for

partnership

TRANSITION TO A RIBA FREE ECONOMY

LL4

investment. The fact remained that, in spite of their fluctuation in value, copper coins served in all localities as the accepted and chief means of petty exchange and continued to be minted in

apparentþ abundant quantities. A-proper understanding of the controversy concerning the status of coPPer coins in cornmerce can, I believe, best be achieved by viewing it in the conrexr of various factors affecting their circulation as described in the preceding paragraphs' The divergerit views of Abu $anifa and Abu Yûsuf on the one hand, and Shaybani, on the other, emanate from an emphasis on

different aspects of the problem as they observed it' To.the former, thã fluctuating value and restricted circulation of copper coinage were Paremount, and they therefore excluded it from use as en investment in any commercial association' For Shaybãru, the circulation and accePtance of copper coins, no

matter how geographically circumscribed, was an established fact of economic life out weighing all other considerations' He therefore holds that "a partnership with fuløs is in the same category

one

with dinar and dirhams'"l7

Apparently, these are two sides of the same question' First, whether følas are an acceptable currency for investment and, second, whether følas are tradable. Clearly, there is no dispute among the above authorities whether a medium of exchange (tbaman) is tradable or noü all agree that it is not. But the question was whether falas were a tbarndn ot Íot,For both Imãm Abü $anifah and Imãm Abu Yusul they were not because of large variation in their quality and specifications. To them it was always possible to 'particularize' (møu'ayyan) goods, fatqs. Once this was done they were no diffèrent from for be sold can one i.e. whose exchange was permissible, føls tsro falas.Undoubtedly, this is a dispute on a point of fact, and not on the underþing PrinciPle. 67

Pdrtnership and Prof.t Princeton University Press. 1970), pp,52-5.

A.L. Udovitch,

Medieaal /s/øræ (New Jersey:

ANNEXURE

Unlike the above view, Imam Muhammad thought that since circuladon was at the core of thaman, so long as fuløs were in circulation, they were tbaman. FIe even rebutted the

argument, often cited in support of the other view, that two people can jointþ agree to derogate the tharnan ftom any fulas. In al-Hi.dãyah one finds the following view of Imam Muhammad: f\Vith regard to the sale of fulas] Muhammad said that this iq not permissible, for their tbarnøniyyab has been proven by the convention of the people, and hence it cannot be derogated by the agreement of fi¡o persons, and when theír thømaniyydh survived they cannot be particularized, just as sale of nonparticularized and of one dirham with two dirhaqrs is not permissible.6s

Thus it is clear that for Imãm Muhammad, the test of tbamanilryah was people's acceptance as such, which v¡as implicit in the fact that the coins v¡ere in circulation. Indeed, this is a stronger, and perhaps more desirable position, from 6

See Burhan al-Dtu al-Marghiúm, al-Hi.dãyah (Beiruu Dãr Iþyã' al-Kutub al-'Arabi, 1995), vol. 3, p. 63. A similar view is attributed to Imãm Milik Imam Mãlik said sale of one. falas with rwo føløs is not permissible and neither is rhe credit sale of. fuløs in return for gold and dinar. See Mãlik bin Ãnas, Al-Madauwønah al-Kabra (Cairo: Matba'at al-Sa'ãdah, t323AH), vol. 8, p. 104. Norice the significance of Imãm Mãlik's declaration that credit sale of. falns in rerurn for gold and silvèr coins is also nor permissible. lfere, manifestly, the l<rm;ds (ajnãs) are different, yet this is held impermissible. The reason is clear: once tharnaniyyøh across ¿ll ajnasis established, credit sale may give rise to excess

in exchange and create doubts about inteiest. Indeed, the fact that Imãm Mãlik had profound undersranding of "thamaniyyah" as the primary condition of a medium of exchange is reflecred in his follov¡ing statement: If leather acquires the convention of a medium of exchange âmongst people, so that the leather becomes a tbaman and coin, then for me the credit sale of leather with gold and silver coin is not permissible.

TRANSITION TO A RIBA FREE ECONOMY

116

the point of view of preventing undesired excursion of interest in such ffansactions. This is evident from the following Passâge

from al-Hi.dayah: Our Professors have not permitted excess (aftl.ul) *en in the case of 'Adã,h and Gbø¡ãrifab conventional coins,' because in our country these are considered very expensive valuables (arnwal) If excess is permitted in such coins then the door of interest will be opened.6e As we sav¡ on pages 108-109 'Adal¡ were the over defective silver coins and apparently Gbatari.fah also belonged to the same class. Yet, on account of the fact they enjoyed popular and widesprcad tbamani.yyab in a given place, excess was not

permitted. Clearly, this was done to foreclose the door of interest, which otherwise was likely to be opened by such exchanges. A similar view is found in the well-knov¡n work, Fatb al-Qaår to (demanding) excess in will reach to excess in pure

So at that time people would get used expensive valuables and gradually

nuqud. Thus, excess has

is for rooting out this expectant disorder that

not been permitted.To

M¿in Lessons Regarding Fulns

we derive our conclusions regarding the paper currency, it would be useful to collect the major lessons we have learnt abor* falus: Before

(1) They

were token coins, which enjoyed the status of ø/-

th am ani.1ryah al- þçil ã.þi1ryøb;

6eSee

al-Marghinãm, al-Hidãyah, vol. 3, p. 84. Mulammad bin 'Abd al-rù(/ãt'id al-Siwdsi, Sbarþ Fatþ al-Qadì.r @eirut: Dãr al-Fikr, n.d.), vol. 7; p.153. 70See

ANNEXURE

tt7

They were issued by local authorities

in a highly

decentralized andunregulated monerary sysrem;

(3) Their intrinsic value was less than their face value; (4) Although føløs were nor formally regulate d by

any

commodity standard (such as goH td ,lrrer), nh.r. *., always a marker in which faløs were exchanged with both gold and silver coins at market determined iates;

(5)

Since many authorities v¡ere involved in issuing such coins, it was not uncommon to see large variations in almost all features of coins - weight, size, shape, colour, engravings, erc. made by different authorities. For these reasons, the geographic acceptability of such coins was quite limited;

(6) In particular, cancellation,

rhree problems were common; (a) frequent (") þ) occasional shortag. in ,,rppl¡

*à

increase and decrease in their prices;

(7)

The price variation was primarily caused by wear and tear

and its extent was always determined in terms of its exchange rate with silver and gold coins. (8) The difference of opinion among faqaha', panicularly regarding the acceptability of fatas as partnership capital and exchange of one fals v¡ith two fatøs, ls oà, difference on rhe principle. Rather it is on a point of fact," whether fulas have the same thamani.lrydh-as found in silver and gold, which are considered absolut e tbdman. Imam Abü $anifah and Imam Abù yusuf, emphasizing the requirement of stability in the value of thaman, finã that faløs lack stable value and hence are nor thaman suitable for investment. On the other hand, Imam Muþammad, emphasizing the properry of popular acceptabiliry, holds that so longasføløs are in circulation their thømdnltyah is proved and hence they are suitable for investment.

TRANSITION TO A RßA FREE ECONOMY

118

Imam Abu Hânifah and Imãm Abu Yusuf, on the basis of their argument that følas can always be paniculxized, have found them- antithetical to thaman, and h"ve accordingly likened them with goods, for which trading with excess was permissible. On the other hand, Imam Muhammad, holds the view that so long as circulation is intact, thamaniyyab is íntact, and for tbamantrade with excess is prohibited'

(9) Similarþ,

Følûs and Paper

Currenry

\Øe have akeady established that the PaPer currency is the evolved f.orm of. falas. That is, it were fulas, which possessed the qualities needed for future currency to meet the needs of * "i.r-.*panding world economy. The question is whether the paper currency has also inherited the controversies with the følas. Ov endeavour would be to show "orro""i.d that just as the paper currency, in the process of its evolution, h", rh.d all the d"f."6 found ín følAs, it has also dissociated from all the controversies that surrounded the følû's' For the following reasons, the paper currency faces none of the problems that gave rise to the controversies: currency is not only the thaman ltülal'n, hke Thts føtns,butit is also the legal tender (tbaman qanuni)' or a thaman are all disputes that relate to whether fulns not have no relevance in our time; (2) Unlike falns, which depended entirely on gold and silver for its valuation through the exchange rate, PaPer currency has no reference to any of the metals or any other standard v¡hatsoever. 'Thus the PaPer currency works entirely at its ov/û, and hence phrases like 'changes in the price of føtal have no corresPonding meaning under the new monetarY system.

(1) The paper

ANNEXT.IRE

tL9

(3) The

paper cuffency of a given denomination cannot be particularized by size, weight, colour or shape etc. and hence it is perfectly malleable or intermingable thdman, which was the key qualiry of gold and silver which were declared as absolute thaman. Accordingly, there is no question of selling a two-rupee note with a five-rupee note or the like. These are manifest transactions of. tbøman, which, unless done in equal number and hand to han{ would be attracting the ruling of. ri.bã al-faQl.

(4)

The paper currency does not face frequent cancellation or shortage of supplies. Even v¡hen cancellation takes place, which is a rare event, the law that gives effect to which the new cancellation itself specifies the rate ^t with cancelled currency, will be tradable the currency which is normally done by the Central Bank of the country.zl Thus there is no ambiguity as to how the old contracts, executed with the cancelled currency, will be settled with the new currency.

(5)

Paper currency is the only form in which all investments and capital stocks are reckoned. Throughout the world, valuation of assets is done in paper currency with no rival rod of measurement. Hence there is no problem v¡hether

71In

Pakistan we have seer two occ¿sions when a cancellation or substitution type of situation took place. For instance, in L96I the new metric system we¡¡ announced. In Pakistan Coins Act, 1961 a suirable amendment was made that fixed tle exchange rate between the new and old coins. Similarly, io 1971, aket the separation of East Pakistan, the old currency was cancelled. The St¿te Bank allowed a one-on-one conversion of old currency with the neq¡ currency. These were simple examples. For more elaborate examples, requiring somewhat complex formulae for conversion reference can be made of still on-going process of monetary reform in the Cenral Asian Republics of former Soviet Union. New currencies are being introduced by these states and complex formulae have been developed for adjusting the old contracts in Rubbles with the new currencies. Also in L99t, Argentina ca¡celled its currency Peso and introduced a new currency called Astro.

TRANSIÏON TO A RIBA FREE ECONOMY

120

paper currency can be a suitable tbaman for forming partnership or rnu/.arabah. Indeed, it is the only tbaman presently knov¡n to people.

(6) Finally,

to further fortify the argument, it may also be pointed out that since paper currency is the legal tender, there is no possibility of its thamaniyyah being stripped by the consensus of two pâr'ties. Still more and

importantly, unhke falas, v¡hich had some non-negligible intrinsic value, which may give rise to the belief that because of weight they may have a purpose other th¿n a medium of exchange, the paper currency, once discarded as legal tender, will have a negligible intrinsic value. Accordingly, trade of one ûilo-rupee note with a fiverupee note could not be possible except with the intent to earn interest.

Evidently, all those problems of fulns,which made them an imperfect tbaman, and gave rise to differences of opinion, are no longer present in the paper currency and hence there are no valid reasons for old controversies to subsist. Those who have attempted to apply the rulings on falas on the paper currency have not been able to fully appreciate the reasons underþing those rulings and the true differences betweenfalas and paper currency. The most notable misperception is to seek legitimacy of indexation from the ruling of Imãm Abu Yusuf in respect of a change in the price of.følas. The misperception emanates from equating the change in the price of følas with the change in the purchasing power of fulas. This is a fallacy that has given rise to rhe unwarranred conclusion that Imãm Abu Yüsuf 's ruling is the affirmation of the principle of indexation. Let us establish these claims.

(1) At the outset, let us note følns are fiduciary

coins

commanding a face value in excess of their intrinsic value.

ANNEXURE

LzL

FIowever, since fulas were readily convertible into dinar and dirham, there was an exchange tate at v¡hich such an '$Øe have already pointed that such exchange was effected. an exchange rate was not guâranteed by any Government authority, rather it was purely market based, and since coins were fiduciary in character, people's trust and confidence were the primary factor determining this rate. Now we have three values attached to the fuløs namely, an intrinsic value (the value of metal), the face value and the rate of exchange betweenfølas and dinar and darham. The question is: v¡hat is the meaning of the price of følas? Q)

Our answer is that it is the rate of exchange beween falas and dinar and dirham. Furthermore, such a price has absolutely no linkage v¡ith the purchasing power of fulas. This claim is'supported by the following arguments:

(3)

As pointed out on page 109, Ibn 'Ãbidin has clearþ stated that the reason why prices of følas or over-defective silver coins were changing was the wear and æâr to which both these coins were subject. In fact, he goes to the extent of sayrng that "their words relating to increase and decrease in the price of currency also point to the same facq because increase and decrease in the price is known only when the defect is large and it is valued in terms of other

currency". (4)

Evidently, the changes in the rate of exchange did not reflect the changes in the relative purchasing powers of different currencies, but the changes in their underþing intrinsic values. In particular, this was applicable to low quality silver coins and falas v¡hose metallic content was constantly changing.

(5)

This positioh is verified from other historical sources [as in footnote 631, showing that weights of copper coins greaþ varied over time.

TRANSITION TO A RTBA FREE ECONOMY

122

(6)

Nowhere has any authority looked at the prices of.falasit relation to its purchasing power. For if this were the case, the same must be done with respect to gold and silvei coins as well. Yet no authority could conceivably give a ruling that such changes in purchasing Powers should be compensated in any of the transactions, credit sale, loans, dowrlr, etc. On the contray, what we have is the following quotatioh from Ibn 'ÃbÎdin: "Our professor says'don't think that Imãm Yusuf's differing view holds under all cases, so that it is applicable to silver and gold coins, such as øl-Sbartfi, al-BundøE, al'Maþammadt, al' Kalbi or al-Ri.yal. Rather, in such cases, by consensus, anyone having a right with,regard to one of these will be entitled to get only that one. To think otherwise will be a clear mistake, and this mistake arises because of the failure to understand the difference between fnlas andnuqud."72

(r7) Clearly, the requirement of compensation was on account of loss of metallic content and was not applicable to those coins which were not subject to such loss. To see this point more transpârently, note that an exchange rate is a ratio of two prices þrice of one currency in terms of another currency). Thus a change in exchange rate means that both prices could change. That the compensation was restricted only to poor quality coins is evident from the fact that it was applicable only to those transactions that were denominated in low quality silver coins or følas.IÍ transactions were denominated in pure gold and silver coins no question of .compensation was raised, even though in terms of falns their prices were changing.T3 72

See

Ibn 'Ãbidin, "Tanbih al-Ruqüd

Masã'il al-Nuqúd"

h Rasa'i.l lbn

'Ãbidin, p.64. T3Suppose

a buyer purchases an ardcle at a price of one silver coin on a deferred payment basis. Suppose funher that at that time the exchange rate between pure silver cotns andfulas had a ratio of 1:48. Now if there âre new

ANI'iIEXURE

r23

the sanctioned procedure. As for gold and silver, they did not suffer from *.", *d tear and hence there v¡as no question of any compensation on that account. More importantly, they were declared as absolute thaman and their trade with excess was forbidden on grounds that it was ribã al'fnd'l' Thul any provision of co-p.osation would have come directþ in conflict with this prohibition. on the other h¿¡nd, poor quality silver coins anð futns were not in the class of nøqud' Rather, they were representativ e of. nuqud. The compensation was allo-wed ,o prå,.", their representarive values. It is lack of this distinction L.r*..r, nøqød and falns that has led people to mistakenly aPPly the compensation principle to PaPer

It is not difficult to see the logic behind

currency.

price of. fulas the ratio will change to fulas in the marker which increase the sale and the buyer will be required the on impact say, 1:40. This will have no the contrary if the s¿le wason coin. silver ,o p y the same one pay either the 48 old falas and if to have would he d.oåáio"t.d io. fø1il.s, or if that is not readily available 40 new the then available rhey are not falûs principle is operating only the compensation clearþ Thus 1 ,ilrr., th.o "oi¡. otr one side. The reason is that only the change in metallic vafue, ois-a'oi's pure gold and silver coins, is recognised for compensation and not the change

in purchasing Power.

Annexure-2 Comparative Statement of Constitutional Provisions on Debts/Borrowings Governmenr of India 1935

1956

Constitution

1962

Anicle-61

(1) AII revetrues

the

received Federal

Government and all loans raised by that Governmedr and all moneys received by it in repayment of any loan, shall form pan of

the (2)

Federal Consolidated Fund. moneys

AU other received by or behalf

of the

Constitution

Anicle-37 All ¡eveoues received and all loans raised by the Central Government and all moneys received by the

1973

Article-78

(1) All revenues received by the Federal Governmenr and all loans raised by that Governmeff, aod all

Central Gover¡ment in repayment of any loan, shall form parr of one consolidated fund, to be hnoc¡n as the Central

moneys received by in

repaymenr

Federâdon

ary

the

Federal Consolidated Fund.

Consolidated Fund.

Q) a-

All othermoneys-

received by

deposited on behalf of Federal

the

Governmenr shall be credited to the Public tåe

loan, shdl form part of

Federal

Accouff of

Constiturion

Government or

received by

deposited with the Supreme Coun or

^îy other

court

established under the

authorþ of

the

Federation; shall be

Article-62:

Anicle-38: The custody of the Central Consolidated Fund, the

Rules may be made by the Governor-General and by the Governor of a Province for the purpose of securing that all moneys received on accouût of ¡evenues of the Federation or of the

(1) The custody of tle

moneys other than

Province, âs thé case may be, shall, with such

the custody of

tlose credircd to

moneys received

exceptions, if an¡ as may be specified in the rules, be paid into the public account of råe Federation or of the Province, and the rules so made may prescribe,

or authorize some person

prescribe. the

Federal

Consolidated

Fund, the paymeot of

payment

moneys into,

moneys into such Fund, the wirhdrawal

and the withdrawal of moneys from, the Ftrnd,

of moneys there from,

and all other

the custody of public

relating ¡o rhar Fund, and

such

Fund received by or on

traasactions

orher

by or on

behdf of the

Cenral

of the Federal. Government and all Governmen!, their transac¡io¡s rela¡irg to Payrne¡rt into the those moneys, and all Public Account of the matters ancillary to or Federation and tåe connected with any of the u¡itídrav¡al of such aforesaid matters, shall be moneys from such regulated by or under and behalf

Account, end

âll

matter conneced with

Act of rhe Leeislature

or.

Central

subiect to

z 2

credited to tåe Public

¡r,

Account of

råe

Federation. Section-151:

F lrl

Antcle-79l.

The custody of the Federal

Consolidated Fund, the payment of moneys into that Fund the wi¡hdrawal of moneys tåere from, the custody of other motreys received by or on behalf of the Fede¡al Governmeff, their payment inro, and withdrawal from, the Public Account of the Federation, and all matters connected

vith or

ancillary ro rhe matters aforesaid shall be regulated by Act of Majlis-eShoora (Parliament) or unril

the provision in that behalf is so made, by rules made by the Presidenl

l.J (Jl

procedures to be followed-in respect of

or ancillary to

the payment of moneys

Act of Padiameff and,.

into the said account, the withdrav¡al of

provision in that behalf

moneys there from, the moneys cu*ody

made by the President.

therein, and any other maüers connected wkh

ancillary to. the

matters aforesaid.

In the exercise of his powers under this

secdon

Governor-

General shall exercise individual his judgment.

metters aforesaid, regulated by

is so made, by a)

All

any such Act, by rules made by the President. .

nrles

moneys received

by or deposited with Any officer employed in connection with the affain of the Federation in his capacþ as such, other than revenues or public

mo¡reys raised or received by the Federal

-l F

zØ .l

zr{

Government;

Any court to the credit

of any

cause, matter, account or Person rrl connecrion wi¡h tåe affairs of the

tÉ

Federation;

Shall be paid into the Public Account of the Federatio¡.

ÞIt

F l¡l rl! lr,

o o

Section-33

Article-64:

(1)

The following

(2)0) The

following

expeoditure shall be charged o¡ the revenues of the Federation:

(a)

The salary allowances of

and

the Governor-General and other expenditure relating to his office for

Article-39:

Article-81:

The followi¡g expenditure

The followi¡g éxpenditure

shall be charged upon the

is charged upon the Central

Federal Consolidated Fund:-

Co¡solidated Fund¡

shall be expenditure charged Federal Consolidated Fundr

þ) The

remuneration payable to the President ¿nd other expenditure relating to his office, and the

remuneration payable 10: -

i- The

Judges of the Supreme Coun;

which provision is required to be made by

þ)

Orderin Council; Debt charges for which

redemption

Commissioner and

and

Regional

other

expenditure relating to raising of loans and the service and redemption of debq

lc) The salaries

and

Election Commissioner;

upgû the

(a) Remuneration

to the

other

payable President and

The

Speaker

and

þ)

Remuneration payable to:

i- The Speaker Deputy Speaken

and and

other members of the

üi-

Supreme Court; The members of the

iv- The Chief

Election

Commissioner;

v- The Comptroller aad Auditor-General;

Islamic ldeolosv:

frt

cF lr

remuneration tåe President and o¡her expenditure relating to his office ¿nd the

payable to

femureratiorl to:-

i- The Judges Supreme

payable

the

Court;

ü-The Chief

Elecdoa Corimissioner;

iü- The Chairman and Deputy Chairman;

iv-

Ministers;.

The

President's Council of

Deputy Speaker of vi- The members of the Advisory Council of the National Assembly: and

(a)

expenditure relating to his office;

The members of National Assembly; Federal Public. ü- The Judges of the

charges

sinking fund charges,

ü-

Sewice Qsmmissiea; üi- The Comptroller and Auditor-General Election iv- Chief

the Federation is liable, including interest,

and

expenditure

The

Speaker and Depury Speaker of

the

National

Assembly; v- The Auditor-Gene¡al

þ) The expenses,

administrative including the

remuneration pavable

allov¡ances minist¿¡g,

of of the

advocate-general, of

chief

com-issioners, and of the smff of the financial ¿dviser; (d) The salaries, allowances

and pensions

to or in judges

payable

respect of

of the

Federal

Court, and

the

pensions payable to or in respect of judges of any High Court. G)

-(Ð-G)-

Any sums required to sadsfy any judgment,

or award of any court or arbitral tribunal; (c) Any other expenditure declared by this Act or any Act of the Federal Leeislature to be so decree

members of vü- Parliamentary

Commission The ¿dministrative

by the President; and vüi-The members of the

including rhe

.Central Public Service Coomission;

the Office of the Chief Election

Delimitation

counselors, of financial

adviser, of

The

to officers and servants of the Supreme Coun, the depanment of the Auditor General and

vi-

þ)

expeûses,

Secretaries appointed

remuner¿tion payable ' to officers and servants of the Supreme Court,

(c)

The

and

administrative expenses of including the remuûerâtion payable to officers and servarrts employed in co¡r¡rection with, the

Auditor General, the Election Commission, the Secretariat of the

National Assembly, the Supreme Court, the Comptroller and

National Assembly and the Delimitation

Auditor General, the

Commission.

Qgmmissig¡1s¡, a¡.y Election Qemmis5i6a, the Advisory Council

the

Federal Public Service Commission, the depanment of the

Comprroller

G) All debt

charges for

which the Goverqment

including

sinking fund

¡he

Fede¡al

liable,

ifferest, charges,

Chief

Elecdon

of Islamic Ideolory and the Central Public Service Commission;

repayment of

(d) Debt

amortisation of capital,

the

and other expendiüre

Goveroment

charges fo¡ which

Central liable,

l\)

Commissioner and of

the

Election

Commission and the

of Senate and Secretaries

the the

N¿tional Assembly; (")

All debt charges for which the Federal Government is liable, including interest, sinking fund

charges,

the repâyment

of amortisation of capial, and other expenditure in co¡nection vith the

raising

the

of loans, service

and a¡rd

redemprion of debt on the securiry of the Federal Consolidated

Ê F Þ

z Ø Þl

-ì 1l Þ

F tp

Ff,

F l!'

lrl

z 3

in connecdon with the

"h"tg"d; (+) Any question c¡hether

any proposgd

of loans, and the sefi¡ice and raising

expenditure

falls within a class of

redemptioo of debt on tåe

tåe security of

expenditure charged on tå.e revenues

of the

Federal

Federation

shall be decided by the Governor-General

i¡

his

Consolid¿ted

Fund; (d)

discretion.

Any sums required to satisfy any judg-s¡¡, decree

or award against

Pakist¿n by any court or tribunal; and

Any other declared by

suûrs

charges,

rep¿ymenr of

¿mortisation of capiral, and othe¡ expenditure in connection v¡itt the raising of loaos and the senrice and redemption of debt on tå.e security of rhe Central Consolidated Fund; G) Su-s required to sarisfy any judgmen-t, decree

or award

the

of Padiament to be

inreresr,

sinking fund

the

Constitution or by Act charged.

includi"g

Fund;

(d) Any sums required to satisfy any judgment, or award against Pakistan by any coun or tribunal; aad decree

G) A"y other declared by

z zf¡f

l¡l

sums

the

Cons¡itution or by Act

Majlise-shoora (Parliament) to be so charged.

against

Pakistan by any Coun or tribunal;

so (Ð

Otler

sums declared by

rhis Consritution or b7 an Act of the Central

Legislature

ro be so

chareed.

Article-34:

(1) So much of estiEates

the

Anicle-65 (1) So much of the Annual Financial Stetement as

expenditure as relates

expenditure

to expeûditure charged upon the revcnues of the Federation shall

charged upon the Federal Consolidated

not be submitted to the vote of the Legislature

but nothing io subsection

i¡

the

h ei¡her Chamber of the

discussion

but shall

submitted

the

be as

Preventiûg

Fund may be discussed

this

shall

construed

(2)

not

to vote of N¿tional

the

National Assembly, before the commencemeût of that year, a steteme¡rt (to be called the Annual Budget Statement) of the estimated receipts

into, and

the

Assembly.

estimated expenditure from

of the A¡nual Financial Statement as

the Central

So much

relates to

other

Coosolidated

Fund for that year.

2- The Annual

Budget

Article-82

1- So much of An¡ual

l¿¡

Budget Sta¡ement as relates

expenditure

charged upon the Federal Consolidated Fund may be

discussed

in, but shall not be submitted to vote of the Nation¿l Assembly. 2- So much of

tle A¡nual

Budget Statement

rel¿tes to expenditure

other

shall

the

expenditure

National Assembly in

on revenue account from other

tlan

the form of

expeoditure and shall shoq¡

the form of demands for grants, and the

grants, and that Assembly shall have Po.\p'er tO ¿Ssent to of

separatelyþ

Assembly

rc in paragraph (a) or paragraph (f) of

estimates relating to expeoditure referred

subsection

(:) of the

last preceding sectio!. the said So much

estimates as relates to other expenditure shall

submited to

the

demands

for

a- The sums required to

meet

refuse to âssent 10 any demand subiect to a reduction oû the

expenditure charged upon the Central Consolidated Fund; and

specified

b- The sums required to

therei¡. Provided

meet other exPenditure

shall

zØ

submiued to

expenditure shall

Fì

Statement shall distinguish

Legislature of any of those estimates other

(2)

relates

Anicle40 1- The President shall, in reìpect of every finangial yeârs cause rc be laid before

zÞ{

o Þ F

have

Power to assent to or 1o refuse to assent to ¿¡lY

4 F

demaod subject

reducdon of the amount specified thereio: Provided... 3- No demand for grant

FI r¡l fr, C)

o zo

be submiæed in the {orm of dema¡ds for gra¡¡rs ro the Federal

Assembly thereafrer ro .

(3)

No dema¡d for

grant

distinguishiag recurring

expendirure

shall be made except

the

and

reco--endado¡ of the

tåe

President.

Council of State and eidrer Chamber shall

expenditure tåat is

recuring

recomnendation of

2, frf

the Federal Governmenr

expenditure,

and showing the extent if *y to which thar

have

new expenditure.

(3)- (4)Anicle 41 (1) So much

a reduction of the ,mouût specified

of an Annual Budget Statemenr as relates to expendirure

therein; (3)"

(a) No - demand for grant shall be oade excepr

charged upon

Central

tåe Consolidated

Fuad mäy be

i¡r but

the reco-tttendation of tåe

Governor-General.

tte

¡ot

otåer expenditure

power'to asseût to or refüse to assent to any demand subjecr to

shall be made except on

from

discussed

shall ror be submitted to rhe vote of the National Assembly.

]

(2)

So much of the Annuel

Budget St¿temenr

relates to

other

expendirure, not being expenditure specified in

the Stateme¡r in

pursua¡rce ofclause (1)

UJ ]J

Article 42 in respect of

any subsequent fi¡ancial year, shall be submitted to tle National Assembly in

(¿)

tle form of

demands for grants. (3)

demand for a grant in respect of a sum that is not shown in the Annual Budget Statement as tew

ma1

expendirure

i¡

the National Assembly but, subiect.to

discussed

clause (4) of this Article,

F Þ

zØ Fì

the demand shall not be submitted to the vote of the Assembly and the

Assembly

shdl

deemed to have assented to the demandr a-

At the expiration

fourteeo days after the Statement v¡âs laid

before or

the

AssemblY;

b The commencement of

-I

o Þ

E Þ

F EI EI

ll!

o zo F4

the financial year ro which the Statemen¡

relates,

X q

z zlfj

!íhichever last occurs (a) The National Assembly may with the consenr of the Presidenr reduce

a demand for a grant referred to in clause (3)

of this Anicle. Section-162:

Subject to the provisions of

Pan XIII of this fact q¡ith respect to borrowing in

sterling the

execurive

Anicle-115: The executive aurhorþ of the Federation shall exrend to borrowing upon the

security

of the

authority of the Federation extends to borrowing withi¡ such limits, if any, as may from time to tiqe be fixed by Act of tåe Federal Legislature and to the giving

limits,

determined.

guarantees

limits, fixed.

within

such

any, es may be so

Federal

Consolidated Fund within such limits,

as may

be determined^r, by Act of Parliament and to the giving

guarantees

within

such

atry, as may be so

Article-139: The executive

Anicle-166:

such limits, if. ary, es may be determined by Act of the Central Legislature, and to

such limits,

authorþ of The executive authority of the Central Governmen¡ the Federation extends to extends to borrowing upon borrowing upon the the security of the Cenral security of the Federal Consolidated Fund within Consolidated Fuod within

the giving of

guarantees

witå.io such limits, if any, may be so determined.

any, as may

from time to time be fixed

by the Act of

Majlis+-

Shoora, and to the giving

guaraûtees limits, if any.

within

such

(¿J

Annexure-3 List of Lav¡s Not Examined by Federal Shariat Court

Contracr

Act

L872 (Act

IX of

\872) Section

73,

illustration (n).

2. 3.

Trusts Act, 1.882 (Act

II of 1882) Section 20,20A.

Transfer of Property Act, 1882 (Act IV of 1882) Sections 58

104.

The Land Improvement Loans Act, 1883 (Act XD( of 1883) Sections 6;7 and 10.

The Agricultural Loans Acts, 1884 (Act

XII of

188a)

IX of

L914)

Section 5.

The Local Authorities Loans Act, t9L4 (Act Section 3 and4.

The Usurious Loans Act, 1918 (Act

X of

1918) Sections 2

and 3.

The Securities Act, 1920 (Act X of t920) Section 13 Q) lmany other parts impþing that securities bear interest].

TheProvidentFunds Act,1925 (ActXD( of L925)section Zlmarry other parts implying that interest is.payablel.

10. ThePublicDebtAct, L944(ActXVü of 19a4) Section [many other parts impþing that interest is payable].

11. The Foreign Exchange Regulation Act, !947 (Act VII of 1947) Section 13 [rnany other parts impþing dealings in interest].

ANNÐ(URE

L35

The National Bank of Pakistan Ordinance,

1949

(Ordinance XD( of 1949) Section 25 and many other parts which imply interest based business. L3.

The House Building Finance Corporation Act, L952 (Act XVItr of L952) Sections 2t and 24 lmarry other parts impþing dealing in interestl.

14. The Industrial Development Bank of Pakistan Ordinance, 1961 (Ordinance

XXXI of 796L) Sections

5 and27 [many

othef parts impþing dealings in interestl. 15.

The Investment Corporation of Pakistan Act, (Ordinance

IV of

1966

1966) Section 23 lmany other parts

impþing dealings in interestl.

Act, L972 (Act X)(D( Section 20 [and many other parts impþing

L6. The People's Finance Corporation

't972)

dealings in interestl. 17.

The National Development Finance €orporation Act, L973 (Act )([tr of 1923) Section 18 [and many other parts impþing dealings in interestl. The Establishment of the Federal Bank for Cooperatives and Regulation of Cooperâtive Banking Act, t977 (Aet D( of L977) Section L7lmany other parts impþing dealings in interest].

L9. The Income Ta:< Ordinance, L979 (Ordrnance XXXI of 1929) Section L7 and numerous other provisions dealing

with interest income. 20. The Companies Ordinance, 1984 (Ordinance XLVII of 1984) numerous provisions dealing with debentures and other fixed income securities.

Appendix: Distribution of Deposits by Size and Typ"

to desire if information regarding the distribution of deposits by the size of account holders and the type of deposits can be provided for its information. The same is done below. These tables are derived or obtained from the State Bank Report. During submissions, the Court was pleased

T¿ble 10 Distribution of Deposits 6¿ Advances by Size of Account Size

Advances

o/o

Deposits

o/oShare

Account ßs.000)

188

0.034

16282

1.835

4-9

1183

0.2t5

78048

8.797

9-40

15473

2.822

t59202

17.945

40-90

28721

5.239

68575

7.729

90-500

68378

L2.472

797783

21.6t7

500-1000

27343

3.893

71876

8.102

1000-6000

93046

76.971

t37450

T4,816

6000-10000

27878

s.085

19425

2.190

10000 and

292048

53.268

150547

t6.970

1-4

above

Totd Source:- SBP

548258

Annaal Report 1 996-97.

887188

t37

APPENDD(

TÂżble

Distribution of DeposiĂŚ by Type (As on 3t-12-1994

TyP.

# Accounts

Amount (Rs. in millions)

5,350,437

214,720

Call Deposits

394,692

20,4t7

Other Deposit Accounts

54L,668

34,387

24,3L0,472

404,926

Less than 6 months

437,278

L06,324

More than 6 months but

90,406

4L,433

than Lyear More than Lyear but

L25,058

5t4,793

r49,308

15,505

L75,43L

21,652

97,994

Lr,730

599,L59

70,73t

L,674,334

322,L68

32,27L,603

996,619

Current Deposits

Saving Deposits

Fixed Deposits

less

than 2 years More than 2yearcbut less than 3 years More.than 3 years but less than 4 years More than 4year but

less

than 5 years 5 years and

Total Fixed Deposits

All Deposits Soarce: SBP Annaal Report 1997-98.

Bibliography

Ahm"{

Ziauddrn, Munarrwar Iqbal and M. Fahim Khaq, eds., Money and Bankí.ng i.n Iskm (Islamabad: Institute of Policy Studies, 19S3).

AmIn, Muhammad, (Ibn 'Ãbidin), "Tanbih al-Ruqud fi Masa,il al-Nuqüd" in Rasa'il lbn 'Ãbùlin (Lahore: Suhail Academy, L976).

DJ. The Discooqrs: A History of Man\ Search ø Knou His lWorld and Hirnself (New York: Random

Boorstin,

Ffouse, 1983).

O and D.P.M. \ØeeraLLody, "Origin, Evolution in the Indian Ocean" in Proceedi.ngs of tbe Narnismatic Vorkshop on *Origin and, Eoolation of Coins" and the International Seminar on "Circulation of Foreign Coins in Sri l-anka and Ancient Sea Routes in The Asian Ocean" Colombo, 8-10 September, 1994 (New Delhi: Manohar Publishers Er

Bopearchchi,

and Circulation of Foreign Coins

Distributors,

L998).

Dornbusch, R. and S. Fischer, Macro Economics,6ú edn. (New York: McGraw-Hi ll, 1994) Fed,qdt Sbdriat Coart !ød.genmt Publishers, 1992).

on Ribd (Lahore: pLD

Index Coins, 48, 62, 79, 8I, 82, 83, 84, 85, 97, gg, gg, 90, 97, gg, gg,

A Abú Hanifah, 6, Ioz, Lo9, LL4,

lL7, LL' Abù Yüsuf, 89, L07, 109, 110, Ill; LL2, Ll3, IL4, lt7, lI8,

t6, 18,20,23, , 49, 5L, 52, 53,57,59,59,76, LLg

Assets, 8, 9, 14, L5,

24,25,29, 46,

Llz, tI3, LL4, L2L

109, 111,

go1d,79,81, 83, g4, g5, gz, gg, 89,ga,93, gg, gg, 100, 105, 106, L07, 109, 110, LLL, 712, L75,717, LLg, tLg,122, L23

silver,79, 81, 85,82, 88, 89, 90,93,97, gg, gg, 100, 105,

B Banks, 11, t4, L5, 23, 24, 25, 26, 27, 29, 29, 3L, 34, 36, 37, 40, 4L, 42, 43, 44, 47, 49, 49,50, . 52, 57, 59, 60, 62, 63, 64, 75, 9L, L04

Bay'mu'ajjal,8

L06, LO7,109, 109, 110, 111,

lL2,

tls,

116,

tl7,

LLg,

rlg,

L2l,122, t23 Collateral,6,7 Commission for Islamisarion of

Econom¡

Commodities, 5, 9, 80, 88, 89,

salam,9

Borrowing, 5,6,7, Ll,14, 16,17, 20, 32, 33, 37, 40, 41, 42, 46, 54,-55, 56, 59, 63, 65, 67, 69,

69,70,7L,79, L04,133 Business, 6, 7, 9, 23, 27, 30,

llt, lt2, tt3, lL4, II5, lt6, L17, LLg, L20, 72L, L22, 723, 139, 140

copper, 81, 83, 85, 87, 99, 106,

120

Amanah, 15,22,25,26 Amonisation, 67, t27 , 128, L29

Baf

105, 106, 102, 109, 109, 110,

!0,

13, L5, 22,

3I, 32, 59, 69, 69,

LL2

Currency, 4,

ll,

14, I9r 20,2L, 23, 34, 49, 62, 93, gg, 92, 93, 94, 97, gg,

loo, Lo7, 1og,

1Og,

lLz, Lt3, Lt4, 116, lL8, llg,120, tzl,122, t23, 110, 111, 140

72,85, t35

c Capital, 4, 5, 8, 9, 14, 20, 28, 39, 50,67,86, gg,90, tLl, lt2, 1L3, lL7, ltg, L2g, \29

Current account, 15, 20, 22, 25, 26,47

D Dinar,

82, 83, 108,

LLI, LLz, L!4,

lts,127 Dirham, 83, 108, LLt, Ll2,lL5, L21

r43

E Economics, 15, 58, 80, 96, !03, LO4,139, L40

Economﾂ｡ 2, 3, t6,

17, L8, L9, 20, 27, 33, 34, 35, 51, 54, 55, 56, 60, 61,77,80, 95, 96, 100, 103,

121

Ijﾃ｣rah,8, 10,28,29 Income, 8, 9, L4, t5, 16, 17, L8, 19, 25, 28, 34, 35, 39, 43, 48,

55, 58,75,104, 135

Indexation, 3, 4, L9, 7 8, 79, 84,

104, 118, 139

Expendirure, L7, 18, 20, 35, 55, 56, 66, 67, 69, 70, 7 L, 99, L27, L28,129, r30, L3l, t32

105,107, Lzo

Inflation, 4, 20, 48, 5t, 103,

Federal Consolidarcd Fund, 40, 66, 67, 68, 7 0, 7 2, L24, L25,

t29,130,

96, 93, 100, 101, L02, 103, 104, 55, 7 8, 79,

93, 94, 96, 97, I00, L}L, 102,

L27,

Ibn'ﾃッidin,

133

Federal Shariat Cottrt,2, LL,28, 7 t, 7 3, 7 4, 7 5, 78, L3;4, 138 Finance, 3, 4, 5, 8, 10, 13, 16, 17, tg, Lg, 20, 21, 22, 28, 3L, 32, 33,34,35, 36,38, 41, 45, 49,

t04, t39

Interest, 3, 4, 5,

60, 61, 63, 64, 67, 70, 71, 72, .

35,36, 39, 40, 42, 49, 50, 53, 55, 56,

7t,72,85,99, t35,

tLL, LL2,

Financial institutions, 14, 15, 16, 24,29, 44, 47 , 49,52, 57, 59, 75,87 Fulus,4, 79,83,86,87, 88, 89,90, 92,93, L05, L06, I07, 108, 109, 110, 111, Ll2, lL3, 114, 115, lL6, tl7, Il8, t20, L21, 122,

L5, L7,18r 20,

80,81,85, 101, 115, Lt6,t20, 127, t34, t35 Investmeff, 7, 10, 14, t5, L6r 20,

56, 57, 58, 59, 65, 68, 69, 70, L39, L4L

tl,

24,25,27,28,29, 45, 46, 48, 49, 50, 5t, 54, 55, 57, 58, 59,

,58, 59, 90, 92, Los,

ll3,

tL4, Lr7,

tl9,

135

Islamic banking, 27, 29, 61, L39 Islamic finance, 3, 4, 8, 10, 13, 18,

L9,20,22,28,3L,L4L

L Lending, 5, 6, 7, 9, Ll, L6, 32, 33,

4L,59,63,68,78, I04

t23 Funds,6, 10, 15, 18, 20,23,26, 27,29, 40, 46, 57, 69, t34

Liabilities, L3, t4, L5, t7, 22, 23,

Fuqaha', 4, 6, 77, 79, 86, 88, 89, 93, L05, L06, L08, LL7

55,62,69 Loan, 6, Il, 14, t5, t6, 2!, 23, 32, 36,39, 4L, 42, 59, 47, 66, 67,

G Gambling, 2,7,L9,74 Gharar,T

25, 26,

3!,

34, 45, 50, 5L, 54,

68,69,72,78, 85, 90, 106,122, L24, t27, L28, L29, 134

TRANSITION TO A RIBA FREE ECONOMY

744

8, 79, 86,.88, 89, 93,

I04, 106,

Ltg, L23

Majlis-e-Shoora, 66, 67, t26, t29,

133

Mark-up, 8,28,29,705

Mone¡

4, 5, 8, 19, 20, 26, 32, 33,

38, 46, 48, 50, 51, 60, 6t, 62,

63,64,68,79, 80, 81, 82, 83, 84, 85, 86, 87, 88, 89, 92, 93, 94, 95, 96, 97, 98, 100, 101, 105 Mudãrabah, 9, 75,23, 57 , 89

Murãbaþaþ,8 Mushãrakah, 9, t6, 23, 57

Seigniorage, 20, 48, 55, 97

Shan'ah, 2, 6, 7, 8, 9, 16, 27

Lll, r22, t23

o Open Market Operations, 40, 60,

P Pakistan Economic Surve¡ 18, L39

13, L5,

, 28, 30,33, 45, 46, 47 , 57,

54,57,59,73,93,107 Shariat Appellqte Berch, 73 State Bank ofPakistan, 36,37,39, 40, 42, 43, 44, 47, 48,50,54,

59,6L, t40

N Nuqud, 79,93, 106,

ll,

!7, !8, L9,20,23,24,25,

T Thaman, 105, 106, 110, 114, 115, Ll7, rL&, LLg, t20, L23 Thamaniyyali, Log, l!!, M, l!6, LL7, LI8, t20 Trade Unions, 102 Transactions, 5, 6,7, t0, LL, L3, 16, 17, 20, 22, 23, 24, 27, 28,

29,3t,

33, 45, 49, 58,59, 60,

70, 7L, 7 4, 76, 78, 80, 88, 90,

Pawnbroking, 35 Pressler Amendment, 41 Privatisation, 49, 51, 52, 53 Prize bonds, 39,40,43

Profit and loss sharing, L5,22, 23, 27,28,30,63

92, 95, 98, 106, 111, LLz,

tL9, L22, L25

U Udovitch, LLt,lI4,L4L 'Lllamã', 19, 26, 28, 63, I70 Usury, L,2,4,85

rür

Qimãr,2,7

rüüorld Bank,41

Ribã, 1, 2, 3, 4, 5, to, Lt, t7, 24, 28, 30, 33, 34, 35, 38, 44, 45, 54, 55, 56, 57,7L,73,74,77,

Zakat,93,106

tL6,

Index Coins, 48, 62, 79, 8I, 82, 83, 84, 85, 97, gg, gg, 90, 97, gg, gg,

A Abú Hanifah, 6, Ioz, Lo9, LL4,

lL7, LL' Abù Yüsuf, 89, L07, 109, 110, Ill; LL2, Ll3, IL4, lt7, lI8,

t6, 18,20,23, , 49, 5L, 52, 53,57,59,59,76, LLg

Assets, 8, 9, 14, L5,

24,25,29, 46,

Llz, tI3, LL4, L2L

109, 111,

go1d,79,81, 83, g4, g5, gz, gg, 89,ga,93, gg, gg, 100, 105, 106, L07, 109, 110, LLL, 712, L75,717, LLg, tLg,122, L23

silver,79, 81, 85,82, 88, 89, 90,93,97, gg, gg, 100, 105,

B Banks, 11, t4, L5, 23, 24, 25, 26, 27, 29, 29, 3L, 34, 36, 37, 40, 4L, 42, 43, 44, 47, 49, 49,50, . 52, 57, 59, 60, 62, 63, 64, 75, 9L, L04

Bay'mu'ajjal,8

L06, LO7,109, 109, 110, 111,

lL2,

tls,

116,

tl7,

LLg,

rlg,

L2l,122, t23 Collateral,6,7 Commission for Islamisarion of

Econom¡

Commodities, 5, 9, 80, 88, 89,

salam,9

Borrowing, 5,6,7, Ll,14, 16,17, 20, 32, 33, 37, 40, 41, 42, 46, 54,-55, 56, 59, 63, 65, 67, 69,

69,70,7L,79, L04,133 Business, 6, 7, 9, 23, 27, 30,

llt, lt2, tt3, lL4, II5, lt6, L17, LLg, L20, 72L, L22, 723, 139, 140

copper, 81, 83, 85, 87, 99, 106,

120

Amanah, 15,22,25,26 Amonisation, 67, t27 , 128, L29

Baf

105, 106, 102, 109, 109, 110,

!0,

13, L5, 22,

3I, 32, 59, 69, 69,

LL2

Currency, 4,

ll,

14, I9r 20,2L, 23, 34, 49, 62, 93, gg, 92, 93, 94, 97, gg,

loo, Lo7, 1og,

1Og,

lLz, Lt3, Lt4, 116, lL8, llg,120, tzl,122, t23, 110, 111, 140

72,85, t35

c Capital, 4, 5, 8, 9, 14, 20, 28, 39, 50,67,86, gg,90, tLl, lt2, 1L3, lL7, ltg, L2g, \29

Current account, 15, 20, 22, 25, 26,47

D Dinar,

82, 83, 108,

LLI, LLz, L!4,

lts,127 Dirham, 83, 108, LLt, Ll2,lL5, L21

r43

E Economics, 15, 58, 80, 96, !03, LO4,139, L40

Economﾂ｡ 2, 3, t6,

17, L8, L9, 20, 27, 33, 34, 35, 51, 54, 55, 56, 60, 61,77,80, 95, 96, 100, 103,

121

Ijﾃ｣rah,8, 10,28,29 Income, 8, 9, L4, t5, 16, 17, L8, 19, 25, 28, 34, 35, 39, 43, 48,

55, 58,75,104, 135

Indexation, 3, 4, L9, 7 8, 79, 84,

104, 118, 139

Expendirure, L7, 18, 20, 35, 55, 56, 66, 67, 69, 70, 7 L, 99, L27, L28,129, r30, L3l, t32

105,107, Lzo

Inflation, 4, 20, 48, 5t, 103,

Federal Consolidarcd Fund, 40, 66, 67, 68, 7 0, 7 2, L24, L25,

t29,130,

96, 93, 100, 101, L02, 103, 104, 55, 7 8, 79,

93, 94, 96, 97, I00, L}L, 102,

L27,

Ibn'ﾃッidin,

133

Federal Shariat Cottrt,2, LL,28, 7 t, 7 3, 7 4, 7 5, 78, L3;4, 138 Finance, 3, 4, 5, 8, 10, 13, 16, 17, tg, Lg, 20, 21, 22, 28, 3L, 32, 33,34,35, 36,38, 41, 45, 49,

t04, t39

Interest, 3, 4, 5,

60, 61, 63, 64, 67, 70, 71, 72, .

35,36, 39, 40, 42, 49, 50, 53, 55, 56,

7t,72,85,99, t35,

tLL, LL2,

Financial institutions, 14, 15, 16, 24,29, 44, 47 , 49,52, 57, 59, 75,87 Fulus,4, 79,83,86,87, 88, 89,90, 92,93, L05, L06, I07, 108, 109, 110, 111, Ll2, lL3, 114, 115, lL6, tl7, Il8, t20, L21, 122,

L5, L7,18r 20,

80,81,85, 101, 115, Lt6,t20, 127, t34, t35 Investmeff, 7, 10, 14, t5, L6r 20,

56, 57, 58, 59, 65, 68, 69, 70, L39, L4L

tl,

24,25,27,28,29, 45, 46, 48, 49, 50, 5t, 54, 55, 57, 58, 59,

,58, 59, 90, 92, Los,

ll3,

tL4, Lr7,

tl9,

135

Islamic banking, 27, 29, 61, L39 Islamic finance, 3, 4, 8, 10, 13, 18,

L9,20,22,28,3L,L4L

L Lending, 5, 6, 7, 9, Ll, L6, 32, 33,

4L,59,63,68,78, I04

t23 Funds,6, 10, 15, 18, 20,23,26, 27,29, 40, 46, 57, 69, t34

Liabilities, L3, t4, L5, t7, 22, 23,

Fuqaha', 4, 6, 77, 79, 86, 88, 89, 93, L05, L06, L08, LL7

55,62,69 Loan, 6, Il, 14, t5, t6, 2!, 23, 32, 36,39, 4L, 42, 59, 47, 66, 67,

G Gambling, 2,7,L9,74 Gharar,T

25, 26,

3!,

34, 45, 50, 5L, 54,

68,69,72,78, 85, 90, 106,122, L24, t27, L28, L29, 134

TRANSITION TO A RIBA FREE ECONOMY

744

8, 79, 86,.88, 89, 93,

I04, 106,

Ltg, L23

Majlis-e-Shoora, 66, 67, t26, t29,

133

Mark-up, 8,28,29,705

Mone¡

4, 5, 8, 19, 20, 26, 32, 33,

38, 46, 48, 50, 51, 60, 6t, 62,

63,64,68,79, 80, 81, 82, 83, 84, 85, 86, 87, 88, 89, 92, 93, 94, 95, 96, 97, 98, 100, 101, 105 Mudãrabah, 9, 75,23, 57 , 89

Murãbaþaþ,8 Mushãrakah, 9, t6, 23, 57

Seigniorage, 20, 48, 55, 97

Shan'ah, 2, 6, 7, 8, 9, 16, 27

Lll, r22, t23

o Open Market Operations, 40, 60,

P Pakistan Economic Surve¡ 18, L39

13, L5,

, 28, 30,33, 45, 46, 47 , 57,

54,57,59,73,93,107 Shariat Appellqte Berch, 73 State Bank ofPakistan, 36,37,39, 40, 42, 43, 44, 47, 48,50,54,

59,6L, t40

N Nuqud, 79,93, 106,

ll,

!7, !8, L9,20,23,24,25,

T Thaman, 105, 106, 110, 114, 115, Ll7, rL&, LLg, t20, L23 Thamaniyyali, Log, l!!, M, l!6, LL7, LI8, t20 Trade Unions, 102 Transactions, 5, 6,7, t0, LL, L3, 16, 17, 20, 22, 23, 24, 27, 28,

29,3t,

33, 45, 49, 58,59, 60,

70, 7L, 7 4, 76, 78, 80, 88, 90,

Pawnbroking, 35 Pressler Amendment, 41 Privatisation, 49, 51, 52, 53 Prize bonds, 39,40,43

Profit and loss sharing, L5,22, 23, 27,28,30,63

92, 95, 98, 106, 111, LLz,

tL9, L22, L25

U Udovitch, LLt,lI4,L4L 'Lllamã', 19, 26, 28, 63, I70 Usury, L,2,4,85

rür

Qimãr,2,7

rüüorld Bank,41

Ribã, 1, 2, 3, 4, 5, to, Lt, t7, 24, 28, 30, 33, 34, 35, 38, 44, 45, 54, 55, 56, 57,7L,73,74,77,

Zakat,93,106

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