Mobilisation of Domestic Funds on Islamic Principles

01 April, 1993

The experience of Islamic banks all over the world, the successful floatation of Mudarabah funds by Islamic and non-Islamic banks, the experience of investment companies and of cooperatives operating on a profit-loss sharing basis in Muslim countries are enough to suggest that the application of Islamic principles of financing and banking in the private sector does not pose any problem with respect to mobilisation of domestic resources in a Muslim economy.

The only issue that is required to be tackled in this context is the monitoring and regulation of the private sector financial institutions so that the money of the depositors (who arc often small savers) is not unnecessarily put at risk or mis-appropriated.

Public Sector Requirements

The public sector, however, is our main concern when discussing the mobilisation of domestic resources under the Islamic principles. The problem is very simple. The public sector needs funds to carry out its various activities, and because the sector is usually large its fund requirements are also large. Though some quarters may justify large public spending in an Islamic economy that is a separate issue.

Irrespective of this is the question of whether there is a Shariah limit on the government expenditure, and how can the public sector mobilize resources to finance its activities on Islamic principles? This simple problem does not have a simple answer.

So far, the following two sets of answers have been offered.

Commercialisation of Activities

The first set of answers includes several suggestions. One suggestion is that the public sector should try to commercialise its activities as far as possible and these activities can then easily be financed through the use of profit-loss sharing techniques or out-put sharing techniques, or techniques based on such principles as of Murabahah, Salam or Ijarah. It is suggested that government activities may function as public enterprises and corporations whose shares can be sold and quoted on stock exchanges. The use of Mudarabah or Musharakah (i.e. profit-loss sharing or income sharing) certificates has also been suggested, for such sectors as transport communication, mass-media and tourism.

The negotiability of such certificates will develop secondary markets for these certificates which will play a catalytic role in mobilising resources for the public sector from small savers in the economy.

Leasing - Based Instruments

In the same spirit it has been proposed that leasing-based instruments may also be developed to mobilise resources to finance infrastructural projects. The infrastructure including buildings and equipment and other physical assets, can be leased to appropriate government agencies and this rental income can be shared by the holders of the certificates.

The negotiability of these certificates in the secondary markets is expected to mobilise small savers to contribute to the resources needed to build up the infrastructure.

This solution however, is not sufficient because with the current state of Muslim economics only a very small part of the public sector can possibly be commercialised to successfully apply these modes of financing for the purpose of mobilising resources.

Sectors like defence, health, education and infrastructure development for the benefit of the poor consumes almost the bulk of the public sector expenditure and so could hardly be run on a commercial basis.

Deferred Payments

An alternative suggestion which would mean a more comprehensive solution, is to apply the concept of mark-up-based deferred payments for all government needs that otherwise cannot be financed from the government’s available resources. The purchase of all supplies, goods and equipment needed for government activities can be made on the mark-up basis with payments deferred for a year or a number of years.

It has been proposed that even part of the salaries and wages can be financed by offering employees the chance to receive part of their wages with a certain mark-up. All building and construction projects could be offered to private parties on a cost-plus basis which could be paid in instalments. Islamic principles of forward sale have also been proposed as a means of financing for several activities.

All these suggestions, though in principle practical and feasible, have not received adequate attention from government circles probably because they require a different institutional set up, which presently does not exist and will require time to develop with few suggestions as to what to do during the interim period

. Compensation on Loans

The second set of answers is based on the principle of allowing the government to pay some compensation, on its loans, to the lenders. One suggestion in this respect is to index the government loans by the cost of living index.

If government borrowing from the public is linked with the rate of inflation, this will induce the savers to lend their money to the government, because it protects the real value of their loans. This solution, which is of ten considered by planning and policy makers as a viable solution to mobilising domestic resources for the public sector, still fails to receive endorsement from the Shariah scholars. Indexation of loans is prohibited according to the Shariah rules.

An alternative suggestion is to apply the concept of indexation, but in a way as to make it more acceptable to the Shariah. This could be done by issuing loan certificates in denominations other than the prevailing currency units. Several variants of this proposal have already been mentioned.

One suggestion calls for issuing loan certificates whose value is defined in terms of a well defined basket of goods. The government will then sell these certificates at the prevailing market price of the basket of goods. The holder of the certificate can cash this certificate at any time he so wishes and he will be paid the value of the basket according to the actual market price of that basket at the time of redemption of the certificate. Another suggestion calls for issuing loan certificates in terms of a unit of a basket of currencies.

Still another suggestion requires the issuing of loan certificates in terms of units of one single universally acceptable and stable commodity like gold.

However, these suggestions have not yet gained the support of the Shariah and their viability from the economic policy perspective is also doubtful.

One condition for the Shariah to accept these suggestions is that the exchange of these loan certificates should not merely be a paper transaction. The possibility of real exchange of goods or currencies underlying these certificates should always actually exist. Thus, if the holder of the certificate denominated in a basket of goods demands the basket of goods itself then the borrower should repay his loan immediately. This condition though feasible in private transactions, is not, of course, practical from the government borrowing point of view.

A Related Solution

A related solution is that the government may give some extra return on its borrowing and that this return will not be announced in advance and will not be guaranteed and only will be a sort of gift from the government to the people who purchase its non-interest bearing securities. This solution has not so far received the Shariah's approval.

Some of these suggestions - in particular a straight forward linkage with the rate of inflation or payment of any positive rate of return, though not guaranteed-receives more attention in government circles because they do not require any new institutions to be developed, the existing institutions will continue to exist and there will be no problem about what to do in the interim period