Introduction
For several centuries Muslim scholars remained pioneers in their fields of learning and continued to push the frontiers of knowledge thus contributing in a highly significant way not only to the advancement of the Muslim world but also the develop- ment of science and the expansion of the store of human learning. Unfortunately, however, there came a period during which the vigour and resilience of the response of Muslim scholars to the fresh challenges they faced remained in low key, and the quality and character of their intellectual con- tributions left much to be desired. In recent years, to the satisfaction of all Muslims, there has been an encouraging revival in the intellectual activity of Muslim scholars around the world and a serious effort is being made to respond successfully to the intellectual challenges that the Ummah is now facing.
Among the fields that have received the special attention of Muslim scholars is the area of monetary and fiscal economics of Islam on which a number of treatises and books have been written so far in several languages. Some valuable ground has already been covered in this field but a large number of questions are yet to be answered
To draw the attention of Muslim scholars to some complex issues in the field of monetary and fiscal economics of Islam, King Abdul Aziz University is issuing this booklet which divides: the subject into four major parts, further subdivided into a total of twenty subjects. The first part relates to the conceptual aspects of riba, credit, saving and investment in Islam and comprises eight subjects. The second part relates to some of the major policy issues involved in organizing monetary, banking and fiscal affairs in a riba-free economy and has also been sub- divided into five subjects. The third part comprises five different subjects concerning the international aspects of Islamic banking and, finally, the fourth part relates to the for- mulation of a theoretical framework for the monetary and fiscal economics of Islam. It is hoped that the booklet by pointing out
the major questions involved, will promote scholarly and con- structive research in this field and ultimately help Muslim scholars come to grips with the major issues and meet successfully the challenges that face the Muslim Ummah.
King Abdul Aziz University takes this opportunity to invite all Muslim universities around the world to encourage promising students and scholars in their Department of Economics and Business to write Masters or Doctors or post-doctoral disser- tations on these subjects not only to generate greater interest in the field but also to help increase our understanding of the complexities of the problems and enable us to find solutions that reflect the genius of Muslim scholarship and are in confor- mity with the dictates of our justice- and welfare-oriented ideology.
King Abdul Aziz University is ready to render whatever assistance it can provide in the pursuit of research on this sub- ject to enable Muslim scholars to answer the questions raised in this booklet.
This booklet has been prepared in collaboration with the Islamic Foundation, Leicester. The University expresses its gratitude to the Islamic Foundation and all those scholars who have co-operated in the production of this study outlining themes for research in Fiscal and Monetary Economics of Islam.*
Dr. Muhammad Omar Zubeir President
King Abdul Aziz University
Original draft of this document was prepared by Dr Muhammad Umar Chapra. It was revised and expanded at the Islamic Foundation by Khurshid Ahmad in the light of alternate outlines suggested by Dr Muhammad Ne- jatullah Siddiqui and Dr Muhammad Uzair The revised document was dis- cussed by a special committee which met at the King Abdul Aziz University, Jeddah (2nd-4th November, 1976) and was attended by Dr Muhammad Omar Zubeir, Dr Hasan Abu Rukba, Dr Muhammad Saqr. Dr Hasan Balkhi, Dr Tawfiq Shawi, Dr Abdul Hamid Abu Sulaiman, Dr Umar Chapra, Dr Muham- mad Anas Zarqa and Professor Khurshid Ahmad. The final draft has been produced in the light of the discussions held by the committee and suggestions and comments made by Dr. Ma’bid Al-Jahri of the Islamic Development Bank
Contents
Part I CONCEPTUAL ASPECTS
1. Riba in the Qur’an, Sunnah and Fiqh.
2. Riba and Muslim History.
3. Survey of Classical Islamic Literature on Money.
4. Survey of Contemporary Islamic Literature on Money, Banking and Monetary Policy.
5. The Place of, and the Rationale behind, the Prohibition of
Ribă in Islam.
The Role of Credit in an Islamic Society.
Saving and Investment in an Islamic Economy. Allocation of Resources in a Riba-Free Economy.
Part II POLICY ISSUES
Money in an Islamic Economy.
The Role of Monetary Policy in an Islamic Economy. Commercial Banks and Other Financial Institutions in an Islamic Economy.
12. Fiscal Policy of an Islamic State and its Relationship with
Monetary Policy.
13. Inflation in an Islamic Economy
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Part III INTERNATIONAL ASPECTS
Foreign Exchange Markets in an Islamic Economy.
15. Debt Servicing Burden of Developing Muslim Countries.
16. The Islamic Development Bank.
17. Islam and the International Monetary Reform.
18. Monetary Integration and the Islamic Dinar.
Part IV THEORETICAL FRAMEWORK
19. Theoretical Framework for the Monetary and Fiscal Economics of Islam.
20. Alternative Institutional Arrangements for an Islamic Economy.
Part I
CONCEPTUAL ASPECTS
Part I
Conceptual Aspects
Subject 1
Riba in the Qur’an, Sunnah and Figh
(a) A review and analysis of the Qur’anic verses and ahadith related to ribā to determine their real meaning and significance.
(b) Ribā as it appears in the Fiqh literature – an examina- tion and analysis of the Fiqhi discussion, particularly of the controversy over Riba al Fadl and Riba al-Nasi’ah, to indicate the points of agreement and divergence and the underlying juristic or socio-economic reasons.
(c) Scrutiny of the claim by certain quarters that “Riba” is equivalent to “usury” and does not apply to “interest” on productive loans. In this connection specific attention needs to be given to the erosion in the real value of the principal amount as a result of the high rate of inflation in the modern world. Does ribă relate to the lending of real commodities, including commodity money (such as gold) or does it also extend to the modern fiat money whose real value is subject to change and having a secularly declining trend in its real value. In the case of riba-free loans where profit-sharing is not feasible, would the introduction of some indexation be in conflict with the Shari’ah? In this respect various forms of indexation may be examined, e.g., the cost of living index or some other price in- dex, the average price of the commodities specified by the Prophet in the ahadith related to riba, and the average rate of return on profit-sharing investments.
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(d) In the light of the discussion in a, b, and c above, what conclusions may be drawn about riba – clearly distinguishing areas where there is concensus and areas where there is, or could be, genuine room for difference of opinion in the light of the Shari’ah.
(e) An examination of the question of earned and unearned income in the light of the rationale behind the prohibition of riba – Is all unearned income riba? Is any form of unearned in- come permissible? In this respect the paper should also ex- amine the concept of just price, and exploitative or monopoly profits, rents, wages and salaries, as well as speculative profits.
Subject 2
Riba and Muslim History
The objective of this paper should be to indicate the monetary system during the classical period (Prophetic and Khilafat al-Rashidah) and the changes that were brought into that system by Islam. The paper should also survey the various forms that lending and borrowing have taken during different periods in Muslim history, particularly during the classical period. The paper should also indicate and evaluate the different techniques adopted during Muslim history to circum- vent the Islamic teachings on ribā and discuss the main socio- economic and political reasons underlying these.
Subject 3
Survey of Classical Islamic Literature on Money
A survey of the opinions of Muslim jurists and scholars on money, including the following aspects:
(a) Its nature, rules of behaviour to which the state should adhere with respect to issue and regulation of money
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(b) The effect of the change in the real value of money on con- tractual relations (such as creditor-debtor relationship).
(c) Rules of behaviour governing transactions involving money among individuals and countries. How should the individual and the state manage their monetary assets?
(d) The paper should take note of any classical literature deal- ing with the relationship of money to economic activity
Subject 4
Survey of Contemporary Islamic Literature on Money, Banking and Monetary Policy
Only the major works of the 20th Century should be examined to highlight the various issues and controversies and to indicate the areas of weakness and strength. This sur- vey should also cover the major models proposed for interest- free banking and indicate as well as evaluate the underlying juristic differences.
Subject 5
The Place of, and the Rationale Behind, the Prohibition of Riba in Islam
The paper should clearly indicate the place and role of the prohibition of riba in the overall value system and way of life of Islam to demonstrate that it is not “capitalism minus riba” that Islam stands for, but that prohibition of ribâ is one of the impor- tant corner-stones of a distinct economic system having its own values and goals that could not be fully realized until ribā is abolished. The rationale should be discussed in the light of the prominent socio-economic goals of Islam like social and economic justice, equitable distribution of income, accelerated and balanced economic growth, and general social welfare. Citations and statistics should be provided from other systems indicating how riba can nullify the socio-economic goals
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cherished by Islam. Could the isolated abolition of riba in most present-day Muslim economies, with their capitalist-feudalist economic systems, help achieve the socio-economic objec- tives of Islam, or would it necessitate an overall implementation of all Islamic values in the light of the Qur’anic verse: “O, you who believe! Enter Islam completely”. (2:208). If a graduated programme is considered desirable in the implementation of Islamic values, where would the abolition of riba stand in such a programme?
The paper should clearly distinguish between economic, moral, social and other reasons for the abolition of riba. On the economic side, the paper should consider separately if possible:
(a) The mechanism for the creation of liquidity.
(b) How different financing schemes influence the risk attached to investment funds and how this affects saving-investment behaviour.
(c) The allocative and welfare effects of monetary exchanges.
Subject 6
The Role of Credit in an Islamic Society
The paper should review and analyse the Islamic values related to credit and critically examine the scope and role of credit in all its major ramifications (consumption, production, etc.) in the life of individuals, firms and the state in an Islamic economy in the light of overall socio-economic goals – Does Islam tolerate, permit or encourage the “living on credit” prevalent in capitalist societies? In the light of the Islamic socio-economic norms would it be desirable that both the private and the public sectors in an Islamic economy place less reliance on credit than is the case in capitalist economies? Does living on credit necessarily promote a better standard of living and produce a more viable/balanced/just economy? Can high rates of growth and improved standards of living be promoted through better distribution of income, value- oriented regulation of consumption, “discouraging” hoarding
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and “encouraging” investment? This paper is closely related to the subject seven. It should specify, if possible, the conditions under which an expansion of credit to consumers and producers may be desirable in an Islamic economy.
Subject 7
Saving and Investment in an Islamic Economy
What is the place of saving and investment in the overall framework of Islamic values what are the various direct or indirect incentives and/or penalties that are built-in or could be employed in an Islamic economy to induce income-earners to save? What incentives and/or penalties are built-in or could be employed in an Islamic economy to induce savers to employ their savings profitably and to overcome the liquidity preference of savers who do not wish to be active investors themselves? What alternative instruments or channels for profitable employment of savings could be made available to savers so as to provide them a positive net increase in the real value of their savings with adequate safety and liquidity of their funds? What would be the role and scope of profit-sharing in the mobilization of savings? It is hoped that this paper will develop a framework for inter-temporal allocation of resources in an Islamic society
Subject 8
Allocation of Resources in a Riba-Free Economy
The paper should deal with at least the following questions (a) Does the rate of interest really perform efficiently the func- tion of allocation of resources in a capitalist economy? (b) How well is the function of resource allocation taken care of in a socialist economy? Is the use of a shadow rate of interest
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really essential and does it introduce greater efficiency? Would it be necessary to have such a rate in an Islamic economy? If not, what would be its substitute?
(c) How would the allocation of resources take place in an Islamic economy? How would resource allocation decisions be taken where profit-sharing is not possible or feasible? What criteria would be used to choose projects for “optimum” allocation and to ensure an equilibrium between supply of, and demand for, financial resources? Would the abolition of riba introduce more, or less, efficiency in the allocation of resources? If the answer happens to be less, would there be any offsetting advantages for the economy in the abolition of riba. In the case of collective choice about allocation, who would have the decision-making powers? How would honesty, equity and efficiency be ensured?
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Part II
POLICY ISSUES
Part II
Policy Issues
Subject
Money in an Islamic Economy
What should be the characteristics of money in an Islamic economy in the light of the Shari’ah? Do the various present- day forms of money fulfil these characteristics to be particularly examined in this respect is the place of the stability of the real value of money in the Shari’ah teachings? Is there any room or scope for a secularly rising price level? Would such a trend be in harmony with a riba-free Islamic economy?
Keeping in view the central goals of an Islamic economy, is it necessary to have full-bodied or fully representative money in an Islamic economy? What is the scope for fiat money? How does fiat money with a secularly declining real value fit into a riba-free Islamic economy? Would the central bank in an Islamic economy have the “privilege” to “print” money without the backing of real resources? If this privilege is to be recognized, can some guiding principles be provided in the light of the Shari’ah to prevent unscrupulous governments from exploiting this privilege and to save the Muslim society from the ravaging effects of inflation resulting from rapidly ex- panding fiat money. What is the scope from the Islamic view- point of the computerized disembodied forms of international money currently being discussed as a possible development in the future? Are there any guidelines available in the Shari’ah to direct the thinking of Muslims?
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What is the scope for deposit money in an Islamic economy, particularly the creation of deposits by commercial banks or other banking institutions. In the Islamic model of banking, would banks be allowed to create deposits?
In the light of the Shari’ah is it possible to say specifically whether any individual or institution has the right to lend money which he or it does not have. Does the creation of deposits, fit into the riba-free framework of the economic system of Islam?
Can any prediction be made about the behaviour of the velocity of circulation of money in an Islamic economy? Can something be said specifically about the velocity of currency, primary bank deposits and derivative deposits in an Islamic economy?
Is it possible for an Islamic State to make its money immune from the monetary, fiscal and foreign exchange policies of other countries? Would this necessitate, or make permissible, certain adjustments in policies?
Subject 10
The Role of Monetary Policy in an Islamic Economy
The paper should discuss the goals and functions of the central bank and monetary policy in an Islamic economy. How and in what manner could monetary policy be oriented to the socio-economic goals of Islam-like social and economic justice, equitable distribution of income, economic stability and growth and general social welfare? Can there be a com- promise between the various goals and, if so, what goals would receive priority? To what extent and under what conditions would the central bank be able to realize its goals?
This paper should examine the various tools of monetary policy in a modern Islamic economy, emphasising their nature
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and scope. How does the abolition of riba influence the role of monetary policy in a modern economy? Could the absence of the rate of interest as an instrument of monetary policy seriously handicap an Islamic economy? Is a substitute for bank rate or other instruments of monetary policy feasible or desirable? What alternative tools of monetary policy can be developed? Is it possible to use profit-sharing as an alternative instrument? If so, how?
The impact of the abolition of riba on international monetary relations of Muslim countries should be discussed.
Another aspect that may also be examined is related to the special context of Muslim developing countries and the role of monetary policy in the overall Islamic strategy of development in these countries whether resource-rich or resource-poor. Is it possible to identify the fundamentals of a monetary policy which is Islamically-oriented and also consistent with the needs, stage of development and level of resources of these countries?
Subject 11
Commercial Banks and Other Financial Institutions in an Islamic Economy
The objective of this paper should be to indicate the differing and complementary roles of different institutions mobilizing savings and allocating these among equity investments and loans. The criteria to be used for this allocation should be carefully examined to provide guidance to prospective riba- free banks or financial institutions. With respect to equity in- vestments, along with the different criteria to be used in choos- ing between different alternatives, the paper should also dis- cuss the question of whether the lending or investing bank should or should not take active part in the supervision or management of the project financed. With respect to loans, all different types of loans should be examined (e.g. production and consumption loans, instalment credit, public sector loans
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for different “productive” and “unproductive” purposes, short-, medium-, and long-term loans and loans with and without profit-sharing). On loans without profit-sharing how would the service charge be determined?
With respect to profit-sharing the paper should discuss the concept of profit-sharing in Islam and attempt to evaluate the controversy over whether the bank alone will bear losses or whether the borrower will also share them in a specified proportion.
This paper should also discuss the question of inter-bank lending and borrowing, particularly the domestic and inter- national relations between Muslim and non-Muslim banks.
With respect to commercial banks lending resources de- rived from demand or short-term deposits, how could the liquidity and safety of their funds be ensured? In the case of financial institutions other than commercial banks, would all their funds be invested in a profit-sharing framework? How would the risk be diversified to ensure the safety of their funds?
Could there be a centralized insurance of deposits to ensure the safety of depositors’ funds? Could there be a centralized in- surance of profit-sharing investments of commercial banks to reduce their risk and ensure the viability of these institutions? Could some guidelines be provided for the insurance of these deposits and/or investments? Would such insurance be in the private or the public sector?
Would it be necessary to have a nationalized banking system in an Islamic economy or would banking be desirable and feasible in a private-sector framework?
How would the functioning of non-Muslim financial in- stitutions be regulated in an Islamic economy with specific reference to their functions as channels for surplus funds towards or away from the Islamic economy?
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Subject 12
Fiscal Policy of an Islamic State and its Relationship with Monetary Policy.
What would be the targets and instruments of fiscal policy in an Islamic State?
What would be the targets and instruments of taxation policy in an Islamic economy, particularly the role of Zakat and other taxation with particular reference to their effect on savings, in- vestment, growth and welfare. Would there be any Shari’ah constraints on the taxing powers of an Islamic State?
What would be the essential features and instruments of the expenditure policy of an Islamic State?
Could the taxation and expenditure policies be used for stabilizing the economy? How would this be done? What would be the role of public borrowing in an Islamic State? Would it be necessary for an Islamic State to have a balanced budget or would it resort to expansionary and contractionary fiscal policies as in capitalist economies? Is there any distinction in this respect between an Islamic State and any other state? What guiding principles could be provided in the light of the Shari’ah? What criteria would be used to allow budgetary deficits or surpluses? Could continuing budgetary deficits be permitted in an Islamic State? Would there be any Shari’ah constraints on the borrowing power of an Islamic State? Can the Islamic State print money to finance its expenses? If so, what specific projects may it finance in this manner? Is it possi- ble that in an Islamic State instead of the rate of interest, other methods, including the distribution of income, could be used as instruments for managing the economy?
The relationship between monetary and fiscal policies should also be examined to indicate their complementary and conflicting roles with a view to suggesting how the two can together be made to serve the ultimate goals of economic policy in Islam
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Subject 13
Inflation in an Islamic Economy
The paper should examine scientifically whether and to what extent an Islamic economy could be plagued by bouts of recession, depression and inflation. A thorough examination of inflation, its causes and cures should also be undertaken in the context of abolition of riba, effects of Zakat on consumption and investment, and the developmental policy of an Islamic State. Is a long-run inflationary trend possible or desirable in an Islamic economy? This paper may also throw some light on the phenomenon of inflation in the contemporary Muslim world and explore the constituents and effects of an Islamic anti-
inflationary policy.
Part III
INTERNATIONAL ASPECTS
Part III
International Aspects
Subject 14
Foreign Exchange Markets in an Islamic Economy
The paper should examine the nature and scope of domestic regional and international markets for foreign ex- change from the point of view of Islamic teachings, with specific reference to the determination of rates of exchange, floating versus stable rate systems, foreign exchange specula- tion, spot and forward markets and international capital movements. What measures may be adopted to regulate (or prevent, if necessary) the outflow of capital from a riba-free economy, particularly through foreign banks. What measures may be adopted to attract the flow of capital towards a ribā- free developing economy? The paper should also discuss the problem of riba from the point of view of international lending and the juristic controversy of dar al-harb and dar al-Islām.
An effort should be made to provide some guiding principles in the light of the Qur’an and the Sunnah to enable an Islamic State to determine its policies in the area of foreign exchange and international monetary relations.
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Subject 15
Debt Servicing Burden of Developing Muslim Countries
The paper should examine the debt servicing burden of developing Muslim countries and indicate its implications for international stability and peace, economic development in the Muslim world and the political strength of Muslim countries in international power politics. The paper should also examine the causes of this indebtedness and indicate the measures that could be adopted by the countries concerned individually to improve their position and by the Muslim countries collectively to provide relief to the affected countries. The paper should also examine the question whether it is necessary to borrow to the extent some Muslim countries have done? Is it possible to use “own” resources more effectively for development with as little resort to international borrowing as possible? In the light of the Shari’ah could certain guidelines be provided to an Islamic State about international borrowing? Is it permissible in the Shari’ah for one generation to borrow and knowingly pass its debt servicing burden to future generations?
Subject 16
The Islamic Development Bank
The paper should discuss the role and scope of the Bank in the light of the problems of the Muslim Ummah and the Bank’s Charter. What problems the Bank is likely to face. The paper should try to provide some guidelines with the rationale behind them to enable the Bank to play an effective role in the Muslim world as a pioneer in the field of Islamic banking.
Until such time as there is an adequate development of short-term riba-free investment instruments in the Muslim world, could the Bank be allowed to invest at least a part of its surplus funds in the traditional outlets for development banks? If the Bank invests in non-traditional outlets for short-term sur-
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plus funds of development banks, how would the safety and liquidity of the Bank’s resources be ensured? Is it necessary for a pioneer Islamic bank to fulfil the dictates of the Shari’ah fully with immediate effect or can some margin be allowed for the development of an Islamically-oriented money market in the Muslim world? In this respect it should be borne in mind that the Bank has to have some source of income of its own if it is to avoid depending on subsidies from member countries for financing its normal day-to-day expenses.
Subject 17
Islam and the International Monetary Reform
The paper should examine the various issues and problems in the field of international monetary reform and attempt to provide guidelines for their solution in the light of Islamic teachings. Would the implementation of these guidelines lead to the evolution of a stable international monetary system? The paper should also critically evaluate, from the point of view of the Shari’ah, the major proposals made so far for international monetary reform? Could an alternative model be provided based on Islamic teachings? How would this model help imple- ment the Islamic ideals of socio-economic justice and general human welfare in an international perspective?
Subject 18
Monetary Integration and the Islamic Dinar
The paper should critically evaluate the need and prospects for, as well as the feasibility of, monetary integration in Muslim countries.
The paper should also critically examine the concept of an Islamic unit of account and a common currency for Muslim countries. What problems are likely to be faced? Would it be
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possible to solve these problems? Are there any pre-requisites or conditions for the creation of such a unit of account or com- mon currency? Do the Muslim countries fulfil these con- ditions? What measures may be taken to create the pre- requisites?
The paper should also propose a plan for the use of petro- dollars to reduce the dependence of the Muslim world on the West. What is the assurance that the petro-funds thus made available would on the one hand, help attain the cherished goals of the Muslim world, and on the other, provide a safe and profitable outlet to the oil countries for their surplus funds?
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Part IV
THEORETICAL FRAMEWORK
Part IV
Theoretical Framework
Subject 19
Theoretical Framework for the Monetary and Fiscal Economics of Islam
The paper should lay down the fundamentals of a balanced monetary and fiscal theory well integrated into the overall framework of Islamic economics and in harmony with the goals and values of the Shari’ah. This cannot be done successfully unless the paper identifies the assumptions and hypotheses underlying human nature and behaviour in the capitalist and socialist economic thought and clearly distinguish and evaluate their counterpart in the Islamic ideology. In the light of the ethical base of Islam and the socio-economic objectives of the Islamic system, could the concepts and methods of capitalist and socialist welfare economics be valid in the Islamic frame of reference? If not, what would be the basic postulates of welfare economics in Islam and how would they affect monetary and fiscal economics in the Islamic framework?
How would the differences indicated above modify the models or ideal types explaining human behaviour in Islamic economics? What kind of structural changes would this in- troduce in the monetary and fiscal economics of Islam? If the changes are fundamental can the monetary and fiscal economics of Islam be studied with capitalist or socialist tools, methods or ideal types? If behaviour models are to be changed
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would some or all of the definitional models also need to be changed accordingly?
In this paper, an attempt may also be made to construct models or ideal types to indicate the behaviour of certain im- portant variables in the monetary and fiscal fields of an Islamic economy. Would these models or ideal types overcome the major limitations of their counterparts in the capitalist and socialist framework and would they explain human behaviour more realistically. In what ways would the policy implications of these be more conducive to human welfare in the Islamic framework?
Subject 20
Alternative Institutional Arrangements for an Islamic Economy
This paper will present some institutional arrangements for different sectors of an Islamic economy in the form of a sample analytical model. It will provide terms of reference for later theoretical and empirical discussions that will hopefully lead to an optimal institutional framework.
