An Islamic Perspective on Discounting

In this part of the paper we first consider whether discounting should be accepted on the ground that it is one condition for investment efficiency. An Islamic viewpoint is presented on the logic of discounting and the propriety of using so-called "compound interest tables”. The Islamic stand on discounting is contrasted with the Marxist stand. Then we examine the need, if any, for using a shadow interest rate in an Islamic economy.

Discounting, Efficiency and Ideology

Economists generally agree that to ignore discounting when it is warranted does lead to loss of efficiency. Even Marxist economists, who have ideological reasons to reject discounting seem to recognise discounting as one requirement for investment efficiency.

It is well known that prevention of Israf (waste) is an important Islamic goal which clearly favours efficiency. May we not use this fact to accept discounting Islamically? The answer is: Yes, provided that discounting is not undesirable on other Islamic grounds.

We have pointed out earlier that Islamic uneasiness about discounting stems largely from its alleged connection with interest. If discounting were to require the acceptance of interest, there can be no doubt that it should be rejected, even if doing so entails the loss of some potential output. For Islam places a high premium on achieving economic justice by eliminating interest.

Fortunately, however, there is no need to make this hard choice. We have clearly shown that the rate of return on equity is the proper discount rate in the uncertain world in which we live.

Thus we may conclude, on the ground of efficiency, that discounting by a rate of return is desirable to achieve the Islamic objective of avoiding Israf. The Islamic acceptability of this conclusion receives further support in the following section.

Source: Fiscal Policy and Resource Allocation in Islam, Ziauddin Ahmed, Munawar Iqbal and M. Fahim Khan. Republished with permission.