Financing Govt Transactions in An Interest-Free Economy: A Case of Pakistan

Elimination of interest from the economy in accordance with the injunctions of Shari‘ah would require that government transactions involving interest are also conducted under some alternative arrangements. This paper tries to examine the nature and magnitude of these transactions in the case of Pakistan and evaluate different proposals to make them compatible with Shari‘ah. Government transactions have both domestic and international dimensions. In this paper, however, we plan to focus mainly (but not exclusively) on the domestic transactions as the international dealings involve certain specific issues which should become the subject matter of a separate paper.

Interest-Based Govt Transactions in Pakistan

Before discussing elimination of interest from government transactions it is important to know the nature and magnitude of these transactions in the overall economic activities. It is only after this type of analysis that the impact of any change in these transactions on the economy can be properly evaluated.

The nature and size of government transactions, interest- based or otherwise, depend on the role of the state recognised in a society. Traditionally, this role was no more than to provide defence services, maintain law and order, provide justice, run civil administration and undertake only those economic activities which were found unattractive by the private enterprise. Most developing countries in the 1950s and 1960s, however, opted for planned development and adopted the mixed economy model. Accordingly, the public sector was assigned a direct role in the development of infrastructure, skills and technology. This required more capital than could be accumulated through traditional means of taxation available to the government. As a result, measures like deficit financing, public borrowing and loan from abroad were more widely resorted to.

In the ease of Pakistan, the decade of ’70s experienced a new spell of increase in the size of the government activity as a result of nationalisation of heavy industries, banks and insurance activities in 1972. This process continued unabated even in the ’80s and now one finds public sector involvement in almost every kind of business activity conducted in our economy. Some efforts, however, have been made in the last few years to reverse this trend and reduce the size of government activity in the economy.

Now as far as the interest-based government transactions are concerned they can take place on the following accounts:

  • Different types of loans extended by any government agency to other agencies or individuals;
  • Government commodity operations (including imports and exports of material and equipment) involving deferred receipts or deferred payments;
  • Government borrowing to finance public goods
  • Borrowing for projects whose outputs can be priced one way or the other to determine their private profitability; and
  • Borrowing from the State Bank of Pakistan (which is a part of the government) or from other financial institutions in public sector.

Unfortunately, not all the transactions mentioned above can be systematically categorised to identify the nature of interest payment or receipt involved. The available data also cannot be used to classify the transactions on the basis of their sources of financing. In some cases, interest is calculated merely as a book entry and may not involve any actual transaction. Therefore, to be able to evaluate the nature and magnitude of interest-based government transactions one may have to use more than one indicator. We, however, have used only those indicators for which the data from the secondary sources were helpful to do the necessary calculation. Accordingly, we try to analyse the following:

  • The size of interest receipts and payments in the federal budgets;
  • The overall fiscal deficit and its impact on interest- based government transactions;
  • The size of public debt with special reference to borrowing from the domestic sources; and
  • The size of intergovernmental transactions and interest payments.

Dr Faiz Muhammad


Source: Elimination of Riba, Khurshid Ahmad, Khalid Rahman and Zahed A. Valie. Republished with permission.
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