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Government Transactions: Pakistan

Interest figures prominently in both internal and external transactions of the Government. The Council’s views in regard to matters related to the elimination of interest from Government transactions are given in this Section under the broad heads of: (i) Internal borrowings of the Federal and Provincial Governments, (ii) Government borrowings from external sources, (iii) Borrowings of local bodies, autonomous corporations etc., (iv) Provident funds, (v) Taccavi loans, (vi) Loans to Government employees, and (vii) Charge of penal interest rates.

Internal Borrowings of the Federal and Provincial Governments

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Internal borrowings of the Federal Government take the form of market loans, treasury bills, treasury deposit receipts, loans from the State Bank and commercial banks and small savings schemes. Provincial Governments’ borrowings consist of loans from the Federal Government, market loans and loans from the State Bank and commercial banks.

Market loans are raised both by the Federal and Provincial Governments to meet a part of their expenditures. The mechanism is to issue long- and medium-term securities carrying different rates of interest. The maturity periods of the existing securities range up to 1999. At present, the marketable government securities are taken up largely by institutional investors. After the abolition of interest, fresh jmarket loans carrying a fixed rate of return will no longer be issued by the Federal and Provincial Governments. It would be difficult to raise resources on profit/loss-sharing basis as most of the items of Government expenditure are not amenable to equity financing. The borrowing requirements of the Government will therefore have to be met largely from the State Bank on interest-free basis. The Council recommends that the State Bank may provide necessary accommodation to the Government for medium and long terms. However, it must be ensured that injection of high-powered central bank money into the economy is kept within safe limits.

Treasury bills are of two types viz., ad hoc treasury bills and treasury bills on tap. Ad hoc treasury bills are issued by the Federal Government to the State Bank at a nominal rate of interest to meet specific financial needs. Their maturity period is usually three months, but they are renewable. After the abolition of interest, the Federal Government may issue interest-free ad hoc treasury bills.

Treasury bills on tap are also interest-bearing and their maturity period is three months. Since they are easily discountable with the State Bank they are purchased mainly by commercial banks to earn some income on short-term funds pending their utilisation in more remunerative and higher yielding assets. After the abolition of interest, there would be no viable basis for issue of treasury bills on tap in the market. Their issue would, therefore, have to cease and the Government could instead have recourse to short-term borrowing from the State Bank. The commercial banks may use their short-term funds, presently invested in treasury bills, in the inter-bank call money market on profit/loss-sharing basis.

Government Treasury Deposit Receipts are a relatively new financial instrument as compared to long-term government securities and treasury bills and have been in vogue since June, 1973. The GTDR scheme aimed at excluding Government sponsored specialised financial institutions from participating in the call money market in the interest of better control of bank liquidity while making available to them a remunerative avenue of investment for their surplus funds. Commercial banks are not allowed to purchase GTDRs. The maturity periods of GTDRs range from 3 months to one year and the rates of interest on them range from 8.25 per cent to 10.5 per cent as against 5.75 per cent on three months Treasury Bills. They are discountable with the State Bank. After the abolition of interest, the issuance of GTDRs would also have to cease and the specialised financial institutions would have to hold their surplus funds in other forms such as N.I.T. Units which are easily encashable.

The State Bank provides ways and means advances to the Federal and Provincial Governments within specified limits to meet their temporary financial needs. The ways and means advances are provided for a period of three months at agreed rates of interest. After the abolition of interest, all types of advances of the State Bank to th Government would have to be without any return.

Being banker to the Government, the State Bank maintains accounts of Federal as well as Provincial Governments. It receiver payments for credit to these accounts and makes payment on behalf of Government by debiting these accounts. In the course of these transactions, the balances in these accounts may sometimes be over-drawn. The amounts over-drawn are designated as debtor balances and are subject to payment of interest. After the abolition of interest, no interest will be charged on debtor balances.

The Federal and Provincial Governments and some of their agencies borrow from the commercial banks for financing procurement of essential agricultural and other commodities with a view to ensuring regular supplies to public at reasonable prices. Commercial banks charge interest on these loans at a rate higher than the bank rate and are entitled to obtain counterfinance from the State Bank at the bank rate. As suggested in Section IV, commercial banks may continue to provide these loans to the Government but on interest-free basis subject to service charge which may be realised by way of a specified fee which would not vary with the amount, while counter-finance may be provided to them by the State Bank in the form of interest-free loan.

A number of small savings schemes introduced by the Government from time to time are in operation through the agency of Post Office Savings Banks and National Savings Centres. The savings media are Khas Deposit Certificates, National Deposit Certificates, Defence Savings Certificates, Savings Accounts, Fixed Deposit Accounts, Bonus Deposit Accounts and Khas Deposit Accounts. Interest is paid on the amounts deposited/invested and the interest income is exempt from income tax. The formalities involved in purchase/sale of certificates/ bonds and in opening, closing and operation of the deposit accounts have been kept to the minimum. In addition, investment in certain savings media are also eligible for investment allowance for income tax purposes. The various certificates are issued and deposits accepted for varying maturity periods so as to suit the preferences of the savers. Interest rates payable also vary according to the maturities. The Government also issues Prize Bonds of various denominations on which, instead of interest payment, prizes are distributed on the basis of lucky draws.

There would be no scope for small savings schemes operating at present on the basis of interest. However, Post Office Savings Bank:, accounts may continue and their proceeds may be invested in N.I.T. Units or other suitable profit-earning avenues and the profit arising therefrom may be distributed among the deposit holders on the basis of daily product of their balances. The existing small savings certificates may be allowed to run their course. The Prize Bonds scheme has a built-in element of gambling and has been misused for tax evasion. The scheme may gradually be tapered off.

The Federal Government provides financial assistance to Provincial Governments to meet both their development and nondevelopment expenditures and charges interest on such loans. The Federal Government may provide these loans to the Provincial Governments without any return after the abolition of interest.

The Federal Government also channels interest-bearing foreign loans to Provincial Governments. These may continue on the existing basis till a viable alternative compatible with Shari‘ah is found in respect of borrowings from abroad.

Government Borrowings from External Sources

The Government of Pakistan has been borrowing substantial amounts from foreign governments and international financial institutions to finance economic development on which interest payments have to be made regularly. The Council feels that efforts should be made to reduce dependence on foreign aid in general and interest- bearing foreign assistance in particular. In addition, efforts should be made to foster greater economic co-operation among Muslim countries so as to promote movement of capital on the basis of profit/loss-sharing or other non-interest basis. With such increased economic co-operation among Muslim countries it is not unlikely that, with the passage of time, non-Muslim aid-giving countries and international financial institutions may also begin to deal with Muslim countries on a basis compatible with SharVah. For the time being, external borrowings will have to be continued on the basis of interest.

Borrowings of Local Bodies, Autonomous Corporations, etc.

The Federal and Provincial Governments provide loans to local bodies, autonomous corporations, etc. for both development and nondevelopment purposes. After the abolition of interest, the Federal and Provincial Governments may provide interest-free loans to these bodies/ corporations for financing such non-profit-earning projects as are considered essential. However, for profit-earning projects they msy also obtain finance from banks/other financial institutions on a basis conforming to SharVah, provided that the financing institutions also consider these projects viable. Interest-bearing foreign loans channelled by the Government to these bodies would, however, need to be continued on the existing basis.

Provident Funds

The Federal and Provincial Governments and their agencies pay interest on their employees’ Provident Fund balances. After the abolition of interest, the Provident Fund balances of the employees may be invested in N.I.T. Units or other suitable investment media and the profits arising therefrom may be credited to the employees’ Provident Fund accounts.

Another possibility is that Government, instead of paying interest on Provident Fund balances, should pay an annual bonus equivalent to the rate of profit declared by N.I.T.

Taccavi Loans

The Provincial Governments provide loans to farmers for agricultural development as well as for relief in times of distress and charge interest at fairly high rates. However, the amounts of loans as well as interest receipts on them are very small. The Council suggests that Taccavi loans may be provided by the Provincial Governments free of interest.

Loans to Government Employees

The Federal and Provincial Governments provide loans to their employees for construction of houses and for purchase of cars, motor cycles etc., and charge interest thereon. Receipts from this source are, however, an almost insignificant proportion of total receipts. Interest on these loans can, therefore, be easily abolished. Interest-free loans for these purposes may be considered as part of the fringe benefits to the Government employees.

Charge of Penal Interest Rates

The Government and its agencies in some cases charge penal rates of interest on their overdues. This practice may be replaced by imposition of appropriate fines.

The elimination of interest occupies a key position in the establishment of the Islamic order. Pakistan being an ideological state, the abolition of riba has from the very beginning formed an integral part of State Policy as enshrined in her Constitution. Yet there has hitherto been hardly any noteworthy progress towards the elimination of interest from the country’s economy. However, in the recent past, the President of Pakistan not only entrusted to the Council of Islamic Ideology the task of preparing a blueprint of an interest-free economic system but has also set a time limit of three years for the elimination of interest from the economy. Further, the Presidential declaration has been given the form of a Constitutional provision. The Council, soon after its reconstitution, appointed a Panel of Economists and Bankers which was assigned the responsibility, inter alia, of examining the technical aspects of the elimination of interest and recommending ways and means for reorganising the country’s banking system in conformity with the SharVah. The present Report of the Council is based largely on the work accomplished by the Panel. However, in adopting the. recommendations of the Panel, the Council has incorporated amendments, wherever necessary, so as to ensure complete conformity with the SharVah.

The basic work having been accomplished, the next step that needs to be taken by the Government is the setting up of various working groups which should be charged with the task of working out the details of the new system. It needs to be emphasised that during the whole process extreme care must be exercised to ensure that the basic stipulations of the new system are faithfully adhered to.

The elimination of interest is but a part of the overall value system of Islam and this measure alone cannot be expected to transform the entire eonomic system in accordance with the Islamic vision. The need for reformatory measures at moral building and eradication of false values of life was emphasised by the Council earlier while submitting its recommendations on the laws of hudood and the introduction of Zakah. However, now as the country is poised for the introduction of an interest-free banking system, this need has increased immeasurably in its urgency. For this purpose the mass media need to be mobilised forthwith for launching a well thought-out persuasive campaign designed to bring home to the people the details of the new system and persuade them to willingly and whole-heartedly accept the challenge and to act with a missionary zeal.

With a view to ensuring the success of the new system of banking, the Government should carry out a thorough reappraisal of the tax system focussing in particular on the need for greatly simplifying the system of Income Tax. 

Ideally the real alternatives to interest under an Islamic economic system are profit/loss-sharing or qard-hasanah, i.e. loaning without additional charge over and above the principal amount. Although the recommendations are based largely on the principle of profit/loss- sharing, yet some of the recommendations lean on other methods in view of the difficulties faced in the practical application of the profit/ loss-sharing system in its pure form on account of the prevalent standards of morality in the society. These alternative methods are, however, no more than a second best solution from the view point of an ideal Islamic economic system. This is because of the fact that although these alternative methods are free of the interest element in the form in which they are specifically laid down in this Report, there is a danger that this could eventually be misused as a means for opening a backdoor for interest along with its attendant evils. They should, therefore, be applied to the minimum extent that may be unavoidably necessary, and that their use as general techniques of financing must never be allowed. In this connection, a basic policy decision may be taken to the effect that with the passage of time the operational field of PLS and qard-hasanah should gradually be expanded while that of the other alternatives reduced. At the same time, efforts must be stepped up to bring about a substantial improvement in the standards of honesty in the society and to remove illiteracy, because both dishonesty and illiteracy militate against the success of the new system.

For remodelling the banking system on Islamic lines it is indispensable to make necessary changes in the existing laws having a bearing on the operations of banks so as to bring these laws in conformity with the Shari'ah. The task of amending and remodelling these laws may be taken in hand simultaneously with the initiative of the process of eliminating interest.

While evolving a workable mechanism for financing on profit/ loss-sharing basis suited to our conditions, the Council has kept in view the Fiqh literature on the subject of Sharakah and Mudarabah. The stipulations pertaining to Sharakah provide that partners are free to agree on any profit-sharing ratios, but losses are to be shared strictly in proportion to the respective capital contributions. The Council, however, felt that under the proposed profit/loss-sharing system, the division of profits between the financial institutions and business and industrial concerns should be regulated by the central bank of the country. The financial institutions may also enjoy the powers of inspection of the projects and their books of accounts and to participate in the decision-making process.

To ensure smooth and unhindered return flow of funds, delay in the payment of amounts due to the banks should attract a penalty for non-payment. However, the amount of the fine should not accrue to the banks but deposited in the Government treasury. Since delay and defaults without genuine reasons would not only be a breach of trust but also jeopardise the success of the new system, deterrent punishments should be provided to defaulters which may include confiscation of property. Delinquents should be black-listed and debarred from any future financial assistance by banks.

For the success of the new system it will be imperative that banks enjoy free and unfettered discretion in respect of acceptance or rejection of financing proposals received by them on the basis of sound banking principles and criteria. Such public sector enterprises as do not meet the criteria of sound banking may either be financed by a separate public agency or the banks should be guaranteed the repayment of the capital and provided with a subsidy by the Government equivalent to the average rate of profit of the bank. A thoroughgoing reform of the auditing system, which presently suffers from a number of weaknesses, will also be necessary for ensuring the success of the new system.

The remodelling of the commercial banks’ operations on the basis suggested in this Report would represent a radical departure from the traditional British pattern of banking on which the commercial banks in this part of the world have been largely operating. However, in the broader international context a reorientation of bank financing on the lines suggested cannot be regarded as entering a field that is completely untried. It cannot be denied that elimination of interest from banking and financial system as a whole is a bold enterprise and problems and difficulties are sure to arise in the initial period. However, once the new arrangements are put into practice and worked in right earnest, a process of evolution would be set in motion and practical solutions to the emerging problems would be found.

The Council considered three different options with a view to suggesting an action plan for the elimination of interest from the economy. These were: (a) a model bank may be set up which may start operations on interest-free basis and, on the basis of experience gained from its working, the operations of the commercial banks and other financial institutions may be reorganised on interest-free basis subsequently; (b) a comprehensive scheme may be prepared for a complete switch-over to the interest-free economic system and then the timing of such a switch-over may be decided; (c) interest may be eliminated from the economic system in a phased manner. The third option was considered to be the most practical and reasonable. It was in this perspective that the Council had earlier recommended elimination of interest from the operations of N.I.T. and I.C.P. as well as from housing finance provided by H.B.F.C. and the commercial banks in the initial phase. A beginning towards elimination of interest in a phased manner has already been made with the switch-over of the N.I.T., H.B.F.C. and I.C.P. Mutual Funds to interest-free operations with effect from July 1, 1979 and the decision announced in the last budget not to charge any interest on bank loans for production purposes to farmers cultivating holdings up to 12acres.

The Council also considered a suggestion mooted in certain quarters that initially only interest-free counters may be opened in the existing commercial banks which may operate simultaneously with interest- based system and that depositor may be given the option to keep their money with banks on PLS basis or on interest basis. The Council strongly opposes such a course of action because it is not only inappropriate but also extremely dangerous, as it is likely to entail perpetuation of the interest-based system and to undermine the efforts at introducing interest-free banking in the country.

The Council has recommended that during the period of about 1 year and 8 months that now remains within the 3-year time limit set by the President the rest of the measures for elimination of interest from the domestic transactions should be taken in three clearly defined phases with specific time schedule. The first phase should start on July 1, 1980 and should cover selected Government transactions with the State Bank and commercial banks, certain inter-governmental financial transactions, Federal and Provincial Governments’ loans to local bodies and autonomous corporations in respect of non-profit- earning but essential projects, Taccavi loans, loans to Government employees, employees’ Provident Fund balances, penalty on Government overdues, commercial bank financing of seasonal needs of the farmers, housing finance by commercial banks, personal loans, Small Business Finance Corporation’s financing of means of transport and loans by ICP under its investors’ scheme.

The second phase to go into effect from July 1, 1981 should aim at eliminating interest completely from the assets side of the banks and other financial institutions in so far as they pertain to domestic transactions. In addition, the remaining elements of interest in the domestic transactions of the Government should be eliminated.

In the final phase of the elimination of interest from domestic transactions, to take effect on 1st January, 1982, banks should cease to accept deposits from the public on the basis of interest and switchover to profit/loss-sharing. Inter-bank transactions would also be switched-over to profit/loss-sharing system and State Bank would abandon the system of providing finance to banks and other financial institutions on the basis of interest and would bring about necessary changes in its monetary policy as set out in Section IV of the Report.

Elimination of interest from transactions relating to international trade and aid, which poses the most difficult problems, should be covered in the third phase. It is necessary to accelerate the efforts for greater economic co-operation among Islamic countries so as to achieve interest-free international trade and aid at least among them. The Islamic Development Bank can also play an important role in this respect. At the same time, by setting a practical example of the Islamic economic and technical system we should seek to convince others about the blessings and virtues of the Islamic system.


Source: Money and Banking in Islam, Ziauddin Ahmed; Munawar Iqabal; M. Fahim Khan. Republished with permission.