International Capital Movements

International capital flows fall into two broad categories. First, those which correspond to exports and imports. Second, those for the sake of earning return on one’s capital whether by (a) lending it overseas, (b) employing it in foreign financial markets or (c) investing in equities and real assets abroad.2 International capital flows at governmental level are a separate category due to their underlying considerations; issues related to these flows are addressed in the next section. When imports are financed by export credits from private or official quarters overseas, a capital inflow into the importing country takes place. Similarly, a capital outflow corresponds to an export financed from domestic sources of the exporting country. The nature of such flows and related Islamic options come under trade financing discussed in the previous section. Pure capital flows of the second type are examined here. International lending by commercial banks — individually or as part of syndicates — is like any oilier loans. The Islamic position in this regard needs no fresh explanation. We, therefore, focus on flows of types (b) and (c).

Fund transfers in the international currency and bond markets are motivated by a desire to cash on exchange-rate fluctuations and interest-rate differentials across countries. Of course, one can also think of potential capital gains as another reason in the case of bonds. Some examples of these capital flows are (i) maintaining a bank deposit in a foreign country in that country’s currency or in another currency (Eurocurrency accounts), (ii) forward trading of foreign exchange, including foreign exchange futures and options and (iii) Foreign Exchange Bearer Certificates (FEBCs) of the Government of Pakistan, the US treasury bills, Eurocurrency bonds or other bonds issued by corporations in international markets.

When a person maintains a bank account in a foreign country, its nature is the same as that of an account with a local bank: the person deposits money, wants to take it back at a later date and is not a legal party to the use of that money by the bank — a standard loan contract for all practical purposes. The Shari1 ah position is clear. If the person deposits $100, he has a right to only $100 in the dollar-for-dollar exchange. Any return over and above the principal, be it fixed or variable, is riba. When a person deposits $100 but wants to receive Lhe payment in, say, German marks, it becomes a tricky matter. If the underlying contract is like a loan contract, the transaction is simply invalid. However, the depositor can look forward to receiving German marks in the context of a forward trading contract. In this ease, the exchange rate has to be the one fixed at the time of depositing money. The option of depositing $100 with a foreign bank — or even a local bank — in return for German marks from the same bank at a later date on that day’s exchange rate is not admissible in view of the Shari'ah ahkam on riba and legitimate trading norms.

The idea of forward buying and selling of foreign currencies on rates fixed in advance does not have unlimited applications. For example, the existing practices of foreign exchange futures and options, both forward transactions, are questionable. Both are tradable instruments. Shari‘ah justification for “trading” of credit is hard to come by. In addition, the following points also go against foreign exchange futures and options. The variability of the daily exchange rate in a futures contract makes it dubious on riba grounds. The payment of an option price to the seller for the contract effectively makes the option a ribawi transaction. In addition to the riba problem, futures and options may also be called into question on qumar grounds.

All kinds of bonds crowding the international financial scene are debt instruments with promises of some return for their holders. No doubt, risks are higher and real returns are anybody’s guess — “variable” in a technical sense. Still there is no doubt about the existing bonds being repugnant to Islam on riba grounds.

Direct foreign investment in equities and real assets — at the individual and multinational corporations’ levels — is a Shari‘ah-permitted activity. A caution is, however, warranted on the operational side of these investments. That is, the running of foreign-owned enterprises with ribawi instruments will bring their legitimacy into question.

Important factors behind international capital flows are the level of return and its safety. Favourable tax treatment, economic considerations behind location of plants by multinational corporations and similar other factors also matter; but their effects again show up through the return and risk. In devising Islamic options for attracting foreign capital (lows, no extraordinary effort is needed. The known solutions for domestic investors are applicable to foreign investors, too. Of course, in an international economic environment revolving around the rate of interest, the Islamic options have to be competitive on account of risk and return.

Investors seeking return in the form of interest rate are essentially looking for a “guaranteed” return. And, the more liquid an investment is, the more welcome it is. These investors may be attracted through mutual funds and bank- sponsored mudarbas specialising in foreign trade financing. Infrastructure and energy projects with relatively safe and favourable returns should also appeal to foreign investors.

Furthermore, equity investment can also be made attractive for foreigners by reducing the risk through good legal framework, tight accounting procedures, stiff penalties for contract violations and specialised institutions monitoring operations of local ventures for a service charge.

Dr Sayyid Tahir

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