Riba, Inflation & Indexation

It is evident that the value off the paper currency has a trend of decrease in the inflationary situation. If a debtor who has borrowed a particular amount of paper currency repays the same amount to his credit after a substantial time, the creditor can suffer the effects of inflation. If he demands his debtor to pay more in order to compensate him for the loss of value he has suffered, can this demand be treated as a demand of riba?

This is a very complex issue. The real cause of erosion in the value of money is to be sought in the wrong monetary and economic policies which result in wide deviations from a state of price stabilisation. One of the major objectives of Islamic monetary policy is stabilisation of the value of money. In the Islamic context, money is primarily a medium of exchange and a measure of values. It is also a measure for deferred payment and as such its value has to be protected.

There is no substance in the thesis that interest is a reward for erosion of the value of money. The discussion in economics relating to the nominal rate of interest and the real rate of interest must not confuse us, because rationale for interest is one thing and the phenomenon of inflation and various ways to reduce, if not to mitigate, the evil consequences of inflation is a different matter altogether. While the challenge from inflation is a real issue, it should not be mixed up with the problem of interest which is multidimensional and must be addressed to separately in its own right. It is illogical to argue in favour of interest on the basis of inflation. Indexation is one of the many ways suggested to fight some of the effects of inflation but the results of such a policy are mixed and inconclusive, if not adverse. In fact, a lot of empirical evidence about movements in interest rates and rates of inflation leads to conflicting hypotheses. It is difficult to find out a positive correlation between the two in all parts of the world and even in the same country over a long-period time horizon. That is why under a regime of inflation even negative rates of interest have prevailed over certain time pe nods. The trends that emerge from empirical and econometric studies remain inconclusive, if not erratic. The remedy for erosion in the value of money lies in a monetary policy aimed at price stabilisation and not in bringing in the red-herring of interest. If in an inflationary situation there can be any “justification” for asking the debtor to pay more in order to compensate the creditors for the loss of value of money why the same should not be applied in the case of deflation and ask the borrowers to pay less? Moreover, why shouldn’t there be an equal concern for the consumers, wage-earners, pensioners who suffer even more than the creditors in periods of inflation? Why this selective concern?

The issue of indexation has been dragged into this controversy over interest, but the two represent independent situations and should not be confused. Moreover, limited indexation would produce new anomalies and inequities and total and overall indexation proves meaningless over a medium and long period. As such all the evidence based on indexation experiments in different parts of the world suggest that the remedy docs not lie in indexation but in curing the disease at its source, that is, monetary policy geared to price stabilisation.

Professor Khurshid Ahmad

 

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


https://islamicmarkets.com/education/riba-inflation-indexation
Copy URL