While Islam restricts the lending and borrowing of money, that is, with regards to the charging or paying of interest, it encourages interest-free lending as the least form of charity. It is desired and strongly recommended that those in need of financial assistance must be helped in the form of charitable giving. In fact, it is considered as equivalent to “rejecting the religion” by someone who refuses to let someone use for free the things people use in their daily lives (Holy Quran: Acts of Kindness (Sura al-Ma’oon)).
Buying and selling permissible items on credit is acceptable, which gives rise to debt. The debt arising from sales is recognised in Islam. However, buying and selling debt for other than its face value is strictly prohibited in shari’a. This makes the restructuring of debt or converting conventional (interest-based) debt into shari’a compliant debt a relatively difficult task. Re-pricing of debt, as is customarily done in conventional restructuring of debt comes under the prohibition of interest, and hence it is not an available option for converting conventional debt into the one that must conform to the shari’a requirements.
There is a growing realisation within central banks of a number of Islamic countries, including the State Bank of Pakistan, that the amount of debt owed by governments on their balance sheet (of the central bank) is very large and growing and hence a need is being felt to restrict debt creation in the economy. One possible solution is to opt for shari’a compliant debt creation, which has a built-in mechanism to ensure responsible lending and borrowing. This built-in mechanism stems from the requirement in shari’a that debt can be created only by selling something of recognised value in shari’a. Just printing money by the central bank and lending it to the government is not recognised in Islam. While creation of new shari’a compliant debt may not be challenging, converting the existing interest-based debt into shari’a compliant debt has its own complexities.
Although a number of Islamic instruments are being used in countries such as Bahrain and Malaysia, it may not be a bad idea to use Ijara Sukuk (leasing-based Islamic bonds or investment certificates) to create national debt in Pakistan. Two types of Ijara Sukuk are important: tradable and non-tradable. Tradable Ijara Sukuk must be issued on the leased assets while a Sukuk issued just on the future rental stream cannot be traded in the secondary markets, because rental falls in the category of debt that must be traded only for its par value to avoid sale of debt, which is prohibited.
In a simple Ijara Sukuk structure, a party wishing to raise additional capital sells something of value to investors for a cash price. The investors then rent that asset back to the seller of the asset for a period (called period of financing). During this period, they receive rentals and at the end of the financing period, they sell the asset back to the first party, usually for the purchase price.
Ijara Sukuk requires the existence and ownership of physical assets by the government and it may very well be the case that many governments do not have qualifying shari’a compliant assets for the purpose of the issuance of Ijara Sukuk. This can restrict a government’s ability to issue debt. This is the whole point of Islamic finance. However, in a transitory period, hybrid portfolios (comprising physical and other Shari’a compliant financial assets) can be used to issue debt. A hybrid portfolio could have a minimum of 33% physical assets to qualify for secondary market trading (some of the Sukuk issued by the Islamic Development Bank follow this principle). This will allow the government to issue debt three times more than its stock of physical assets. This could be used as a prudential requirement for the government for responsible borrowing.
In a country such as Pakistan that faces burgeoning national and foreign debt and a mammoth task of reducing inflation, it is important to put responsible borrowing through shari’a compliant debt creation at the centre of the national public sector borrowing requirements.
The writer is a Shari’a advisor to a number of banks and financial institutions and can be contacted at [email protected]
