Riba Resolved (Part 02)

Introduction

Excessive currency printing has an impact on Inflation. The interest rates and inflation both affect the creditor and debtor, which will be briefly analysed in the light of the Quran. “The Riba Resolved” is “A Solution” to the complex issue, in prevalent environment in Pakistan, not “The Solution”. The proposed Riba free solution can also be applied universally by Muslims privately if not enforced through the law of land of in Muslim or non-Muslim countries. 

The Riba issue has been resolved on the basis of guidance from the Quran, the final criterion to judge right and wrong, which has clarification of everything, guidance and mercy and glad tidings for the Muslims. The Quran is the Only, Last, Complete, Protected Divine Book of Guidance, without any doubt, all other books are human efforts and none can claim to be complete, free from error and doubt, however may be consulted as they contain wisdom and explanations but under  the shadow of the Quran. The perverse hearted, who do not believe in Supremacy of Quran, and blindly prefer the opinion of their religious lords, will not benefit but, it will add further to their perversity. They may continue to remain hostage in a perpetual state of delusive sin and guilt. 

It is common perception that the present international monetary system, an offshoot of capitalists USA and the West  is blamed to be the interest/Riba based system of infidels which has been imposed on Pakistan, to keep it under the shackles of economic slavery. However in the same system there are 26 infidel countries with zero interest/Riba rates and 29 with less than 1%, only KSA and Bahrain are the Muslim countries among them, but not yet Riba free. We may try to look into the system and try to analyse to get rid of interest/Riba and join the club of the 26 interest/Riba free countries. There is not any barrier except the will and effort.

Currency Printing

Precious metals, gold and silver were historically used as the basis for money in the early Islamic period, but today are traded mainly as a portfolio diversifier and hedge against inflation. The Government of Pakistan prints cash at an exorbitant rate, diluting the value of cash deposited and increasing inflation. This option did not exist 1400 years ago hence the eternal principles highlighted by the Quran will have to be applied intelligently in a prevalent environment to ensure justice  and fairness eliminating Riba.

Basis of Currency Printing

In any country the responsibility to print and manage a country’s currency rests with the Central/State Bank of that country. The volume and value of currency to be printed is done on the basis of a forecasting model which takes into account, among other things, expected growth in gross domestic product (GDP), likely inflation, seasonal factors, currency lying in its vaults, replacement demand (old notes that come back) and growth of non-cash payments (cheques, card and electronic payments). GDP (nominal) per capita does not, however, reflect differences in the cost of living and the inflation rates of the countries.

Inflation Control 

How Inflation Shrinks Savings. Let’s say you have $100 in a savings account that pays a 1% interest rate. After a year, you will have $101 in your account. But if the rate of inflation is running at 2%, you would need $102 to have the same buying power that you started with. You’ve gained a dollar but lost the buying power. Any time your savings don’t grow at the same rate as inflation, you will effectively lose money.

Inflation is an important factor for consideration in the printing of money. If inflation increases, use of physical money increases, hence, the State Bank has to print more money according to the percentage increase in inflation. So the State Bank conducts various calculations according to the inflation rate to determine how much money should be printed.

Data for the last 19 years indicates that investors have not always responded eagerly to lower rates nor have higher rates kept them from investing.

Hyperinflation

Hyperinflation is a term to describe rapid, excessive, and out of control general price increases in an economy. While inflation is a measure of the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month.

Although hyperinflation is a rare event for developed economies, it has occurred many times throughout history in countries such as China, Germany, Russia, Hungary, and Argentina. The reasons include Excessive Money Supply, Loss of Confidence in the Economy or Monetary System. 

If a government isn’t managed properly, citizens can also lose confidence in the value of their country’s currency. When the currency is perceived as having little or no value, people begin to hoard commodities and goods that have value. As prices begin to rise, basic goods such as food and fuel become scarce, sending prices in an upward spiral. In response, the government is forced to print even more money to try to stabilize prices and provide liquidity, which only exacerbates the problem.

The Shariat Appellate Bench of Pakistan 1999 Judgement & Hyperinflation

The Shariat Appellate Bench, of Pakistan’s judgment in a 1999 case declined to accept indexation of currency because it is a normal part of any economic system, [interest is also a normal part of this economic system, which the Court said is forbidden in Islam, not accepted, then why reject one thing and accept another thing of the same system i.e. inflation? What is the hypocrisy] however in case of Hyperinflation [defined as 50% or more per month], the Court accepted the right of creditor for compensation of heavy loss. Ignoring lesser loss i.e. less than 50% per month i.e. 49% , 40, 30 , 20 , 10% per month is not loss? Even 9% inflation per month will devalue the deposits by 108% within a year, but the Court considers it a normal part of the system! Riba/interest, small or compound is forbidden, Haraam, then loss to Principal amount of creditor small or big is also forbidden, is Haraam. If inflation is part of any financial system it must be addressed being un-Islamic. Even the percentage of excessive money printed by the government of Pakistan is indexed with deposits, it will save the principal value of creditors however normal inflation caused due to supply/ demand and market forces may be borne by all. 

This judgement is against the Quran, because Quran says:

1. you are entitled to your principal; do no wrong, and no wrong will be done to you. (Quran;2:279), No one can change His words, and you shall not find any other source beside it. (Quran;18:27) Nor shall you obey one whose heart we rendered oblivious to our message; one who pursues his own desires, and whose priorities are confused. (Quran;18:28)
2. “Therefore, establish Balance in the society in absolute justice. And never belittle the Scale of Justice in the community and in all your transactions with your own ‘Self’ and with others” (Quran;55:9)
3. Full measure and weight in all fairness. Do not defraud.” (Qur’an;11:85).
4. Consuming of the people’s wealth unjustly is forbidden. (4:161)
5. Don’t take money illicitly.  [Quran 2:188]

Injustice cannot be categorised on less or more amounts, it is unfair and deprives the creditor of its principal wealth deposited with banks or state institutions. 

We cannot print unlimited money. 

An uncontrolled printing of currency may spell disaster for the economy for it may lead to inflation and in extreme cases to hyperinflation. A classic example of an uncontrolled printing of money is Zimbabwe which resorted to the same solution and with the passage of time its local currency is not even worth the paper on which it is printed.

The currency printing may be pegged with GDP, Gold, Oil, US$/ money basket etc. as determined by experts to keep it under control.

Printing a large number of notes increases inflation.

Analyst Sana Taufiq says that printing more notes means more money is coming to people. This is increasing their purchasing power and if they spend more money, it increases the prices of things as well as the inflation rate. She points out that interest rates are raised to control such inflation. 

Printing in Financial Trouble 

Most of the major economies around the world now use fiat currencies. Since they’re not linked to any physical asset, governments have the freedom to print additional money in times of financial trouble. While this provides greater flexibility to address challenges, it also creates the opportunity to overspend.

Decrease in Worth & Purchasing Power

With more of the currency in circulation, each unit is worth less. While modest amounts of inflation are relatively harmless, uncontrolled devaluation can dramatically erode the purchasing power of consumers. If inflation reaches 10% annually, each individual’s savings, assuming it doesn’t accrue substantial interest, is worth 10% less than it was the previous year. Naturally, it becomes harder to maintain the same standard of living. For this reason, central banks in developed countries usually try to keep inflation under control by indirectly taking money out of circulation when the currency loses too much value.

Indexation

Indexation is a system of economic control in which certain variables (such as wages and interest) are tied to a cost of living index so that both rise or fall at the same rate and the detrimental effect of inflation is theoretically eliminated. Indexation requires identifying a price index and determining whether linking the value to the price index will accomplish the organization’s goals. Indexation is most commonly used with wages in a high inflation environment. “Indexation” is also known as “Escalating”. 

The indexation of government debt to inflation is related to transferring the inflation risk from depositors to the government in an attempt to reduce inflation. Some governments have ultimately subjected their short-term debt instruments to de-indexation so their central bank could regain control of short-term interest rates from a monetary policy standpoint and be in a better position to fight inflation. Another objective of indexation, for certain governments with already low inflation rate, is to reduce their borrowing cost by paying lower interest rates to depositors in exchange for assuming inflation risk. Both the UK and the US have issued inflation indexed government bonds to reduce their borrowing costs. When governments such as the UK and the US issue both inflation indexed bonds and regular nominal bonds, it gives them precise information on inflation expectation by observing the difference in yields between the two types of bonds. Robert Shiller has done extensive research on all mentioned aspects of government bond indexation.

The indexation of currency or exchange rate often refers to a country pegging its currency to the US dollar. In other words, such a country’s central bank would buy or sell dollars so as to maintain a stable exchange rate with the dollar. Such a policy has been adopted by several Asian countries including China. 

Various assets and values might be subject to indexation. Some countries might apply indexation on certain types of tax payments at varying periods. For instance, it might be applied to debt mutual funds that have been held for a certain minimum amount of time before being sold. In such a case, the original purchase price is adjusted for inflation when calculating long-term capital gains that will be taxed when those debt funds are sold. This can lead to a discount on taxes after the transaction for the seller of such assets.

Indexation might also be applied to pension funds to reassure participants that their assets will keep pace with inflation. That way, the value of those assets do not erode as time passes.

Application of Indexation of Inflation with savings/deposits will remove Riba to any party, an Indexation calculator can be prepared by experts.  

Indexation & Shariat Appellate Bench of Pakistan 1999 Judgement

The Shariat Appellate Bench, of Pakistan’s judgment in 1999 case declined to accept indexation of currency because “it is a normal part of any economic system”, however in case of Hyperinflation [defined as 50% or more per month], the Court accepted the right of creditor for compensation of heavy loss. Ignoring lesser loss i.e. less than 50% pm i.e. 49%, 40, 30, 20, 10% per month is not loss? Riba/interest, small or compound is forbidden, Haram, then loss to Principal amount of creditor small or big is also forbidden, is Haraam. If inflation is part of any financial system it must be addressed being Un-Islamic. This judgement is against Quran, because, Quran says:

Injustice cannot be categorised on less or more amounts, it’s unfair and deprives the creditor of its principal wealth deposited with banks or state institutions. 

What Is Real Saving/Capital

Real Saving [Real Capital] is how much money an individual or entity possesses after accounting for inflation and is sometimes called real saving/capital when referring to an individual’s savings/capital. Individuals often closely track their nominal vs real saving/capital  to have the best understanding of their purchasing power. [derived/modified from Real income definition]

Special Considerations for Investing to offset Inflation Effects

Many individuals and businesses invest a significant portion of their income in risk-free investment products and vehicles that match or exceed the economic inflation rate in order to mitigate the effects of inflation on their income. There are several risk-free investments that offer a return of approximately 2% or more [in USA]. These products include high yield savings accounts, money market accounts, certificates of deposit, Treasuries, and Treasury Inflation-Protected Securities (TIPS). Beyond that, investors may be willing to take on slightly more risk in order to keep their income yielding at or above inflation. For more sophisticated investors, municipal and corporate bonds are often used for obtaining 2%+ returns, beating inflation, and helping income to grow steadily over time.

When inflation occurs, a consumer must pay more for a fixed quantity of goods or services. Theoretically, this is why savvy investors seek to hold a significant portion of their income in investments with a 2%+ return. In that case, with inflation at 2% they would be able to maintain their purchasing power at a constant level.

For instance, assume a consumer spends approximately $100 per month for a total of $1,200 per year on food during a year when inflation is rising at an annual rate of 1%. Also, assume that the consumer saw no change in their wages.

A consumer with a $60,000 annual nominal salary would have lost approximately $595 of purchasing power over a year, or one cent per dollar spent, due to the effects of inflation. In terms of their food purchases, this means the same quantity of food cost them $12 more during the current year compared to the past year. Alternatively, if this consumer isn’t following a strict food budget, they will likely spend approximately $101 per month or $1,212 to get the same amount of food they would have bought in the previous year.

Why Interest rates change?

There are many reasons for change in interest rates, but two key factors are the supply of money and inflation. The interplay between borrowers’ demand for money and lenders’ supply of money also has an impact on interest rates. At the micro level, if a bank experiences greater demand for its loans relative to its supply of deposits, then its interest rates tend to rise. In order to lend additional money, the bank must incur additional costs either from borrowing money from another bank, raising capital, or increasing the rate it must pay depositors to attract additional deposits. Ultimately, the bank passes these costs on to borrowers in the form of higher interest rates.

Interest rates also can vary because of inflation. When determining the interest rate to charge borrowers, lenders factor in their estimates of what future price levels will be in order to ensure lenders will profit from the loan. High inflation, or anticipated inflation, will result in higher interest rates.

The Fisher Equation

The inflation factor was considered being a common sense  matter, however it was found that there is proper rule on this subject, called “The Fisher Equation”

The Fisher equation provides the link between nominal and real interest rates. To convert from nominal interest rates to real interest rates, we use the following formula:

Real interest rate nominal interest rate inflation rate.

To find the real interest rate, we take the nominal interest rate and subtract the inflation rate. For example, if a loan has a 12 percent interest rate and the inflation rate is 8 percent, then the real return on that loan is 4 percent. 

In general, as interest rates are reduced, more people are able to borrow more money. The result is that consumers have more money to spend. This causes the economy to grow and inflation to increase. The opposite holds true for rising interest rates.

• There is a general tendency for interest rates and the rate of inflation to have an inverse relationship.
• In the U.S, the Federal Reserve is responsible for implementing the country’s monetary policy, including setting the federal funds rate which influences the interest rates banks charge borrowers.
• In general, when interest rates are low, the economy grows and inflation increases.
• Conversely, when interest rates are high, the economy slows and inflation decreases.

Pakistan – Excessive  Currency Printing 

The Central Bank website in Pakistan provides information on the currency figures in circulation in the last eight financial years. According to this, the number of currencies in circulation at the end of FY 2012 was 1.73 trillion which increased to 1.93 trillion the following year [11.56% increase in currency but GDP growth up by only 0.89%]. 

At the end of fiscal year 2014, the number rose to 2.17 trillion [Currency printed +12.43%, GDP growth increased only 0.28%], then the following year the number reached 2.55 trillion. In FY16, the number of currencies in circulation increased even further and closed at 3.33 trillion. The following year it increased to 3.91 trillion. At the end of FY 2018, the number reached 4.38 trillion and the following year saw huge growth in printing, closing at a high of 4.95 trillion.[+13%, but GDP growth change -4.5%]. 

The last financial year, 2020, saw an unusual increase in its number when it closed at the level of 6.14 trillion. According to Farid Alam, Head of Research, AKD Securities, the growth in the last financial year was the highest. He said that the present government has increased (printing) twice as compared to the previous government. He said that the government is printing more currency.

Pakistan – GDP Factor

Another important factor that affects the amount of money to be printed is Gross Domestic Product. The government prints money of the same value, as the value it has gained into their economy or in a simple way GDP. Increase in GDP directly increases the process of printing more money, of the same value. The point worth noting is the government gives people the same amount of physical currency as a medium of exchange as the value it is getting in return from GDP and inflation. Pakistan’s last 10 years GDP growth rates reflects; 2019 GDP 0.99%, decrease  -4.85% to the previous year, the increase to the previous year remains below 1% from  2012 to 2019. GDP growth varied between 3.5% to 5.84% from 2012 to 2018. How can currency note printing at much higher rate than GDP growth be justified? It would cause inflation.

To be continued …. Next Part-3:  Case Studies: Currency and Inflation.

References: 

https://SalaamOne.com/Riba