Federal Minister for Finance and Revenue of Pakistan, Ishaq Dar, after taking the oath in September 2022 promised to eradicate interest from Pakistan’s economy and comply with the Federal Shariat Court (FSC) in April. The first petition in FSC to eliminate interest was filed in 1990 and the process is still ongoing.
The coalition parties arranged a Hurmat-e-Sood conference at FPCCI hall in Karachi in which Ulema of almost every sect was present. They collectively promised to help the government of Pakistan in freeing the economy from the evil of interest. A transition towards an interest-free economy seems quite revolutionary but it is much more of political rhetoric than reality.
Islam prohibits interest and calls it a war with the Almighty God. To gain political objectives, several individuals in leadership wish to eliminate interest and save the ship of the Pakistani economy. Although the FSC and the finance division of Pakistan announced these motives, no pragmatic steps have been taken in this regard.
Islamic Banking or Shariah-compliant desks have been introduced in banks, but they are unable to achieve the motives. In the last two decades, Islamic banking has grown exponentially trusting the fatwa of so-called shariah boards of banks. Yet there is a staunch critique on the issue of what comprises riba.
Even post-2007/2008 financial crisis, industrialized nations brought their interest rates to zero but, before dreaming about such a destination, the economy of Pakistan has to go through some major changes and thorough research. Interest rate is directly proportional to some economic needs that I will try to argue here.
Production is the building block of capitalism, and it is related to the supply and demand theory. For this purpose to be served, high investments are inevitable. In the modern capitalistic system, banks are the providers of investment. Capitalistic economies strengthen themselves by meeting the demands and using financial resources efficiently. Intermediation by the banks is the core facilitator to fulfill the gap on the investment side, thus giving rise to interest-rate disparities.
Money is a basic commodity in itself. It is the most liquidated product available in the capitalistic framework. Inflation and interest rate complement each other by maintaining the economy. The money supply is managed by the interest rates and thus inflation is controlled. I want to argue that the government can control inflation without having fluctuating interest rates.
The interest rate tool is used to curb the growing inflation rate. Interest rate contracts the money supply in the economy and consequently lowers the demand, with the low demand leading to low inflation growth. Without the interest rate tool, inflation will grow to an extreme level, the money supply will increase to an intense level, causing economic viability to be jeopardized.
The aforementioned graph represents the inflation growth rate (YoY) and policy rate of the State Bank of Pakistan. The graph depicts how the policy rate of the central bank played a positive role in lowering the inflation growth rate from March 2017 to Nov 2022. Whenever the inflation growth rate was at a high level, the central bank increased the policy rate to limit the inflation growth rate. (Graph 1)
The interest tool is used to slow down the economic growth of the country i.e. GDP growth. It limits the expansion of businesses, expenditures, and profits. When an economy is heated, businesses continue to expand their operations through borrowing from commercial banks. The interest rate is increased to curb the expansion of the business by lowering the borrowings. The raised interest rate leads to less expenditure and hence limits GDP growth.
The interest tool is not only used for businesses but also a large population borrows from banks through credit cards. When the interest rate is high, the markup payments rise, ultimately limiting the share of income for expenditure. This makes the GDP grow at a slower pace.
The real-time example is from the economy of Pakistan. In FY 2018, Pakistan grew at a pace of 6.1%, but in 2019, the GDP growth slowed to 3.1%. In July 2018, the policy rate was at 7.5%, but in July 2019, the policy rate was clocked at 13.25%. Without any limitations tool, the borrowings will increase to a tremendous level and the economy will be overheated, which consequently leads to the destruction of the economic system.
Interest rates act as a bread earner for the banking system in modern times. Banking is a complex structure whose profit is based on the interest rate. Governments and the public borrow from banks to run their businesses and, in return, pay back the principal amount with the decided interest rate. In this way, the needs of both—the lender and the borrower—are fulfilled which eventually assists the economy.
The recent shout for an interest-free economy could endanger the existence of the banking system and pose an existential threat to the credit payments that are lent by the banks. One of the largest banks in Pakistan, Habib Bank Limited (HBL), earned PKR 131 billion in interest income in 2021 compared to PKR 81 billion in 2016.
United Bank Limited (UBL) earned PKR 71 billion in the year 2021. In terms of profiteering, interest is the quintessential component of the modern banking structure. If the government of Pakistan aims to eradicate the interest rate and transform our financial system, it would be devastating and costly if done without suggesting a solid and functional alternative.
The Pakistani economy has been suffering severely for the past three decades, with the total debt surpassing PKR 50 trillion, out of which PKR 33 trillion is domestic debt in Pakistani currency. Pakistan has rarely seen balance in its payments, as recurring deficits pave the way to more borrowing, doubling the repayments. How we are going to fund our deficits? How are inflation and banking structures going to work in an interest-free system? These existential questions demand thorough research rather than mere rhetoric.
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