P L d 2000 s c 225 (Riba prohibition stayed)

 

sources:                       

 

                                                           

 

(Rs. Billion)     

 

 

 

            (i) State Bank of Pakistan         Rs. 333.8 billion

 

 

 

            (ii) Commercial banks               Rs. 297.0 billion

 

 

 

            (iii) Non-Bank borrowing          Rs: 627.2 billion

 

                                                          ______________

 

(Saving schemes)` “:

 

 

 

Total    Rs. 1258 billion

 

 

 

In addition, Government’s foreign debt as of 31st March, 1999 stood at $ 31.15 billion or Rs. 1610 billion at the current inter-bank rate. Together, the national debt at Rs.2868 billion amounts to nearly 95 % of the GDP. All this debt is based on fixed interest rates.

 

 

 

Government borrowing from the commercial banks at Rs.297 billion constitutes nearly one-third of banks total lending and investment. It is asserted in the note that rates of return on these lendings have implications for the banks’ policies including forecasting of their balance sheets. The conversion of this stock of debt will have implications for the profitability of banks and hence for both the depositors and borrowers. The same position prevails as regards the Government borrowing from the State Bank which stands at Rs.333 billion. Next comes the Non-Bank Borrowing through various national savings schemes which stand at Rs.627.2 billion which is half of the total public domestic debt. Thus the savings are owned by people of different walks of life such as pensioners, old people, widows and others, who exclusively depend on reasonable return on their savings. The point of view advanced in this note is that all this data is based on interest rates and  till such time that the Government fiscal deficit is totally eliminated either through improvement in its resource mobilization or containing its expenditure and investment to the absolute minimum, the Government borrowing from the above sources would be inevitable and if the Government’s need to borrow continues, this would require the evolving of interest-free, equity-based or similar instruments which in turn involve research and analysis and some period of experimentation. It is added that both the developing of such instruments and then gradual introduction will be time consuming exercise. It is urged that keeping in view the size and complexities associated with this management both the conversion of this debt into interest free instruments that do not disrupt the operations of financial system or its retirement will take a long time. The note does not spell out this “long time” statedly noted for adopting interest-free economy system. The major issues in the fiscal policy in shifting to interest-free operations have been summarized as under:---

 

 

 

(i)         To retire and/or convert and restructure the stock of public debt in a manner that the new arrangements are acceptable to the savers, investors and other economic agents without major economic disruptions.

 

 

 

(ii)        To reduce and eventually eliminate the Government borrowing in future.

 

 

 

The problems which are likely to be faced in converting the interest-based system to interest-free operations have been detailed as under:---

 

 

 

“The conversion to interest-free economy needs a great deal of in depth research and analysis, an appraisal of experience of countries where similar experiments have been made and finally developing of instruments, representing real assets, which can replace the existing instruments, can be handled efficiently and are acceptable to savers, investors and other concerned economic agents. This will also involve a broad-based training programme for bank staff, familiarity with terminology, changes in documentation, new methods of accounting and a whole series of other changes including the attitude of users of credit. One major constraint will be the uncertainty both about the principal and the rates of return which can be overcome over time when economic agents can base their expectations on changes in developments that determine profitability etc. Banks and other financial institutions which are traditionally used to investing in fixed rate papers would have to operate within this constraint. As yet, there is no precedent of a central bank managing an efficient monetary policy through interest-free instruments. The experiments made so far show only partial success in this area.”

 

 

 

As regards operations of the commercial banks dealing with private sector both for working capital and for investment, it is urged that the difficulties arise mostly on the assets side of banks as it requires the development and introduction of efficient and compatible with Shariah modes of financing. It is urged that to provide credit to private sector on interest-free basis, without adequate home work in research and analysis, is likely to generate many problems including uncertainty, the need for monitoring, transparency and detailed documentation. Experience has shown that established investors/entrepreneurs are generally reluctant to share profits with management of bank or even equity holders. In fact in some countries where Musharaka (or partnership) has been tried, the problem has been that of different perceptions on the part of bank and the borrower about profitability, costs and accountability. According to Mr.Ashraf Janjua, “additional problems and difficulties that the commercial banks are likely to face include tax system that encourages lavish expenditure by the corporate sector and makes it reluctant to make full disclosure of its financial affairs, lack of awareness among public about the new system, lack of expertise and even commitment among the bankers to successfully manage financing under Islamic modes, apprehension of the business and industrial community that if they enter into Musharaka agreement with banks for financing, there may be undue interference by the banks in their management, their perception that Islamic system of Musharaka is full of complexities, and lack of speedy disposal of the default cases and disputes. If banks are advised to engage in purchasing/selling of commodities and to create inventories for the purpose of genuine Murabaha it will not only encourage corruption among the banks incumbents, but also adversely affect their intermediation function. Murabaha, because of being simple transaction is very popular whenever Islamic modes of financing have been tried. However, it requires actual purchase and sale of commodities with the. purchaser assuming the risk before selling it on credit to the buyer. Also, because of its popularity, banks have turned into trading houses.”

 

 

 

The note of Mr.Ashraf Janjua also describes the problems relating to external sector as follows:---

 

 

 

“Pakistan has a large foreign sector comprising exports, imports, receipts and payments of invisible, home remittances, inflow of resources including borrowing by the Government and servicing of country’s external debt. Even for a reasonable rate of economic growth Pakistan is dependent on inflow of resources particularly from international financial institutions. These institutions being of international character have their own policies. As a beneficiary of the resources of these institutions, Pakistan has to observe a measure of discipline and meet a number of commitments. Among other things, liberalization of economy, market-orientation of management, removal of distortions and frictions, competitiveness in the financial sector and similar other conditions are invariably a part of commitments. Also, Pakistan has been borrowing from the international market and from banks in the private sector. Except for foreign investment other inflows involve not only conditionalities and discipline may be at variance with the requirements of a system working under interest-free arrangements. Resolving of these conflicts will take its own time.

 

 

 

Because of its overriding importance, Pakistan’s external debt deserves a special mention. As of end-March, 1999 Pakistan’s external debt stood at $ 31.5 billion. In the past five years the stock of debt has increased at an average annual rate of $ 1.33 billion.. This is in addition to foreign investment, foreign currency accounts and some other liabilities. Like domestic debt the problem of both the stock of foreign debt, or even a significant part of it, looks unlikely in the foreseeable future. The only options are to renegotiate the debt, if possible, and contain the further expansion of stock through improvement in balance of payments. It is also necessary to encourage the non-debt creating inflows like Foreign Direct Investment (FDI) and home remittances. This requires, besides the creditworthiness of the country, a competitive environment. which responds to price signals and a robust private sector. Lately, both the foreign investment and home remittances have shown a declining trends for a number of reasons. Renegotiations in terms of conversion of foreign debt into equity based and other modes acceptable in Shariah is not a promising option either. At best, we can devote greater efforts to removing misgivings, entailing any changes in the financial system which, in all likelihood, will be interpreted as having religious motivation.”

 

 

 

The conclusions drawn in the note may now be reproduced:---

 

 

 

“There is a general agreement that the interest-based financial sector and economic management in Pakistan should be shifted to Riba-free modes of operations. However, the features of the operation of financial sector as detailed above i.e. a large Government debt held by various segments of the economy, monetary and credit policy anchored to the market mechanism, age old working of financial sector particularly the banks, on interest based instruments and transactions, savings and investment in the economy and the size, the attitude and expectations of private sector indicate that shifting to interest-free arrangements of all these operations will involve a fairly long transitional period. A great deal of research work, institutional changes and broad-based reforms will be necessary. It will have to be a gradual process and will involve development of new instruments of monetary and fiscal policies, improvement in the documentation of the economy, transparency of operations, amendment in laws, research and analysis, education and training, change in the attitude and values of people and, above all, a strong and flourishing private sector in a competitive environment which offers investment opportunities and responds to price signals which would require removal of distortions and frictions in the markets. Any intervention in the financial sector without first addressing the abovementioned problems could cause serious disruptions in the economic management with adverse impact on growth and cost-price relationships.

 

 

 

The requisite changes and improvements mentioned above would need to be watched, coordinated and monitored by a high powered Board consisting of Shariah scholars who are familiar with economic and economists and bankers with some understanding of Shariah as well as experts in other relevant fields. Doing a thorough job may require the hiring of the services of international experts and scholars. Such a Board should ponder over how the concerned institutions can be reoriented and new instruments developed. It should also overview the entire process of transition from the present interest-based system to interest-free modes of economic and financial management.

 

 

 

It is pertinent to point out in this connection that during the past two decades a number of Islamic countries including Pakistan, Iran and Sudan have tried to introduce comprehensive Islamic financial system. However, there has not emerged any example of a really Islamic system of finance and banking that could serve as a standard of reference and lend guiding principles for a comprehensive move towards elimination of Riba, in letter and spirit. There exists a number of differences in perception regarding interpretation of Riba and the minimum acceptable standards of various modes of financing. The scholars in Iran permit the system of giving gifts as return on loans, sale and purchase of debt with discount or premium and discounting of bills, and the return paid on intra-Government loans. Scholars in Pakistan and the Middle East are not inclined to accept this view-point. A consensus can be of great help in achieving the real objective. Reliance of banks in all such countries, and even in the case of individual banks, on short-term financing on the basis of lending-based modes likes cost plus sale or leasing is due to a number of serious impediments and difficulties. The most important areas that needs to, be addressed are research for development of the requisite equity-based monetary policy and regulatory instruments, ensuring transparency and all pervasive accountability, restructuring the corporate sector, tax system and the legal framework, creating conducive environment and enhancing the expertise of banks’ incumbents at-all levels.”

 

 

 

Though the note concedes that there is a general agreement that interest-based financial sector and economic management in Pakistan should be shifted to Riba-free modes of operations yet nothing has been said as to the steps taken by the State Bank of Pakistan which is the Central Bank of the nation and which monitors the monetary and fiscal operations as to the steps it has taken despite the aforenoted general agreement and the consensus and the judgment of the Federal Shariat Court pronounced in the year 1991. Even in the note the Court has not been taken into confidence as to the estimate of time needed for adopting the Riba-free modes of operation and what is the thinking of the State Bank of Pakistan as to the practical steps needed to be taken for creating of necessary infrastructure and establishment of the bodies or institutions for introducing, managing and monitoring the Riga-free economy. We can only express regret while noting that due thought has not been given by the concerned authorities/officers of the State Bank to various recommendations made by Commissions and bodies constituted. by the Government of Pakistan for the purposes of elimination of Riba. Even in this note they have not referred to these recommendations what to say of commenting on their point of view. These bodies are Council of Islamic Ideology, Prime Minister’s Committee on Self-Reliance, Commission for Islamisation of Economy.

 

 

 

The Reports of the Council of Islamic Ideology and the views expressed therein have been noted in the impugned judgment. These need not be reiterated here.

 

 

 

The Prime Minister’s Committee on Self-Reliance in its Report, at pages 49, 50 deals with the Inter-Governmental Debt, Bank Loans to Government and Non-Bank Loans to Government as under:---

 

 

 

“Inter-Governmental Debt

 

 

 

These loans are rarely contracted on economic basis nor are such considerations relevant in their settlement. It is quite feasible, as such, to convert such loans on’ an interest-free basis. A rationing scheme could be adopted to decide on future allocational problems in this category of loans. A specific proposal can easily be developed in the context of an award by the National Finance Commission, which is expected soon.”

 

 

“Bank Loans to Government

 

 

 

These consist primarily of Government borrowing from banks, including from State Bank of Pakistan, against Treasury Bills. The Government’s transactions with the State Bank are of a book keeping nature. It is proposed that Government would no longer pay interest on State Bank holdings of Treasury Bill; future borrowing will continue as before except that it would be on an interest-free basis. In so far as other banks are concerned, existing Government debt will have to be settled by provision of new non-interest bearing Government paper, which will be redeemed by the State Bank of Pakistan over a five-year period. This essentially amounts to creating additional reserves of the banks with the State Bank which will be released over a five-year period. Accordingly, no undue inflationary pressures will be developed in the economy. This will also he profitable to banks as, in return for losing interest on this debt, its low yielding fund [Government pays substantially lower interest rates on these bills relative to its other borrowings] will be gradually released which could be subsequently used for more profitable investments.

 

 

 

After the commencement day of the Ordinance, no new borrowing from banks [except the State Bank] will take place. The commodity operations of the Government can be conducted on the basis of trade related modes of financing. However, if there are losses they should be covered from borrowings from the State Bank of Pakistan.

 

 

“Non-Bank Loans to Government

 

 

 

This consists mainly of Khas Deposits, Defence Saving Certificates etc., and is perhaps the most important component of domestic public debt, which needs special care in its settlement, since it is owned by private individuals. To settle this debt, it is proposed that the Government creates ,a mutual fund out of its shares in selected public sector corporations or Government Sponsored Corporations (GSCs). Salient features of the proposed fund, including a proposed portfolio and 12 Modes of Financing have been given in the Self-Reliance Report, 1991 as Annex-6 and Annex-7. This fund would be managed initially [for three years] by an independent group of portfolio managers appointed by the Government; subsequently, the portfolio managers would be chosen by the shareholders. Share certificates in this mutual fund would be issued to holders of this type of debt, equivalent to the value of their holdings.

 

 

 

The idea of a mutual fund, would be particularly effective in insulating small investors form exposure to risk. The need to minimize risk is important since part of this debt is held also by windows, retired individuals and other small investors, whose risk taking capability is minimal. Through the fund these investors would be allowed to hold a diversified portfolio of shares, thus enjoying the benefits of risk-spreading.

 

 

 

Also this would be fully in keeping with the Government’s policy of privatization and disinvestment, on which there has been no progress. This measure would serve to speed up the implementation of existing Government policy. This would also be a step in the direction of deregulation and would help to increase the efficiency of public enterprises.

 

 

 

As of 30th June, 1989, the book value of the combined assets of these corporations amounted to Rs.800.442 billion and their net equity was more than Rs.100 billion. Given that the market value of the equity is likely to be a multiple of the book value, it should be possible to redeem the full amount of about Rs.155.08 billion of obligations outstanding at the end of May, 1990. This portfolio can be expanded to include T&T, Railways, etc. which have presently been excluded.”

 

 

 

This Commission has made with regard to Foreign Public Debt the following comments and recommendations:

 

 

 

“As on 30th June, 1990, the total outstanding and disbursed foreign debt amounted to Rs.345 billion ($15.67 billion). The composition of this debt is biased in favour of Consortium countries which account for some 86 per cent. of this amount. However, within the Consortium,. the debt is fairly diversified with USA holding 23 percent., Japan 14 per cent., West Germany 10 per cent., multilateral agencies 42 per cent. and the rest is held by Belgium, Canada, France, Netherlands, Italy and U.K.

 

 

 

Given the amount of uncertainty involved in settling the matter with the foreign creditors, a variety of scenarios need to be constructed to meet the likely contingencies. In fact the response of foreigners would depend in large measure on how they perceive our motives. As we will show below, the proposed measures should not pose much difficulties for the foreigners as they are not designed to evade our obligations towards them. It is intended in the perspective of moving towards a self-reliant way of life and hence has no ultra motive, such as a ploy for defaulting on the debts owned by the country.

 

 

 

To ease the process and to ensure that there are no disruptions in economic relations with our creditors, the committee felt that some preparatory time should be given to the Government in which it will negotiate with the foreigners, on a bilateral basis, an interest-free basis for the existing debt. Unlike the domestic debt, which is proposed to be eliminated with effect from 1st July, 1991, a two-. year preparatory period is given for achieving this goal in the case of foreign debt. It is proposed that a committee be formed that would hold -negotiations with the foreigners.

 

 

 

Thus on the effective date all the principal and interest will become due and payable, unless converted into an interest-free obligation. The period of two years is hopefully sufficient to arrive at an alternative basis. There will be no restrictions on capital movements if they are done on the basis of non-interest arrangements ......................................A number of options are available which can form the basis of renegotiating external debt by the proposed committee, as well as to mobilize resources for cases where conversion may not be feasible. The most significant of these methods is the debt-equity conversions being used extensively by countries facing foreign debt problems. On such method, known as `debt-equity swaps’, requires the debtor country to allow a foreign investor to purchase its debt from the creditor at a discount and convert it into local currency for purchasing a local equity-based asset. Typically, the creditor is willing to sell the debt at a discount thus allowing the investor to obtain a discount on purchase of local currency. The scheme could be preferentially offered to any non resident Pakistani with foreign holdings, on a simple conversion basis.

 

 

 

Here, a marginally higher exchange rate would be offered to resident purchasers of debt obligations. In addition, no restrictions should be placed on-the use of local currency obtained through the conversion. A variant of the scheme could also be offered to resident importers who could mobilize foreign exchange earnings from abroad.

 

 

 

Another source of foreign resources could be disinvestment of shares of public sector corporations to resident and non-resident Pakistanis in foreign exchange. Such receipts would -he particularly useful in releasing the pressures on foreign exchange resources.

 

 

 

Finally, the creditors can be asked to convert their debt into equity in those projects where the fund are used. This is quite feasible as a sizeable amount of foreign debt has been used for on-lending to private sector through the financial system. Hence the debt is supported by a portfolio of assets; which can allow conversion into equity. “