Monzer Kahf

In this rapidly changing world, several countries and political movements, especially in the Middle East, are calling for the establishment of an Islamic economic system. This paper seeks to explain the area of public borrowing in such a system and to explore its use in today’s world. In the literature, the term “budget deficit” denotes the gap between public revenue and expenditures. Revenues normally come from taxation and public property, while expenditures may cover development projects and current governmental expenses. In general, such a deficit is bridged by increasing revenues, reducing expenditures, internal borrowing (i.e., from the public commercial banks or the central bank), and by external borrowing. In the past, governments used to borrow from their rich citizens only to meet the financial needs associated with wm and natural calamities. Today, however, public borrowing has become a major feature of contemporary economies in both developed and developing countries.

This paper consists of four sections: the principles of financing in Islam, the Islamic point of view on the provision of public goods, various instruments for public resource mobilization that can be developed on the basis of Islamic principles of financing, and a conclusion.

The Principles of Financing

There are several recorded cases of public borrowing during the time of the prophet, as well as others by the ‘Abbasid and the Ottoman governments (Siddiqui 1992). This practice has persisted into the modern era, as evidenced by Egypt and the Ottoman Empire during the middle of the nineteenth century. Such borrowing usually came from external sources, mainly foreign governments and bankers.

While borrowing by the Prophet and the ‘Abbasids did not result in the issuance of any debt instruments, it is possible that the ‘Abbasid treasury ministers responsible for such matters may have issued IOUs to the lenders. Historical sources mention that the transactions of the government treasury (baitul mal)were recorded and documented. However, there are no reports available on the negotiability of such IOUs, if they ever existed. Public borrowing was also known to the classical writers of Islamic jurisprudence. For instance, al Mawardi talked about resorting to borrowing for payments of dues on the treasury and argued that successive rulers are bound to repay such loans.

As the Qur’an prohibits interest in very clear terms, an alternative form of financing had to be used. The method approved by the Qur’an (2:275) is sale. While the following verses mention charity and giving a period of grace to the debtor, as there is no expected financial return, these methods cannot be considered as true alternatives to interest-based financing. Another alternative, based on the practice of the Prophet, is the principle of profit and loss sharing and output sharing.

The Sale Principle of Financing. This principle is seen in action when the physical factors of production, intermediate inputs, or consumption goods and services are provided against deferred payment. Thus the object of financing can be either goods or services, regardless of whether they are used for production or consumption. This financing mode can be used by financial intermediaries (i.e., Islamic banks), factory owners, producers, and other economic agents and intermediaries (Kahf and Khan 1993).

Such financing may take the form of sale or lease. There are, however, a few differences as regards their respective legal conditions. Sale includes deferred payment sale-usually a sale at mark-up to the purchase orderer - (murabahah), order purchase with deferred payment (istisna), and deferred delivery sale (salam). Lease financing (ijarah) is also practiced in the form of leasing to the purchase ordered.

It is argued that, unlike interest-based financing, mark-up sale and leasing do not create a situation in which the financier’s return is known in advance (Khan 1992). The rationale behind this is that the seller/lessor cum-financier assumes certain risks (i.e., a voided contract, defective merchandise) when he/she p u r c b and owns, sells, or leases the item in question. Moreover, in the case of lease, the item in question remains in the financier’s ownership for the contract’s duration. Like interest-based financing, sale financing creates a debtor/creditor relationship between the two parties. But in contrast to interest-based financing, sale-based financing is committed to a complete or perfect correspondence with the physical or real market, and involves the financier in commodity-based relationships, rather than in pure financing, in the strictest sense of the term.

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