Shariah compliance and public sector borrowing

The government needs to limit its role to defence, judiciary and management.

As the debate on public sector borrowing intensified in the wake of the recent US debt crisis, and before that the adverse budgetary situations in a number of European countries, including but not limited to Greece and Ireland, led to political debate on the issue, it would be instructive to look into Shariah guidelines for public debt.

The issue is also relevant to a number of Muslim countries, including Pakistan, where Shahid Kardar, the former governor of the State Bank of Pakistan, resigned perhaps because of disagreement over the government’s stance over public debt.

Public sector borrowing has direct implications for inflation and for private capital accumulation (if the government borrows either from the private sector or its central bank).

One of the greatest Islamic economists of the present times, Dr Umer Chapra, lists four reasons for excessive borrowing by the Muslim states of the past and present: corruption and wasteful spending, price subsidies, large and inefficient public sector, and defence expenditure. It appears as if all these factors exist in today’s Pakistani economy, contributing to excessive public sector borrowing. It would help to see what a country like Pakistan should do to reduce its public sector borrowing requirement.

Monzer Kahf, another leading contemporary Islamic economist, lists three basic functions that the early Islamic governments performed: defence, judiciary and what was known as society’s management (internal social/tribal affairs and foreign relations). Social goods (health, education, drinking water etc) were provided through philanthropic actions and Auqaf. Therefore, the first and foremost action that Pakistan should undertake is to reduce public sector output. If the state limits itself to the provision of defence and internal security, judicial sustenance, and the running of national politics and international relations, a lot of expenditure that the government now incurs could either be shifted to the private sector or not-for-profit sector, also known in Islamic economics as the third sector.

The government must stop subsidising certain goods and services. The experience of the recent past of subsidising petroleum products has resulted in the on-going energy crisis in the country in addition to worsening the budget deficit and increasing the public sector borrowing requirement. The government must also not pay cash to support lower-income families and business units. This does not result in any increase in the productive capacity in the economy.

Shariah guidelines with regards to public sector borrowing are simple. These guidelines clearly state that the government must not borrow in order to provide goods and services that the private sector or the third sector has otherwise ability to produce and supply. Therefore, there is no point of keeping on borrowing to run such corporations like Pakistan Railway, Pakistan International Airlines, and similar corporations.

These guidelines also state that borrowing for meeting the non-developmental expenses of the government cannot be justified. If a government fails to collect enough taxes to meet its current expenses, it is certainly an incompetent authority that must not be allowed to borrow.

Under Shariah guidelines borrowing from the central bank for meeting current expenses should not be allowed. It is an act of injustice on the present and future generations who must pay the price of subsequent increase in inflation.

The writer is an economist and PhD  from Cambridge University

Published in The Express Tribune, February 27^th, 2012.