PAKISTAN: MOVING TOWARD AN ISLAMIC ECONOMY

Created: 8/1/1980

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Zia has taken the first steps to reshape Pakistan's economy along Islamic lines! The budget Tor the fiscal year that began0 includes provisions for implementing Koran-based taxes on wealth and agriculture. Both taxes arc traditional Islamic tools for redistributing wealth and for discouraging hoarding. Under Islamic law, proceeds of the taxes can be used only for assisting the needy.

Zia is also establishing interest-free banking, another cardinal element of an Islamic economy. Isl imabad is introducing an interest-free system in several areas of finance and? blishing facilities for accepting interest-free bank deposits. Many Muslims interpret the Koran as prohibiting all interest and instructing those who lendhare inof beingixed return in ^mcrcstajjjnjj

Complementing these measures, the government isype of interest-free bond and is exempting companies from income tax if they are organized along traditional Islamic lines and ifercent of their income is distributed to participants in the company.^

It is unclear how far and how fast Zia intends to move the economy closer to the Islamic pattern, partly because any definition of an Islamic economy is highly subjective. Pakisun's Shia minority, which comprises someercent of the Sunni-dominated Mi"!im population, has already resisted some of the new measures. Nevertheless, Zia believes the new measures will strengthen his Islamic credentials at home and abroad. Movement toward an Islamic economy provides the minimum prerequisite for continued political and financial support from the Arab world, and especially from Saudi Arabia

Pakistan: Moving Toward an Islamic Economy

The Zia government is moving closer toward instituting an Islamic e- onomy. The recently announced budget for the fiscal year that began0 includes provisions for implementing Koran-based taxes on wealth and agriculture and applying interest-free bankingimited scale. Beginning his fourth year in power, Zia until now has been slow to adjust Pakistani life to Islamic teachings despite his public commitment to do so soon after overthrowing the Bhutto government inlthough Islamabadarsh judicialit claimed conformed withteps rj islamize the economy largely remained in the realm of rhetoric. In part, Zia probably judged the economic and political environment too fragile initially following Bhutto's ouster and later his execution innother and more practical consideration almost certainly has been Ihe conceptual nightrrurc of interest-freeubject that has bedeviled Islamic scholars for severala rs. WmM

How far and how fast Zia intends to move Pakistan's economy along the Islsmic path is unclear. Although any definition rf an Islamic economy is highly subjective, Zia's concept has focused only on Islamic-based taxes and the prohibition of interest, as described in Islamicational commission established by Zia is studying the revision of Pakistan's commercial and civil laws to bring them into conformity with Islamic iaw, but completing [his task is at least severali |

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Pakistan and Islam have been inexorably linked since the nation was createdears ago when India was partitioned. In pre-independence India, sumeercent of the population was Muslim and it was for Muslims that the early leaders of the Pakistani movement for an independent state claimed to speak. Islam! was effective in creating PakLttan because Muslims in undivided India fearedhe majority Hindus, and educated Muslinc sought their own state in which to develop what theyrue Islamic society should be. Thus, with the reluctant acquiescence of British and Hindu leaders. Pakistan was picved together out of th^se areas of the subcontinent that were predominantly Muslim.|J

Zia is not the first Pakistani national leader attempting to tap the wcllspring oftam (life according to the teachings of the Prophet Muhammad) has been the byword of Pakistani politicians sincciindependence.lam lay dormantolicy issue after ihe death of Pakistan's founder, Muhammad Ali Jinnah,owever.

Postihdependence problems of economic development tiial facedPakistani leaders overshadowed the religious and social needsM'tsHm community, which constitutesercent of the LI';

The idea of'an Islamic state resurfaced in0 election campaignZulfiqar Ail Bhutto. Althoughlam at first wasBhutto by opposition religious leaders and devout Muslims,committed his government to Islamic Socialism and wonelection victory. Popular doubts about the seriousness withpracticed Islam nonetheless remained, and his failure to moveof an Islamic state beyond poiilical symbolism partly explainsby General Zia in I 'T^|

The concept of an Islamic economy has been open to widely different interpretations among Pakistanis well'as scholars throughout the Islamic world. This reflects the lackpecific economic theory put forth by Islam, which offers only guidelines for many kinds of economic behavior that should be viewed as the theoretical ideal. Islam calls for justice and moderation in consumption, while scorning monopoly oower, inefficient use of resources, andhe objective of an Islamic economic system is to secure the widest and most beneficient distribution of wealth through institutional arrangements and moral exhortation. Since all forms of wealth are the gift of God to all mankind, each individual is required toealth with the community. At the same time, Islam recognizes differences in and consequently economicmong people, but it demands that each individual be responsible not only to himself but also lo those less endowed and to societyhole. As such, it is the duty of an Islamic state to ensure atubsistence level of existence for all it citizens by, if need be, redistributing wealth from the rich to the poor. |

evout orthodox Muslim, made his first move toeconomy closer to the Islamic pattern ine announced with much fanfare, that the government intended to impose1 two basic Islamic fiscal measurcs^xaAflt'ux on wealth) and ushrax on agriculturaloth taxes arc traditionajjslamic tools for redistributing wealthiscouraging hoarding!

Zakat, as one of lhe "five pillars of Islam,'* is an indUpensible requirement for an Islamics specified in the Koran, zakatoluntary annual levy on personal wealth. According to Islamic law, it can be used only for the benefit of the poor and the promotion of Islam. Zakat clearly fits in with Islamic concepts cf state and individual social responsibility for the basic human needs of disadvantaged Muslims. Zia, however, isakat that is more than voluntary.crcent self assessed tax on personal properly, the government is levying an annual* percent' tax collected at the source on most savings depositslthough allowing exceptions for widows, the needy, and other special circumstances. Zia also originallylanket application of the tax to financial instruments, such asnsurance policies, and retirement funds, but was told by Islamic scholars that this would not accord with Islamic precepts if the funds are the sole source of income for widows, the aged, and the needy.esult, applying the tax on these financial instruments will be decidedase-by-case basis. In addition, the tax will not be paid annually but ai maturity for savings certificates or at Ihc time of sale for stocks aiH bondsl

Collection and distribution of zakat is aoninisieredive-tiered Islructureof committees ranging from thr* national to the local level! Al the national level, Islamabad prefers thatmcmbrr committee be composed of Islamic religious scholars. The chat/man of the committee is nominated by the President and mustitting judgeigh court or the supreme court. At the other levels, tht committees consistombination of layschohrs. clerics, and ordinary citizens.0 loctl zakal committees have been established. Taxes collected alource will go to the national committee, while those collectedelf-assessment basis go to the; local committees, who are responsible fornforcing collection.!

Oshrisot less symbolic importance lhan zakat. Nonetheless, itong historyource of revenue for Islamic treasuries Traditionally, ttshr was collected from Muslim farmers at harvesttime on crop output ir. excess of

costs. The levy was based on the kind of crop,and cost of .'. I

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aversion of mhrerc-,nt mandatory tax on farmers. The tax will apply to eacharmer grows; for example,armer grews wheat, beans, and millet, each crop will be separately taxed to the extent its output

'Theother four pillars are failing during lhe Ranodan holy monih. praying fir-ay,ilgrimage to Mecca during one's lifeiime, and professing the faith vcTballygjSBBSSj

ilograms of wheat or its equivalent; one-fourth of outputilograms will be treatedost of production and exempt from ushr. Ail landowners are subject to the tax, but whether it will be applied to enants and sharecroppers is still under consideration. Farmers of rain-fed land will be required to pay anercent tax because they are now exempt from paying water taxes. Local committees are responsible for assessing and collecting ushr. Although Zia intended to begin applying ushr at the same timexakat, collecting the tax probably willjbe delayed until at leasthile some fiae points still being debated by Islamic scholars and administrative details are resolve

Wrestling With Interest

most difficult and contentious reform proposed by Ziaully Islamic economy is the abolition of all in1 :rcst charges and associated reform of,the banking system. From the start, Islamabad faced serious conceptual problems [laying out the rules for an interest-free economy that Zia hoped to have in effectslamic schoLrs themselves are divided on the interpretation of Muhammad's proscription against interest pay-ments. Some interpret the Prophet's commentaries on the financial abuses of his age as prohibiting all charges that even remotely resemble interest; others interpret the doctrine more loosely, as the prohibition on usurious chargesonlyJH '

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Although Islamabad was workinormat for applying interest-free bar king, Zia decided to introduce the conceptery small scale. The government implemented interest-free housing loans for lower grade civil servants, interest-free loans for bicycle purchases, and interest-free loans for subsidence and tenant farmers. Although the housing and bicycle loan program are touted as interest free, they arc not. Asommon inside Saudi Arabia, the prohibition against interest isented byithe borrower'supplementary "gift" when paying back theican.Mi

is nowroader application of interest-free banking. While the government is emphasizing phasing in the concept, in the budget message Finance Minister Ghulam Khan said that Islamabad wants this "firsi package of policies and actions large enough to bringasic change i$ the situationnd ja foundation be clearlyuch, the government is introducing jart interest-free system among several specialized government-owned financial entities; nnd in selected areas of corporate'finance and lending to small business firms. In addition, interest-free lending in the agricultural sector will now include fi'hing and interest-free loans will be available for irrigation improvement projects.

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Lastly /commercial banks will establish separateor accepting interest-free deposits that will be invested in financial instruments such as i1 export and import bills and letters of

j; Application of interest-free banking in these areas will be based on thestablished Islamic tenet that those who lend should share inof beingixed return in interest. Thusonform corporate financing wiih Islamic law, the government isng the "participation term certificate" to replace interest bearingolders of tScsc certificates will become participants in the profitshe companycricd not'to exceedears and the certificates willcCureden on the company's fixed assets. On the deposit side, interest-free accounts presumably [will operate in much the same manner as banks with simitar facilities already.established in couniries such as Dubai,rabia; Sudan, and Egypt. These facilities invest most of their capitalrofitmaking cntcrt. ises and share profits on loans among depositorsroportion bathe size of the depositor's account.I

I Islamabad is also introducing theorm of businessthat was prevalent in Muhammad's time, in the corporate sector.slamic law, iWclmudarabaontract between two parties, one ofprovides the financial capitalenture and the other which operates the enterprise. Profits and losscs| are distributed according lo fixed, contracted shares. On different levclsl mudaraba can be, for example,ank that provides financing (but does not participate in the business) and an entrepreneur who manages the operation.maller jcale, mudaraba could be between an entrepreneur who provides the capitalaborer who performs the day-to-day work: In the latter case, the worker could

il negotiate beforehand toixed share of the profits in lieuage.

! Mudaraba is approved by some Muslim jurists as ideal for anconomy because it recognizes disparities in wealth, encourages use of idle capital.and gives both entrepreneurs andreater incentive to

:As envisaged by Islamabad, companies, banks, and other financial institutions will register as1 mudaraba companies and float mudarabas for specific or general purposes. Because the business activities of mudarabas will be restricted to those approved by Islamic law, they will require] approvalnewly established religious board. The entire incomeudarabas will be exempt from income tax, provided thatercent of the income is distributed to the participants.

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i* In practice, however, some Islamic banks guarantee Iheir depositors minimum rued rates of profit returnstrict interpreter* of Islamic tenets the practice1 i* tantamount to paying 'interest; and a* such is condemncdgasBBBB ' I*

Impact of th* Measures

is confident that the new interest-free measures can be implemented without serious disruption to production, trade,inancial system that until now has operated exclusivelyestern-style commercial banking system. Even if its optimism is borne out, Pakistan still faces difficulties in integrating an interest-free system with the conventional international financial community, on which the country depends for much of its development financing. At present, Islamabad docs not intend to act in this; area Lnd has taken steps to forestall concern by multilateral lending agencies such as the Asian Development Bank and the World Bank, Is'amabad has assured these institutions that Foreign loans will not be affected by the new measures, and domestic development financethat obtain foreign credits will continue theirode of

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The government expects the new Islamic tax measures lo yield0 million annually, of0 million would be generated by zakat* Land and Wealth' taxes now yieldillion annually. The current low yield reflects extensive exemptions and widespread lax evasion. Largelybecause of uncertainties about the yield of the new taxes, Islamabadresent does not plan to tnciude them in the government budget. Nonetheless, when the yield becomes more precise. Islamabad will consider reducing its social welfare outlays to compensate for spending on these services from the Islamic taxes. The new taxes will also result in an estimatedillion reduction in government tax revenues because (a) amounts paid as zakat can be deducted from income taxes, (b) assets subject to zak at win be excluded from the existing wealth tax, and (c) land taxes have been abolished in lieu of paying ushr. (Jg

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Zia has acted quickly to collect the zakat al the source.urprise move Islamabad closed the banks on0 to deduct theercent levy on most savings accountsreliminary estimates indicate that the yieldillion. Zia moved with equal speed ordering distributionillion onhe first day of Ramadan, to anlthough only Muslims are liable for payingii?indicate lhat the small number of Pakistanis belonging to other religious faiths arc eligible to receive zakat paymcnts.B

Even if revenues from the new taxes reach the levels anticipated by Islamabad, they will be stretched thin. In addition to the0 million donield, Pakistan0 million contribution for

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'Total central government lax revenue* arc no*6 billion annually, an amount equivalent ioercent of GNP. Ml

'The holy month ofhe ninth month of the Muslim year, which ii devoted to prayer and fa*tint from lunrise to luruet.l

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The Poiilical Fallout

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the zakal fund from Saudi Arabia. Although the funds were delivered in0 .mdslamabad used the contribution for dirent balance of payments support, thereby subverting its Islamic welfare0 million zakal fund was available, however, it wruld transjaie into per capita outlays of lessor the poorestercent of which actouii's forillion people

Ushr is likely to have an adverse but as yet unmcasurablc impact on farm output. The agricultural sector is now only lightly taxed, yet little margin exists to absorb'taxes among most of the Pakistani farmers. For example, although implementation of ushr is on the horizon. Islamabad is reducing fertilizer subsidies which means higher input costs for farmers. Assessing ushr will probably prove an administrative nightmare. Many small farmers do not keep good records, and the local committees arc likely to run into the same administrative problems with which the government tax authorities have to contend. It would be surprising if irsArdocs not reduce incentives, morale, and purchases of needed inputs ic agriculture!

The new tax measures haveixed response. By far the sharpest reaction occurred in early July0 Shia Muslims protested against the taxes in Islamabad. The Shias. which comprise someercent of (he Sunni-dominaicd Muslim population, were offended by the compulsory provision of zakat. They argued that compulsion is not in accordance with Islamic teachings which say the tax should be voluntary. After discussions with Shia leaders and in return for, calling off the demonstrations. Zia agreed tb meet [their ti.-mandsJ He promised to amend the law by mid-September, making the la xcs voluntary for the Shia minority. J

The episodeoss of face for ihc regime, however, andotentially dangerous precedent-Some political observers in Pakistan believe that other sects or minorities may now be emboldened to press their Case's on specific issues. The Shia leaders reportedly believe that they have successfully defeated the governmentasic Islamic issue.

Lcss-stricl Muslims are taking refugee in the possibility of minimizing the self-assessed share of the zakat and avoiding the compulsory levy on savings accounts nnd other financial assets. For example, n* early as March-April zakal was seriously proposed, rumors developed lhal

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rnelaibon haUnee nf payment* problem* see CIA. IIRakiiian. on Necm. IJ

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Pakistanis were withdrawing money from banks and reportedly sending the funds abroad. As yet. there have been no signs of capital flight since the! new ta* measures were announced in the budget.

Despite the Shia; incident, the government is attempting to get as much political mileage as possible from imp cmcnting the new tax and interest measures. Islamabad is aiming its message at the great majority of poor Pakistanis.since they in principle will benefit from the taxes. From Islamabad's!respective, the new measures should satisfy those elements in Pakistan's society seeking some demonstration of the government's Islamic commitment and iignscf social and economic reform. Zia sees the new taxese cornerstone of the Islamic wc farehatot only prevents concentration of wealthew hands but also meets the needs ol*

N. Ill .

Zia almost cert niy considers the new measures as strengthening his Islamic credentials abroad, as well as domestically. He probably views the practical movement toward an Islamic economyinimum prerequisite for cWinucd political and financial support Irom the Arab world. This is partjcularlytruc for relations with Saudi Arabia which has emerged as

"sionof nee of

troubled Riyadh,

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' For details on Pakistan's economic relation* with Saudi Arabi- accCIAecret Noforn

the Middle turf Connection.

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