There is a common narrative that budget deficits are financed by money (currency) printing by the government. This is fiction. The facts are:

The government does not print money — examine the currency note of any denomination and you will observe that it is issued by the State Bank of Pakistan bearing the signatures of its governor.

The SBP is an independent body enjoying, parliament-sanctioned, autonomy for formulating the country’s monetary policy, not withstanding that it is fully owned by the government. (Note: the world’s largest central bank, the Federal Reserve of the US, is a privately-owned institution).

The government, to meet its budget deficits, in fact borrows money from the banking system either from SBP or commercial banks or both or externally. In this scenario the government is a debtor, and the banking system the creditor.

As a net borrower, the government incurs debt obligations of interest payment to the lender at market rates and redemption liability of principal borrowed. The latter is more in the realm of fiction, for the government’s outstanding national debt keeps increasing never displaying a decrease in absolute terms.

The currency note that is issued by the SBP is a debt instrument upon which the State Bank receives interest when lending it to the potential borrower — the government.

Accordingly, the currency note is obtainted with an element of interest in its existence. For the very conservative Muslims who abhor anything to do with interest and will not engage in borrowings or in placing deposits with banks in an interest-bearing account but would rather prefer all dealings and savings, in cash-currency note, will thus feel to be in compliance with the prohibitions against Riba-interest? My answer is no, because he is engaging nevertheless in an interest-bearing instrument (currency notes) for his daily trades etc.

So long as currency notes are issued by central banks and are lent to the governments at interest, the concept of interest-free economic mechanism is impossible.

Shahid Hassan

Karachi

Published in Dawn, December 2nd, 2015