62 AN INTRODUCTION TO ISLAMIC FINANCE
The lending of money is a currency transaction that is treated as being simi-
lar to the exchange of a commodity, and thus any compensation for the fall
in the value of money is not justifi able.
Secondly, scholars also argue that by virtue of the presence of infl ation
in the economy, the investor’s or lender’s purchasing power would be at
stake irrespective of whether money is lent as a loan on a non - riba basis or is
invested in a return - bearing security. In either case, the net loss to the lender
is a real interest rate or real return. Even if money was not lent but was kept
for consumption purposes, the same loss of purchasing power would occur.
Therefore, it seems unreasonable to expect the borrower to bear all the loss
which is likely to occur to the lender in any case.
Thirdly, it is argued that even if some form of indexation is allowed, it
may not be consonant with the notion of justice and therefore may not serve
its intended purpose. While it is recognized that infl ation represents a loss of
purchasing power and indexation is a compensation for such loss, there are
several factors that contribute to infl ation and the magnitude of each factor
and party cannot be determined. Therefore, it is unjust to ask one party to
bear the entire burden, while others are burden - free, particularly if the bor-
rower alone is asked to compensate for a loss which may have been caused
by factors beyond the borrower’s control — including, perhaps, irresponsible
government policy.
In discussing the practice of indexation, some argue that there is no
perfect index that can fully capture the loss of value. The constituents of the
cost - of - living index may not serve as a good proxy for the loss in purchas-
ing power. Also, the index represents the consumption habits of an average
person in an economy and since the cost of living may differ from region
to region and from city to city, it would not be possible to measure it accu-
rately. This inaccuracy can lead to an unjustifi ed transfer of wealth from the
borrower to the lender or vice versa. Similarly, infl ation indices are based
on a lag and are therefore not readily available to be used in daily fi nancial
transactions. All these factors make indexation less practical and prone to
biases, which may open a back door for unjustifi ed charges.
Shari’ah scholars and economists say that price stability and fi scal dis-
cipline have to be achieved to combat infl ation. In this respect, the role of
the state in causing infl ation should receive serious attention. Some econo-
mists argue that it is the responsibility of an Islamic state to take effective
steps to check infl ation in order to minimize the depreciation in the value of
money. Where government policies are the source of infl ation, the govern-
ment should compensate the borrower.
As an alternative to indexation as a means of combating infl ation, the
loan could perhaps be denominated in gold: the lender could lend a certain
quantity of gold to the borrower who is obligated to return the same quan-
tity at the expiry of the loan. Other remedies might include the partnership
and profi t - and - loss sharing instruments of the Islamic economic system,
which provide a built - in compensation for infl ation because profi t is shared