Riba (Interest) & Inflation

The Supreme Court of Pakistan, in determining the applications and implications of the term “Riba” asked for assistance of religious scholars and other interested people of the country. For this purpose, answers to ten questions were sought. The sixth among these questions was:

It is evident that the value of the paper-currency has a trend of decrease in the inflationary situation. If a debtor who has borrowed a particular amount of paper currency repays the same amount to his credit[or] after a substantial time, the creditor can suffer the effects of inflation. If he demands his debtor to pay more in order to compensate him for loss of value he has suffered, can this demand be treated as a demand of Riba?

My Reply to the question follows:

Any inflationary adjustment, in which the rate of such adjustment is based on the actual rate of inflation cannot be brought under the ambit of “Riba”, because it is neither a gain on a loan and nor is it given (to the lender) at a predetermined rate related to time (i.e. percent per annum).

Any equitable method for such inflationary adjustment may be adopted. Such adjustment may, for example, be:

• based on the rate of inflation declared by the state of Pakistan; or

• based on the average price index of a particular number of the most consumed items in the country; or

• based on the price fluctuation of gold^[1] in the country. For example, at the time of securing a loan the lender and the borrower mutually agree on relating the loan with the prevalent market price of gold and also agree on retiring the loan by relating the loan with the market price of gold at that time. Suppose A lends Rs. 100/= to B. the market price of gold at the time of the transaction is Rs. 100/= per gram. Thus, it shall be agreed that A has lent one gram of gold to B. If the market price of one gram of gold, at the time of the retirement of the loan is Rs. 150/=, B shall have to pay Rs. 150/= to fulfill his obligation. By the same token, if due to any reason, the market price of gold falls to Rs. 90/= at the time of retirement of the loan, B shall be considered to have cleared his obligation by paying Rs. 90/= to A.

It may be added here that such inflationary adjustments are not only allowed but also desirable. Just like the concept of “Riba” exploits the borrower and is an injustice done to the him, avoiding inflationary adjustments in times of inflation or in other words avoiding to pay back the loans by relating these loans to the real value of paper money exploits the lender and is an injustice done to him. Islam allows neither of these exploitations and injustices.