Can Islamic Risk-Sharing Stabilise Economic Growth?

A slowdown in the economic system can create havoc to an indebted economy. Countries affected by economic recession are more likely to experience debt servicing difficulties. Syed Aun Raza Rizvi’s and Shaista Arshad’s article in The World Economy explores the use of a GDP-linked sovereign paper as an instrument in providing economic stability to developing economies.

The authors explore the theme of Islamic economics and finance, which lies in the risk-sharing principle of economics. Heavily indebted countries can opt to index their sovereign debt payments to real economic variables as a mechanism to reduce financial stress. The authors propose the development of a Shariah-compliant equity contract called GDP-linked sovereign paper that can be used by developing countries to raise financing from the global markets, instead of relying on interest-based loans from multilateral agencies. Empirical data of the stability offered by this instrument in economic growth, for a large sample of developing economies, comprising a bulk of Islamic countries has been studied. Findings indicate the lowest income group countries to be the biggest beneficiary of this instrument, as their average real GDP per capita over a 20-year period of 1992-2012 will be significantly higher than their actual real GDP per capita recorded. Despite the cost disadvantage, there are benefits from cumulative GDP per capita.

The positive results and public benefits this instrument can create should encourage multilateral agencies and regional development banks to play an active role as “market-makers” for this instrument. Their involvement could help address the concerns regarding the liquidity and scale of transactions of these securities. Policymakers might be interested in the long-term benefits through multiple channels provided by this GDP-linked sovereign paper. The instrument would assist in stabilising government spending and limiting the recurrence of fiscal pressures by requiring smaller liability servicing costs during times of slower growth. This would lead to more fiscal space for the implementation of higher spending or lower taxes and vice versa. It is important to mention that this runs counter to the experience of emerging economies, which are often forced to undertake fiscal tightening during periods of slow growth in order to maintain access to international capital markets.

This study is an initial exploration of this topic and has scope for future development. The authors aim to initiate dialogue and deliberation on the concept of GDP-linked securities from an Islamic perspective.

Rizvi, S.A.R., Arshad, S. (2018). Stabilising Economic Growth through Risk Sharing Macro Instruments. The World Economy, 41, 781-800.

doi: 10.1111/twec.12513

About the Author

Syed Aun Raza Rizvi is Assistant Professor at the SDSB, LUMS. He teaches Islamic Banking and Finance, Islamic Capital Markets and Instruments, and Principles of Finance. He is the co-program director for the executive programs on Islamic Finance for Managers, and Islamic Finance for Academicians. His research interests are financial markets, Islamic finance, econophysics, and equity markets in emerging and Islamic countries. His research has been featured in Emerging Markets Review, Economic Modelling, and The World Economy