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PostPosted: Sat Jan 12, 2008 11:24 am    Post subject: 2006-Global Economy Reply with quote

The Star Global Malaysians Forum - Posted: 15 February 2006 at 6:51pm

Quickies on Global Economy

2004 - catching up. 2005 - a bit slow. 2006 - moderate perhaps at 3.5 %. average growth.Progress in developing countries - coming up fast. Performance in US, Europe and Japan - moderate. South East Asia - forecasted 5-6% growth (2006)

Key Global Issues requiring attention 2006 :

* employment,
* inflation,
* surging/fluctuation/control of oil price,
* deficit,
* stock market and other investments,
* balancing liquidity and interest rates,
* Global Exchange Rate/Fiscal policies - review and improve till the best is achieved,
* Disease & Epidemic Control
* Terrorism
* Price of Non-Oil Commodity
* Natural Disasters

Good News?

* Property Market - potentially booming
* International Trade - still OK
* more Free Trade Zone (hopefully)
* Food & Drugs Industry - still OK
* Service industry - still OK but be more susceptible 'on things happening around you'


* Agriculture/Biotechnology - focus on domestic growth rather export,
* International Conventions - 'walk the talk - not talk the walk' - no lip services,
* More FDIs
* More financing and debt relief
Posted: 13 March 2006 at 6:03pm

I think almost all quarters relevant have unanimously agreed that the stock market and the economy will see a better performance this year.

Since earnings from export have now shown signs of good performance, the GDP will definitely rise to - if not = 6% at least > 5%. I'm also 'betting' on this year's GLC's improved performance and FDI pouring in. I must say that I'm quite impressed with 'positive' signs been happening around me since nearly a week now (that's explains my 'long dissapearance' from this forum topic for almost a fortnight. Well, been roaming in the physical world to run some 'experiments') such as smooth mergers and acquisitions of finance/banking sectors, current stock value on the exchange, increased interest in Mesdaq, - hmmm...we should be lucky I guess.

I wanted to be optimistic for just this moment - The above concise statement would definitely be 'absorbed' into the 'uncertainties' to 'restore balance' especially those related to interest rates, oil price, policies, inflation, ringgit alignment, technology etc. The 'balancing restoration' will create the 'cushion' for future impact.

Yeap...I think we're quite ready...

p.s. 15/03/2006 - forgot to add another issue - employment...I'm also quite happy to see some 'corporate sectors' especially banking/finance move to take in graduates - training and paying them more handsome allowances - eventually employing them.
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PostPosted: Sat Jan 12, 2008 11:25 am    Post subject: GOLD AND AGRICULTURE (BIOTECH) - Nik Zafri Reply with quote

The Star Global Malaysians Forum

nikzafri-11 January 2006 at 9:48pm wrote:

Someone very wise** once told me (in 1998) - during my 'downfall'

(** - Ybhg Tuan Haji Ahmad bin Che Din of Taman Merdeka, Selama, Perak - my mentor)

1. Invest in Gold
2. Invest in Agricultural Products

Not long after that, the Honourable Tun Dr. Mahathir started to talk about prospects of 'Dinar Emas and Gold Coins'. In 2005, YAB Prime Minister, Dato Seri Abdullah Ahmad Badawi gave further and stronger emphasis on expanding the prospects of Biotechnology (focus : agricultural). It's not something to be too serious about or 'hitting the panic button' scenario but it's something worth pondering.
Today, as reported in the Star :

Rising value of gold makes it a good investment

[email protected]

KLANG: Step aside, athletes. Businessmen are going for gold these days.

Federal and Selangor Indian Goldsmith Association adviser N.P. Raman believe that businessmen and cash-rich people were purchasing gold for investment.

�It is business logic to include gold in a diversified investment portfolio. Gold can act as a hedge against inflation. Keeping your assets in gold is sound economic sense,� he said.

Yesterday, the gold price stood at RM2,090 an ounce, compared with RM1,617 on June 5 last year.

Raman said that for those with cash, gold was a good buy as long-term savings, and added that gold coins would be a better choice.
�A person who buys gold coins now would get the market price of the day when he decides to sell it,� he said.

Going by the market trend now, Raman said, the price of gold was expected to escalate.

�Right now, it is about RM70 a gram, and is expected to hit RM100 per gram in two to three months,� he said.

Raman operates from Jalan Tengku Kelana, where scores of goldsmiths are located.

Most of them are worried that middle-income people, who form the bulk of their customers, will not be able to afford gold now.

�For Indians, the period between mid-January and March 15 is an auspicious time for weddings. It is a time for a roaring business but now couples are resorting to simple three-pound gold chains instead of nine pounds. Their buying power has weakened,� he said.


It's not something to be too serious about or 'hitting the panic button' scenario but it's something worth pondering.

Here it comes again :

Gold hits 25-year high in London

LONDON: Gold rose to a 25-year high in London as gains in crude oil prices increased speculation that inflation will accelerate, eroding the value of assets such as stocks and bonds.

Gold rose 18% last year in London as investors bought the metal as a hedge against record oil prices stoking inflation.

Oil rose before the United Nations' atomic watchdog meets today to consider referring Iran's nuclear programme to the Security Council, which may impose sanctions the second largest exporter in the Organisation of Petroleum Exporting Countries (Opec).

nikzafri - 02 January 2006 at 5:41pm wrote:
3) ...Have a 'cushion to fall on' in the case of inflation...

�Rising oil prices will continue to keep gold prices buoyant this year, as it's likely to lead to inflation,� Ross Norman, an analyst at, said in an interview yesterday.

Gold for immediate delivery rose as much as US$3.85, or 0.7%, to US$573.20 an ounce, the highest since January 1981. It traded at US$572.99 at 10:09am London time.

The situation in Iran was a �double whammy� for the gold market, Norman said.

�It increases geopolitical tension as well as oil prices, both of which are good for gold,� he added.

Crude oil for March delivery rose as much as 63 US cents, or 1%, to US$67.19 a barrel in electronic trading on the New York Mercantile Exchange.

World gold prices are likely to rise to US$610 an ounce by March/April, but this is unlikely to deter Indians from importing the same amount of the precious metal in 2006 as last year, according to the head of the country's leading bullion trade body.

Mukul Sonawala, president of the Bombay Bullion Association, said on Wednesday that gold could see a small correction before it rose again.

He said a price of US$540 per ounce would provide a buying opportunity.

�There is inherent strength in the market,� Sonawala told Reuters. �All the fundamental factors are pointing to that.� � Agencies
Posted: 24 February 2007 at 3:34pm

My Gold Fact Sheet

Gold price indicates:

a) inherent value
b) quoted currency relative strength

On Supply/Demand

- the price will always be stable and doesn't seem to be much effected by even reduction in supply or in net selling by the bank,

- demand - be it raw material or investment) still going high - (you can simply based on sales of jewellery - ask my wife)

- supply - production results, hedging by mining companies, scrap/net sales by bank -all still going steady


As Portfolio diversifier. All over the world, calculation is based on standard
returns correlation/volatility.

And of course - Gold is a Reserve Asset.

What? There's more?

- inflation seem to have not much effect on Gold as well,
- Gold is all time purchasing power indicator,
- Gold's liquidity power is guaranteed,
- in case anything happen (even market crash), gold will come to the rescue
- provide confidence, insurance, assurance and security (try keeping them, or perhaps buy a genuine Rolex at least, you'll know)



(Search the'll know)
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PostPosted: Sat Jan 12, 2008 11:26 am    Post subject: FUND MANAGERS GUIDE - Nik Zafri Reply with quote

The Star Global Malaysians Forum - Posted: 09 December 2005 at 4:02pm

Nik's comments - in my opinion, I wouldn't say that the following article is meant exclusively for fund managers but we too can learn something out of it as well (in our very own capacities)

Opinion & Analysis

Posted to the web on: 08 December 2005 - Ingredients of success for fund managers - Matthew de Wet

WE KNOW that relying on past performance alone to select a fund manager is likely to produce disappointing results. We also know intuitively that fund managers that display certain characteristics � for example, a solid process and sensible philosophy � are more likely to be successful.

But are there any specific fund-manager attributes that have proven to increase the likelihood of success?

The answer is yes, according to a study that recently appeared in the Canadian Investment Review. The study, which took place over the six-year period ending December 2003, considers hundreds of different investment managers across different regions, and analyses how a number of different organisational and process factors affect the ability of the fund manager to produce superior results. Of the 17 factors tested, four were identified as being statistically significant in explaining an investment manager�s performance:

Ownership: The study concluded that investment management firms that have a high degree of employee ownership are more likely to produce superior results than those that have little or no employee ownership. This is intuitive as the greater the degree of ownership, the greater the incentive for employees to perform well.

Low personnel turnover: It was shown that firms that had a high degree of turnover in key investment staff tended to produce inferior results compared with those that had low turnover. It was also concluded that low levels of staff turnover were positively correlated with the level of ownership � that is, boutique firms tend to have lower levels of turnover of key investment individuals and that this manifested itself in superior performance.

Number of counters: The conclusion here was that as portfolios became too diversified in terms of the number of counters held, the tendency to generate outperformance decreased. Again, this is intuitive as the more counters held, the lower the tracking error and the higher the likelihood of producing average returns. Further, the study also highlighted the fact that the larger a firm, the more likely it was to have a low tracking error. It suggests that this is further evidence of the tendency of larger firms to manage portfolios in a manner that reduces business risk rather than investment risk.

Bottom-up: This factor relates to the percentage of the investment process that was focused on top-down asset allocation, or theme selection, versus bottom-up stock picking. The conclusion was that the greater the focus on bottom-up stock picking, the more likely the firm was to produce superior results.

It is interesting to note that the first three factors are more closely aligned with entrepreneurial or �boutique� type investment firms (which tend to have a high degree of employee ownership, lower key staff turnover and portfolios with higher tracking errors) than they are with large, institutional type firms. The fourth factor is not specifically aligned to boutique or institutional type managers.

A number of factors that one may expect to have an effect on the ability of managers to perform could not be conclusively proven. These included portfolio turnover, age of firm, number of staff, and number of management visits.

The study suggests that potential investors are well served by identifying boutique investment firms with low staff turnover, whose process is one of active, bottom-up stock picking.

* De Wet is head of investments at Nedgroup Investments.
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PostPosted: Sat Jan 12, 2008 11:27 am    Post subject: ECONOMIC FORECASTING - Nik Zafri Reply with quote

Something to ponder. There are some 'good lessons' we can learn here. The article may appear 'a bit old' but most of what the author suggested here still apply! Having reading it, it makes me wonder sometimes...are we or are we not doing the right thing? Read it and tell me what you think.

Original Source :

Economic Forecasting (updated 27 Feb 99)

Almost every financial services firm has an extensive economic forecasting effort. It is usually part of a so-called 'top-down' investment process, which starts with an outlook for the economy and monetary conditions, continues to the strongest industries, follows with detailed company study for stock selection and may include an overlay of technical analysis to provide a timing dimension. Some would add analysis of social and political conditions even before economic studies

Economic forecasts derive from models - usually of the aggregate national or global economy, but sometimes of parts of those economies: particular industrial sectors, regions of the world or even single products or firms. Basic approaches to forecasting simply extrapolate the past; more sophisticated models attempt to understand the sources of past changes and build them into their forecasts. The latter requires knowledge of economic history and economic principles, though, even then, forecasting is by no means an exact science. But while the accuracy of economists' predictions is frequently a target of jokes, forecasting remains a popular pursuit.

Forecasts for the macroeconomy are published regularly by academic institutions, thinktanks, governments, central banks and international organizations like the OECD and the IMF. In these places, modeling can, to a certain extent, be conducted free of the constraint of producing quick and usable data on a daily basis. But in the investment world, forecasts are required to be done 'early and often'. A relatively short-term outlook is normally the limit of their aspirations - what will happen to interest rates within the next month? - with decision-makers demanding rapid output that they hope will be directly relevant to their immediate problems.

Much of the output of financial market models is naturally closely guarded in the hope that it may bring advantage to its owners and their clients. But, at the same time, investment economists like to maintain a public profile for marketing purposes, and are often called on by the media to give their opinion on the latest macroeconomic developments. Their interpretations of economic data may give some clues as to how the financial markets will react, though more often than not, they are explaining why the markets have already reacted as they did. Invariably, too, there are disagreements about what various indicators mean, depending on different beliefs about the economy, and whether the firm is taking an optimistic or pessimistic view of the markets.

Each month, the Economist polls a group of financial forecasters and calculates the average of their predictions for real GDP growth, consumer price inflation and current account balances in a variety of countries. More specialized services like Consensus Economics survey over three hundred economists each month and offer details on average private sector predictions.

Economic forecasting guru: Peter Bernstein

Despite the pressures for 'early and often' forecasts, a number of Wall Street and City economists do as good a job as any forecasters, among them Abby Joseph Cohen, Steve Roach and Ed Hyman. Most such investment economists are good students of market conditions - careful keepers of useful data, and on occasion creative in extracting some kind of signal out of the noise. Ed Yardeni, for example, the chief economist at Deutsche Bank Securities, turns his website into a cyber chart room. If you want to access data and view charts, Yardeni's site is an essential stop. He also makes his commentary available in a section for clients that is password protected, but a substantial amount of the content is openly accessible.

One economic commentator stands amid the few that many of us would class as the best: Peter Bernstein. He grew up heading his father's investment firm, Bernstein MacCauley in New York. He was the first editor of the Journal of Portfolio Management, founded by Gil Kaplan, and has received many awards, among them the highest honor granted by the investment management industry's professional body, the Association of Investment Management & Research.

Bernstein is able to walk on both streets - with practitioners and academics. He writes a newsletter, Economics and Portfolio Strategy, to test and disseminate his analyses. And writing is one of his main strengths: his two books on the history of risk and on how 'capital ideas' came to Wall Street have been regulars on the business bestseller lists during the 1990s.

Like a good academic, Bernstein marshals all the arguments, especially those that are counter to his own position. His mid-February 1998 letter, for example, examined the case for exuberant stock prices in the United States, giving particular emphasis to the markets' reliance upon an all-knowing Federal Reserve for economic management. Bernstein concluded that 'stocks are a risky investment and should be managed accordingly'. Since that analysis was approximately the same as his November 1997 conclusion, he was ahead of the wave and for the right reasons. Bernstein is also faster than most to admit where he has been wrong and to try to examine what led him astray - or, as he jokes, 'what led the market astray when it failed to act the way I thought it would'.


Financial analysts are professional forecasters. But why study the economy, a traditional lagging indicator, if you want to forecast investment measures? The investment record of this process is only rarely better than random - and when you take account of the expenses of achieving these results, they come out a little bit less than chance. Why do it at all with that unconvincing record of success?

Economic forecasts are supposed to be meaningful. But if you believe that asset prices reflect a forecast of future outcomes, it would seem quite difficult to use a technique that reaches back into the past to get an idea of the future. But that is what economic forecasting does. It is teased for forecasting three recessions for every one that actually happens. No wonder it is called the dismal science.

Financial Times economics columnist Sir Samuel Brittan makes a pointed reflection on the practice of forecasting: 'The golden rule for economic forecasters is: forecast what has already happened and stay at the cautious end. Forecasts tell us more about the present and the recent past than about the future.'

Poor methods, bad models and inaccurate data are all blamed for the recurrence of serious forecast errors. But according to Oxford economics professor David Hendry, these are not the primary cause of systematic mistakes. Rather, unanticipated large changes within the forecast period are the culprit. The primary fault in economic forecasting is not rapidly adjusting the forecasts once they go wrong.

Hendry uses an analogy from rocket science: a rocket to the moon is forecast to reach there at a precise time and location, and usually does so. But if it is hit by a meteor and knocked off course - or destroyed - the forecast is systematically badly wrong. That outcome need not suggest poor engineering or bad forecasting models - and certainly does not suggest that Newtonian gravitation theory is incorrect.

Guru response

Peter Bernstein comments: 'For better or worse, economic forecasting is an essential ingredient in investing because earnings and interest rates are both conditional on economic conditions. So you have to do it or use it in some fashion. Furthermore, although a forecast of next quarter's GDP or even next year's earnings per share may be wrong, the kind of forecasting I do - and really that Abby Cohen does too - is to try to define the basic environment - inflationary or not, fast growth or not, competitive or not, and so on. That kind of thing is most helpful and has paid the biggest dividends over the years, not just in this cycle.'

At the front of this book is further commentary from Peter Bernstein: a grand sweeping history of the markets reprinted from the 1 December 1998 issue of his newsletter.

Where next?

Forecasting is a key task in financial institutions because of the profound effects economic developments can have on potential profits. And while leading economic indicators might provide a hint as to what the economic future holds, they do not anticipate what the additional effects of powerful economic agents like government policy and the financial markets themselves might be. To try to get ahead of the competition, companies will aim to model more accurately, and with more consideration of possible discontinuities in the markets.

One way to make forecasts more useful - though not necessarily better - might be to follow the principle of 'truth-in-labeling' used on food packages and elsewhere. We could describe the kind of forecast we are making more accurately. For example, if we are using backtesting, we should say that that is exactly what we are doing and which of two varieties.

One form of backtesting is 'momentum': the forecast is derived from a view that the past momentum will continue in roughly the same direction - often straight line - as it has in the past. The other form is 'regression to the mean': we think things will not go back or up or down, but return to average conditions. This is like a series of coin flips that goes ninety-nine times in one direction, and we think the next event is related to the preceding one.

Alternatively, we can say that our forecast comes from our own insight or novelty, and label it that way so we know that it is essentially out of our head and our own creativity - or lack of creativity, which we will know in time. Sometimes different techniques like high-frequency forecasting come from this. Or it can come from news and our response to new news. This is not necessarily insider information but news that is not necessarily generally recognized by others - a form of forecasting derived from information.

Finally, the most common form of forecasting is waffle: we do benchmark investing or stick to the middle because we do not know what else to do. That is perfectly all right, but we should label it as such. Let us say that is what we are doing, so people can understand what they are getting when they listen to us. Most of the time, a waffle is the right thing to do, but at all times, we can make our forecasts better by correctly labeling them.

Read on

In print

Peter Bernstein, Against the Gods: The Remarkable Story of Risk Peter Bernstein, Capital Ideas: The Improbable Origins of Modern Wall Street Peter Bernstein's newsletter Economics and Portfolio Strategy Reports from Consensus Economics

Online - Bill Goffe's 'resources for economists on the internet', one of the best entry points on the internet for economic information - David Hendry's research project on the econometrics of macroeconomic forecasting - website of The Economist - website of the Financial Times - Ed Yardeni's website
Almerica's Response (in blue) : Posted: 18 September 2005 at 10:27pm and Nik Zafri's Response (in red) : 24 September 2005 at 7:53pm

nikzafri wrote:
.....But, at the same time, investment economists like to maintain a public profile for marketing purposes, and are often called on by the media to give their opinion on the latest macroeconomic developments. Their interpretations of economic data may give some clues as to how the financial markets will react, though more often than not, they are explaining why the markets have already reacted as they did. Invariably, too, there are disagreements about what various indicators mean, depending on different beliefs about the economy, and whether the firm is taking an optimistic or pessimistic view of the markets.

This is where the danger lies where the urge to maintain a public profile for marketing purposes may cloud vital information that could have been made transparent to the public. More often than not publicity seekers thrive on being the bearer of good news and thus conceal certain information on the repercussions that could happen no matter how small the potential risk is which they already know before hand but in their opinion are not likely to occur. Only thing is that things don't always go as planned.

Yeap...highlight the good things and hide the 'bad' things - when we get these kind of people, do reverse reading - highlight the bad things and hide the good things - that's exactly what they are doing.

I ain't worried - as I know that in the end, these kind of 'soothsayers' will ask the infamous question - "who moved my cheese?"

nikzafri wrote:
....The investment record of this process is only rarely better than random - and when you take account of the expenses of achieving these results, they come out a little bit less than chance. Why do it at all with that unconvincing record of success?

It is actually due to the fact that it is the bread and butter of any analysts. lol

I think a true analyst conducts proper analysis. He/she should know for the fact that if there have been repetitive trends of "unconvincing records of success' derived from their so-called 'nostradamous' capabilities - these kind of 'analysts' should seriously consider looking for a new job. When you have to go, you have to go - your time is over - go find something else rather than 'clouding' people's minds.

nikzafri wrote:
Economic forecasts are supposed to be meaningful. But if you believe that asset prices reflect a forecast of future outcomes, it would seem quite difficult to use a technique that reaches back into the past to get an idea of the future. But that is what economic forecasting does. It is teased for forecasting three recessions for every one that actually happens. No wonder it is called the dismal science.

To a certain extent it is important eventhough it is dismal. It serves as a guideline for every individual's decision making process. They need to know the details, what to expect and understand what could and could not happen. They need to know the details so that they will be prepared for any direction the market turns. Many plan and know what they will do when they get windfalls but how many have a plan B or plan C to prepare themselves for adverse situations. So such economic forecasts which are genuine and transparent are always needed but to the individual it is not a recipe of success but rather an eye opener to help you prepare for the potential good as well as the potential bad.

Yes my friend, nowadays, nobody can really forecast by merely depending/trusting figures/statistics or merely conventional economic hypotheses - you have to 'experience' it yourself....there is a saying - "The analysis tools/mechanisms are not meant to change the formal decision making - sometimes good decisions are based merely on intuition" Despite there are abundance of these tools, sometimes a real businessman should trust his 'business instinct'

nikzafri wrote:
Financial Times economics columnist Sir Samuel Brittan makes a pointed reflection on the practice of forecasting: 'The golden rule for economic forecasters is: forecast what has already happened and stay at the cautious end. Forecasts tell us more about the present and the recent past than about the future.' Hendry uses an analogy from rocket science: a rocket to the moon is forecast to reach there at a precise time and location, and usually does so. But if it is hit by a meteor and knocked off course - or destroyed - the forecast is systematically badly wrong. That outcome need not suggest poor engineering or bad forecasting models - and certainly does not suggest that Newtonian gravitation theory is incorrect.

This is absolutely true. Notice how inaccurate certain analysis have been at times. Many are still not aware that it is no longer the reliable and predictable conditions that we have all been so accustomed to throughout the past one or two decades. There have been quantum leaps of advancements and the extent that what is a sure thing today could be a thing of the past. At the draw of a pen, embargos could be imposed or lifted, closed economies could be opened up. Tecnological discoveries occur almost every week...what was once invested as a need suddenly becomes a white elephant even before the investments have been amortized. What was once affordable could suddenly become free thus opening the gates to all of your competitors which run at lower operating costs to eat into your business. And then you get the daily news of violence and natural disasters. Economic analysts can never provide the framework of what to do when such things occur because it was never expected in the first place. Therefore the risks today deepens because the number of affecting factors (besides just statistical numbers and charts) have just grown out of hand.

I call this 'unwanted risk taking' and 'gambling' - based on luck and a little bit of law of probability..that's all. Indeed, the most dangerous path and pitfall!

nikzafri wrote:
Where next?

Forecasting is a key task in financial institutions because of the profound effects economic developments can have on potential profits. And while leading economic indicators might provide a hint as to what the economic future holds, they do not anticipate what the additional effects of powerful economic agents like government policy and the financial markets themselves might be. To try to get ahead of the competition, companies will aim to model more accurately, and with more consideration of possible discontinuities in the markets.

One way to make forecasts more useful - though not necessarily better - might be to follow the principle of 'truth-in-labeling' used on food packages and elsewhere. We could describe the kind of forecast we are making more accurately...

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PostPosted: Sat Jan 12, 2008 11:28 am    Post subject: Reply with quote

Islamic Banking - by Mohamed Ariff, University of Malaya, taken from Asian-Pacific Economic Literature, Vol. 2, No. 2 (September 1988), pp. 46-62

Islamic banking is a new phenomenon that has taken many observers by surprise. The whole banking system has been islamized in both Iran and Pakistan. In addition, there are some thirty Islamic banks in operation in other parts of the globe, including the Jeddah-based Islamic Development Bank (IDB) but excluding numerous non-bank Islamic financial institutions (see Appendix). What is more, the speed with which Islamic banks have sprung up and the rate at which they have progressed make it worth-while to study them systematically. An attempt is made in this paper (a) to survey the growing literature on Islamic banking, in particular (b) to trace the growth and development of Islamic banking, and (c) to highlight its salient characteristics.

The first modern experiment with Islamic banking was undertaken in Egypt under cover, without projecting an Islamic image, for fear of being seen as a manifestation of Islamic fundamentalism which was anathema to the political regime. The pioneering effort, led by Ahmad El Najjar, took the form of a savings bank based on profit-sharing in the Egyptian town of Mit Ghamr in l963. This experiment lasted until l967 (Ready l98l), by which time there were nine such banks in the country. These banks, which neither charged nor paid interest, invested mostly by engaging in trade and industry, directly or in partnership with others, and shared the profits with their depositors (Siddiqi l988). Thus, they functioned essentially as saving- investment institutions rather than as commercial banks. The Nasir Social Bank, established in Egypt in l97l, was declared an interest-free commercial bank, although its charter made no reference to Islam or Shariah (Islamic law).

The IDB was established in l974 by the Organization of Islamic Countries (OIC), but it was primarily an inter-governmental bank aimed at providing funds for development projects in member countries. The IDB provides fee- based financial services and profit-sharing financial assistance to member countries. The IDB operations are free of interest and are explicitly based on

Shariah Principles

In the seventies, changes took place in the political climate of many Muslim countries so that there was no longer any strong need to establish Islamic financial institutions under cover. A number of Islamic banks, both in letter and spirit, came into existence in the Middle East, e.g., the Dubai Islamic Bank (l975), the Faisal Islamic Bank of Sudan (l977), the Faisal Islamic Bank of Egypt (l977), and the Bahrain Islamic Bank (l979), to mention a few. The Asia-Pacific region was not oblivious to the winds of change. The Philippine Amanah Bank (PAB) was established in l973 by Presidential Decree as a specialized banking institution without reference to its Islamic character in the bank's charter. The establishment of the PAB was a response by the Philippines Government to the Muslim rebellion in the south, designed to serve the special banking needs of the Muslim community. However, the primary task of the PAB was to assist rehabilitation and reconstruction in Mindanao, Sulu and Palawan in the south (Mastura l988). The PAB has eight branches located in the major cities of the southern Muslim provinces, including one in Makati (Metro Manila), in addition to the head office located at Zamboanga City in Mindanao. The PAB, however, is not strictly an Islamic bank, since interest-based operations continue to coexist with the Islamic modes of financing. It is indeed fascinating to observe that the PAB operates two 'windows' for deposit transactions, i.e., conventional and Islamic. Nevertheless, efforts are underway to convert the PAB into a full-fledged Islamic bank (Mastura l988).

Islamic banking made its debut in Malaysia in l983, but not without antecedents. The first Islamic financial institution in Malaysia was the Muslim Pilgrims Savings Corporation set up in l963 to help people save for performing hajj (pilgrimage to Mecca and Medina). In l969, this body evolved into the Pilgrims Management and Fund Board or the Tabung Haji as it is now popularly known. The Tabung Haji has been acting as a finance company that invests the savings of would-be pilgrims in accordance with Shariah, but its role is rather limited, as it is a non-bank financial institution. The success of the Tabung Haji, however, provided the main impetus for establishing Bank Islam Malaysia Berhad (BIMB) which represents a full- fledged Islamic commercial bank in Malaysia. The Tabung Haji also contributed l2.5 per cent of BIMB's initial capital of M$80 million. BIMB has a complement of fourteen branches in several parts of the country. Plans are afoot to open six new branches a year so that by l990 the branch network of BIMB will total thirty-three (Man l988).

Reference should also be made to some Islamic financial institutions established in countries where Muslims are a minority. There was a proliferation of interest-free savings and loan societies in India during the seventies (Siddiqi l988). The Islamic Banking System (now called Islamic Finance House), established in Luxembourg in l978, represents the first attempt at Islamic banking in the Western world. There is also an Islamic Bank International of Denmark, in Copenhagen, and the Islamic Investment Company has been set up in Melbourne, Australia.


The essential feature of Islamic banking is that it is interest-free. Although it is often claimed that there is more to Islamic banking, such as contributions towards a more equitable distribution of income and wealth, and increased equity participation in the economy (Chapra l982), it nevertheless derives its specific rationale from the fact that there is no place for the institution of interest in the Islamic order.
Islam prohibits Muslims from taking or giving interest (riba) regardless of the purpose for which such loans are made and regardless of the rates at which interest is charged. To be sure, there have been attempts to distinguish between usury and interest and between loans for consumption and for production. It has also been argued that riba refers to usury practiced by petty money-lenders and not to interest charged by modern banks and that no riba is involved when interest is imposed on productive loans, but these arguments have not won acceptance. Apart from a few dissenting opinions, he general consensus among Muslim scholars clearly is that there is no difference between riba and interest. In what follows, these two terms are used interchangeably.

The prohibition of riba is mentioned in four different revelations in the Qur'an.1 The first revelation emphasizes that interest deprives wealth of God's blessings. The second revelation condemns it, placing interest in juxtaposition with wrongful appropriation of property belonging to others. The third revelation enjoins Muslims to stay clear of interest for the sake of their own welfare. The fourth revelation establishes a clear distinction between interest and trade, urging Muslims to take only the principal sum and to forgo even this sum if the borrower is unable to repay. It is further declared in the Qur'an that those who disregard the prohibition of interest are at war with God and His Prophet. The prohibition of interest is also cited in no uncertain terms in the Hadith (sayings of the Prophet). The Prophet condemned not only those who take interest but also those who give interest and those who record or witness the transaction, saying that they are all alike in guilt.2

It may be mentioned in passing that similar prohibitions are to be found in the pre-Qur'anic scriptures, although the 'People of the Book', as the Qur'an refers to them, had chosen to rationalize them. It is amazing that Islam has successfully warded off various subsequent rationalization attempts aimed at legitimizing the institution of interest.

Some scholars have put forward economic reasons to explain why interest is banned in Islam. It has been argued, for instance, that interest, being a pre- determined cost of production, tends to prevent full employment (Khan l968; Ahmad n.d.; Mannan l970). In the same vein, it has been contended that international monetary crises are largely due to the institution of interest (Khan, n.d), and that trade cycles are in no small measure attributable to the phenomenon of interest (Ahmad l952; Su'ud n.d.). None of these studies, however, has really succeeded in establishing a causal link between interest, on the one hand, and employment and trade cycles, on the other. Others, anxious to vindicate the Islamic position on interest, have argued that interest is not very effective as a monetary policy instrument even in capitalist economies and have questioned the efficacy of the rate of interest as a determinant of saving and investment (Ariff l982). A common thread running through all these discussions is the exploitative character of the institution of interest, although some have pointed out that profit (which is lawful in Islam) can also be exploitative. One response to this is that one must distinguish between profit and profiteering, and Islam has prohibited the latter as well.

Some writings have alluded to the 'unearned income' aspect of interest payments as a possible explanation for the Islamic doctrine. The objection that rent on property is considered halal (lawful) is then answered by rejecting the analogy between rent on property and interest on loans, since the benefit to the tenant is certain, while the productivity of the borrowed capital is uncertain. Besides, property rented out is subject to physical wear and tear, while money lent out is not. The question of erosion in the value of money and hence the need for indexation is an interesting one. But the Islamic jurists have ruled out compensation for erosion in the value of money, or, according to Hadith, a fungible good must be returned by its like (mithl): 'gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt, like for like, equal for equal, and hand to hand ...'.3

The bottom line is that Muslims need no 'proofs' before they reject the institution of interest: no human explanation for a divine injunction is necessary for them to accept a dictum, as they recognize the limits to human reasoning. No human mind can fathom a divine order; therefore it is a matter of faith (iman).

The Islamic ban on interest does not mean that capital is costless in an Islamic system. Islam recognizes capital as a factor of production but it does not allow the factor to make a prior or pre-determined claim on the productive surplus in the form of interest. This obviously poses the question as to what will then replace the interest rate mechanism in an Islamic framework. There have been suggestions that profit-sharing can be a viable alternative (Kahf l982a and l982b). In Islam, the owner of capital can legitimately share the profits made by the entrepreneur. What makes profit- sharing permissible in Islam, while interest is not, is that in the case of the former it is only the profit-sharing ratio, not the rate of return itself that is predetermined.

It has been argued that profit-sharing can help allocate resources efficiently, as the profit-sharing ratio can be influenced by market forces so that capital will flow into those sectors which offer the highest profit- sharing ratio to the investor, other things being equal. One dissenting view is that the substitution of profit-sharing for interest as a resource allocating mechanism is crude and imperfect and that the institution of interest should therefore be retained as a necessary evil (Naqvi l982). However, mainstream Islamic thinking on this subject clearly points to the need to replace interest with something else, although there is no clear consensus on what form the alternative to the interest rate mechanism should take. The issue is not resolved and the search for an alternative continues, but it has not detracted from efforts to experiment with Islamic banking without interest.


As mentioned earlier, Islam does not deny that capital, as a factor of production, deserves to be rewarded. Islam allows the owners of capital a share in a surplus which is uncertain. To put it differently, investors in the Islamic order have no right to demand a fixed rate of return. No one is entitled to any addition to the principal sum if he does not share in the risks involved. The owner of capital (rabbul-mal) may 'invest' by allowing an entrepreneur with ideas and expertise to use the capital for productive purposes and he may share the profits, if any, with the entrepreneur- borrower (mudarib); losses, if any, however, will be borne wholly by the rabbul-mal. This mode of financing, termed mudaraba in the Islamic literature, was in practice even in the pre-Qur'anic days and, according to jurists, it was approved by the Prophet.

Another legitimate mode of financing recognized in Islam is one based on equity participation (musharaka) in which the partners use their capital jointly to generate a surplus. Profits or losses will be shared between the partners according to some agreed formula depending on the equity ratio. Mudaraba and musharaka constitute, at least in principle if not in practice, the twin pillars of Islamic banking. The musharaka principle is invoked in the equity structure of Islamic banks and is similar to the modern concepts of partnership and joint stock ownership. In so far as the depositors are concerned, an Islamic bank acts as a mudarib which manages the funds of the depositors to generate profits subject to the rules of mudaraba as outlined above. The bank may in turn use the depositors' funds on a mudaraba basis in addition to other lawful modes of financing. In other words, the bank operates a two-tier mudaraba system in which it acts both as the mudarib on the saving side of the equation and as the rabbul-mal on the investment portfolio side. The bank may also enter into musharaka contracts with the users of the funds, sharing profits and losses, as mentioned above. At the deposit end of the scale, Islamic banks normally operate three broad categories of account, mainly current, savings, and investment accounts. The current account, as in the case of conventional banks, gives no return to the depositors. It is essentially a safe-keeping (al-wadiah) arrangement between the depositors and the bank, which allows the depositors to withdraw their money at any time and permits the bank to use the depositors' money. As in the case of conventional banks, cheque books are issued to the current account deposit holders and the Islamic banks provide the broad range of payment facilities - clearing mechanisms, bank drafts, bills of exchange, travellers cheques, etc. (but not yet, it seems, credit cards or bank cards). More often than not, no service charges are made by the banks in this regard.

The savings account is also operated on an al-wadiah basis, but the bank may at its absolute discretion pay the depositors a positive return periodically, depending on its own profitability. Such payment is considered lawful in Islam since it is not a condition for lending by the depositors to the bank, nor is it pre-determined. The savings account holders are issued with savings books and are allowed to withdraw their money as and when they please. The investment account is based on the mudaraba principle, and the deposits are term deposits which cannot be withdrawn before maturity. The profit- sharing ratio varies from bank to bank and from time to time depending on supply and demand conditions.4 In theory, the rate of return could be positive or negative, but in practice the returns have always been positive and quite comparable to rates conventional banks offer on their term deposits.5

At the investment portfolio end of the scale, Islamic banks employ a variety of instruments. The mudaraba and musharaka modes, referred to earlier, are supposedly the main conduits for the outflow of funds from the banks. In practice, however, Islamic banks have shown a strong preference for other modes which are less risky. The most commonly used mode of financing seems to be the 'mark-up' device which is termed murabaha. In a murabaha transaction, the bank finances the purchase of a good or asset by buying it on behalf of its client and adding a mark-up before re-selling it to the client on a 'cost-plus' basis. It may appear at first glance that the mark-up is just another term for interest as charged by conventional banks, interest thus being admitted through the back door. What makes the murabaha transaction Islamically legitimate is that the bank first acquires the asset and in the process it assumes certain risks between purchase and resale. The bank takes responsibility for the good before it is safely delivered to the client. The services rendered by the Islamic bank are therefore regarded as quite different from those of a conventional bank which simply lends money to the client to buy the good.

Islamic banks have also been resorting to purchase and resale of properties on a deferred payment basis, which is termed bai' muajjal. It is considered lawful in fiqh (jurisprudence) to charge a higher price for a good if payments are to be made at a later date. According to fiqh, this does not amount to charging interest, since it is not a lending transaction but a trading one.

Leasing or ijara is also frequently practised by Islamic banks. Under this mode, the banks would buy the equipment or machinery and lease it out to their clients who may opt to buy the items eventually, in which case the monthly payments will consist of two components, i.e., rental for the use of the equipment and instalment towards the purchase price.

Reference must also be made to pre-paid purchase of goods, which is termed bai'salam, as a means used by Islamic banks to finance production. Here the price is paid at the time of the contract but the delivery would take place at a future date. This mode enables an entrepreneur to sell his output to the bank at a price determined in advance. Islamic banks, in keeping with modern times, have extended this facility to manufactures as well.

It is clear from the above sketch that Islamic banking goes beyond the pure financing activities of conventional banks. Islamic banks engage in equity financing and trade financing. By its very nature, Islamic banking is a risky business compared with conventional banking, for risk-sharing forms the very basis of all Islamic financial transactions. To minimize risks, however, Islamic banks have taken pains to distribute the eggs over many baskets and have established reserve funds out of past profits which they can fall back on in the event of any major loss.

Literature: Theory

It is not possible to cover in this survey all the publications which have appeared on Islamic banking. There are numerous publications in Arabic and Urdu which have made significant contributions to the theoretical discussion. A brief description of these in English can be found in the Appendix to Siddiqi's book on Banking without Interest (Siddiqi l983a). The early contributions on the subject of Islamic banking were somewhat casual in the sense that only passing references were made to it in the discussion of wider issues relating to the Islamic economic system as a whole. In other words, the early writers had been simply thinking aloud rather than presenting well-thought-out ideas. Thus, for example, the book by Qureshi on Islam and the Theory of Interest (Qureshi l946) looked upon banking as a social service that should be sponsored by the government like public health and education. Qureshi took this point of view since the bank could neither pay any interest to account holders nor charge any interest on loans advanced. Qureshi also spoke of partnerships between banks and businessmen as a possible alternative, sharing losses if any. No mention was made of profit-sharing.
Ahmad, in Chapter VII of his book Economics of Islam (Ahmad l952), envisaged the establishment of Islamic banks on the basis of a joint stock company with limited liability. In his scheme, in addition to current accounts, on which no dividend or interest should be paid, there was an account in which people could deposit their capital on the basis of partnership, with shareholders receiving higher dividends than the account holders from the profits made. Like Qureshi, above, Ahmad also spoke of possible partnership arrangements with the businessmen who seek capital from the banks. However, the partnership principle was left undefined, nor was it clear who would bear the loss if any. It was suggested that banks should cash bills of trade without charging interest, using the current account funds.

The principle of mudaraba based on Shariah was invoked systematically by Uzair (l955). His principal contribution lay in suggesting mudaraba as the main premise for 'interestless banking'. However, his argument that the bank should not make any capital investment with its own deposits rendered his analysis somewhat impractical.

Al-Arabi (l966) envisaged a banking system with mudaraba as the main pivot. He was actually advancing the idea of a two-tier mudaraba which would enable the bank to mobilize savings on a mudaraba basis, allocating the funds so mobilized also on a mudaraba basis. In other words the bank would act as a mudarib in so far as the depositors were concerned, while the 'borrowers' would act as mudaribs in so far as the bank was concerned. In his scheme, the bank could advance not only the capital procured through deposits but also the capital of its own shareholders. It is also of interest to note that his position with regard to the distribution of profits and the responsibility for losses was strictly in accordance with the Shariah.6 Irshad (l964) also spoke of mudaraba as the basis of Islamic banking, but his concept of mudaraba was quite different from the traditional one in that he thought of capital and labour (including entrepreneurship) as having equal shares in output, thus sharing the losses and profits equally. This actually means that the owner of capital and the entrepreneur have a fifty-fifty share in the profit or loss as the case may be, which runs counter to the Shariah position. Irshad envisaged two kinds of deposit accounts. The first sounded like current deposits in the sense that it would be payable on demand, but the money kept in this deposit would be used for social welfare projects, as the depositors would get zero return. The second one amounted to term deposits which would entitle the depositors to a share in the profits at the end of the year proportionately to the size and duration of the deposits. He recommended the setting up of a Reserve Fund which would absorb all losses so that no depositor would have to bear any loss. According to Irshad, all losses would be either recovered from the Reserve Fund or borne by the shareholders of the bank.

A pioneering attempt at providing a fairly detailed outline of Islamic banking was made in Urdu by Siddiqi in l968. (The English version was not published until l983.) His Islamic banking model was based on mudaraba and shirka (partnership or musharaka as it is now usually called). His model was essentially one based on a two-tier mudaraba financier-entrepreneur relationship, but he took pains to describe the mechanics of such transactions in considerable detail with numerous hypothetical and arithmetic examples. He classified the operations of an Islamic bank into three categories: services based on fees, commissions or other fixed charges; financing on the basis of mudaraba and partnership; and services provided free of charge. His thesis was that such interest-free banks could be a viable alternative to interest-based conventional banks.

The issue of loans for consumption clearly presents a problem, as there is no profit to be shared. Siddiqi addressed this problem, but he managed only to scratch the surface. While recognizing the need for such interest-free loans (qard hasan), especially for meeting basic needs, he seemed to think it was the duty of the community and the State (through its baitul mal or treasury) to cater to those needs; the Islamic bank's primary objective, like that of any other business unit, is to earn profit. He therefore tended to downplay the role of Islamic banks in providing consumption loans, but he suggested limited overdraft facilities without interest. He even considered a portion of the fund being set aside for consumption loans, repayment being guaranteed by the State. He also suggested that consumers buying durables on credit would issue 'certificates of sale' which could be encashed by the seller at the bank for a fee. It was then the seller not the buyer who would be liable as far as the bank was concerned. However, the principles of murabaha and bai' muajjal were not invoked.

Strangely, Siddiqi favoured keeping the number of shareholders to the minimum, without advancing any strong reasons. This is contrary to the general consensus which now seems to have emerged with reference to Islamic banks operating on a joint stock company basis, a consensus which incidentally is also in line with the Islamic value attached to a broad equity base as against heavy concentration of equity and wealth. Ironically, Siddiqi thought that interest-free banking could operate successfully 'only in a country where interest is legally prohibited and any transaction based upon interest is declared a punishable offense' (l983b:l3). He also thought it important to have Islamic laws enforced before interest-free banking could operate well. This view has not gained acceptance, as demonstrated by the many Islamic banks which operate profitably in 'hostile' environments, as noted earlier.

Chapra's model of Islamic banking (Chapra l982), like Siddiqi's, was based on the mudaraba principle. His main concern, however, centered on the role of artificial purchasing power through credit creation. He even suggested that 'seigniorage' resulting from it should be transferred to the public exchequer, for the sake of equity and justice. Al-Jarhi (l983) went so far as to favor the imposition of a l00 per cent reserve requirement on commercial banks. Chapra was also much concerned about the concentration of economic power private banks might enjoy in a system based on equity financing. He therefore preferred medium-sized banks which are neither so large as to wield excessive power nor so small as to be uneconomical. Chapra's scheme also contained proposals for loss-compensating reserves and loss-absorbing insurance facilities. He also spoke of non-bank financial institutions, which specialize in bringing financiers and entrepreneurs together and act as investment trusts.

Mohsin (l982) has presented a detailed and elaborate framework of Islamic banking in a modern setting. His model incorporates the characteristics of commercial, merchant, and development banks, blending them in novel fashion. It adds various non-banking services such as trust business, factoring, real estate, and consultancy, as though interest-free banks could not survive by banking business alone. Many of the activities listed certainly go beyond the realm of commercial banking and are of so sophisticated and specialized a nature that they may be thought irrelevant to most Muslim countries at their present stage of development. Mohsin's model clearly was designed to fit into a capitalist environment; indeed he explicitly stated that riba-free banks could coexist with interest-based banks. The point that there is more to Islamic banking than mere abolition of interest was driven home strongly by Chapra (l985). He envisaged Islamic banks whose nature, outlook and operations could be distinctly different from those of conventional banks. Besides the outlawing of riba, he considered it essential that Islamic banks should, since they handle public funds, serve the public interest rather than individual or group interests. In other words, they should play a social-welfare-oriented rather than a profit-maximizing role. He conceived of Islamic banks as a cross-breed of commercial and merchant banks, investment trusts and investment-management institutions that would offer a wide spectrum of services to their customers. Unlike conventional banks which depend heavily on the 'crutches of collateral and of non-participation in risk' (p. l55), Islamic banks would have to rely heavily on project evaluation, especially for equity-oriented financing. Thanks to the profit-and-loss sharing nature of the operations, bank-customer relations would be much closer and more cordial than is possible under conventional banking. Finally, the problems of liquidity shortage or surplus would have to be handled differently in Islamic banking, since the ban on interest rules out resort to the money market and the central bank. Chapra suggested alternatives such as reciprocal accommodation among banks without interest payments and creation of a common fund at the central bank into which surpluses would flow and from which shortages could be met without any interest charges.

The literature also discusses the question of central banking in an Islamic framework. The general opinion seems to be that the basic functions of a modern central bank are relevant also for an Islamic monetary system, although the mechanisms may have to be different. Thus, for example, the bank rate instrument cannot be used as it entails interest. Uzair (l982) has suggested adjustments in profit-sharing ratios as a substitute for bank rate manipulations by the central bank. Thus, credit can be tightened by reducing the share accruing to the businessmen and eased by increasing it. Siddiqi (l982) has suggested that variations in the so-called 'refinance ratio' (which refers to the central bank refinancing of a part of the interest-free loans provided by the commercial banks) would influence the quantum of short-term credit extended. Siddiqi has also proposed a prescribed 'lending ratio' (i.e., the proportion of demand deposits that commercial banks are obliged to lend out as interest-free loans) that can be adjusted by the central bank according to changing circumstances. In this context, reference may also be made to a proposal by Uzair (l982) that the central bank should acquire an equity stake in commercial banking by holding, say, 25 per cent of the capital stock of the commercial banks. The rationale behind this proposal was that it would give the central bank access to a permanent source of income so that it could effectively act as lender of last resort. The discussion of central banking in an Islamic context is somewhat scanty, presumably because Islamic central banking is viewed as too far-fetched an idea, except in Iran and Pakistan.

It emerges from all this that Islamic banking has three distinguishing features: (a) it is interest-free, (b) it is multi-purpose and not purely commercial, and (c) it is strongly equity-oriented. The literature contains hardly any serious criticism of the interest-free character of the operation, since this is taken for granted, although concerns have been expressed about the lack of adequate interest-free instruments. There is a near-consensus that Islamic banks can function well without interest. A recent International Monetary Fund study by Iqbal and Mirakhor (l987) has found Islamic banking to be a viable proposition that can result in efficient resource allocation. The study suggests that banks in an Islamic system face fewer solvency and liquidity risks than their conventional counterparts. The multi-purpose and extra-commercial nature of the Islamic banking operation does not seem to pose intractable problems. The abolition of interest makes it imperative for Islamic banks to look for other instruments, which renders operations outside the periphery of commercial banking unavoidable. Such operations may yield economies of scope. But it is undeniable that the multipurpose character of Islamic banking poses serious practical problems, especially in relation to the skills needed to handle such diverse and complex transactions (Iqbal and Mirakhor l987).

The stress on equity-oriented transactions in Islamic banking, especially the mudaraba mode, has been criticized. It has been argued that the replacement of pre-determined interest by uncertain profits is not enough to render a transaction Islamic, since profit can be just as exploitative as interest is, if it is 'excessive' (Naqvi l98l). Naqvi has also pointed out that there is nothing sacrosanct about the institution of mudaraba in Islam. Naqvi maintains that mudaraba is not based on the Qur'an or the Hadith but was a custom of the pre-Islamic Arabs. Historically, mudaraba, he contends, enabled the aged, women, and children with capital to engage in trade through merchants for a share in the profit, all losses being borne by the owners of capital, and therefore it cannot claim any sanctity. The fact remains that the Prophet raised no objection to mudaraba, so that it was at least not considered un-Islamic.

The distribution of profit in mudaraba transactions presents practical difficulties, especially where there are multiple providers of capital, but these difficulties are not regarded as insurmountable. The Report of Pakistan's Council of Islamic Ideology (CII l983) has suggested that the respective capital contributions of parties can be converted to a common denominator by multiplying the amounts provided with the number of days during which each component, such as the firm's own equity capital, its current cash surplus and suppliers' credit was actually deployed in the business, i.e., on a daily product basis. As for deposits, profits (net of administrative expenses, taxes, and appropriation for reserves) would be divided between the shareholders of the bank and the holders of deposits, again on a daily product basis.

Literature: Practice
Recent years have brought an increasing flow of empirical studies of Islamic banking. The earliest systematic empirical work was undertaken by Khan (l983). His observations covered Islamic banks operating in Sudan, United Arab Emirates, Kuwait, Bahrain, Jordan, and Egypt. Khan's study showed that these banks had little difficulty in devising practices in conformity with Shariah. He identified two types of investment accounts: one where the depositor authorized the banks to invest the money in any project and the other where the depositor had a say in the choice of project to be financed. On the asset side, the banks under investigation had been resorting to mudaraba, musharaka and murabaha modes. Khan's study reported profit rates ranging from 9 to 20 per cent which were competitive with conventional banks in the corresponding areas. The rates of return to depositors varied between 8 and l5 per cent, which were quite comparable with the rates of return offered by conventional banks.
Khan's study revealed that Islamic banks had a preference for trade finance and real estate investments. The study also revealed a strong preference for quick returns, which is understandable in view of the fact that these newly established institutions were anxious to report positive results even in the early years of operation. Nienhaus (1988) suggests that the relative profitability of Islamic banks, especially in the Middle East in recent years, was to a large extent due to the property (real estate) boom. He has cited cases of heavy losses which came with the crash of the property sector.

The IMF study referred to earlier by Iqbal and Mirakhor (l987) also contains extremely interesting empirical observations, although these are confined to the experience of Iran and Pakistan, both of which have attempted to islamize the entire banking system on a comprehensive basis. Iran switched to Islamic banking in August l983 with a three-year transition period. The Iranian system allows banks to accept current and savings deposits without having to pay any return, but it permits the banks to offer incentives such as variable prizes or bonuses in cash or kind on these deposits. Term deposits (both short-term and long-term) earn a rate of return based on the bank's profits and on the deposit maturity. No empirical evidence is as yet available on the interesting question as to whether interest or a profit-share provides the more effective incentive to depositors for the mobilization of private saving. Where Islamic and conventional banks exist side by side, central bank control of bank interest rates is liable to be circumvented by shifts of funds to the Islamic banks.

Iqbal and Mirakhor have noted that the conversion to Islamic modes has been much slower on the asset than on the deposit side. It appears that the Islamic banking system in Iran was able to use less than half of its resources for credit to the private sector, mostly in the form of short-term facilities, i.e., commercial and trade transactions. The slower pace of conversion on the asset side was attributed by the authors to the inadequate supply of personnel trained in long-term financing. The authors, however, found no evidence to show that the effectiveness of monetary policy in Iran, broadly speaking, was altered by the conversion.

The Pakistani experience differs from the Iranian one in that Pakistan had opted for a gradual islamization process which began in l979. In the first phase, which ended on l January l985, domestic banks operated both interest- free and interest-based 'windows'. In the second phase of the transformation process, the banking system was geared to operate all transactions on the basis of no interest, the only exceptions being foreign currency deposits, foreign loans and government debts. The Pakistani model took care to ensure that the new modes of financing did not upset the basic functioning and structure of the banking system. This and the gradual pace of transition, according to the authors, made it easier for the Pakistani banks to adapt to the new system. The rate of return on profit-and-loss sharing (PLS) deposits appears not only to have been in general higher than the interest rate before islamization but also to have varied between banks, the differential indicating the degree of competition in the banking industry. The authors noted that the PLS system and the new modes of financing had accorded considerable flexibility to banks and their clients. Once again the study concluded that the effectiveness of monetary policy in Pakistan was not impaired by the changeover.

The IMF study, however, expressed considerable uneasiness about the concentration of bank assets on short-term trade credits rather than on long-term financing. This the authors found undesirable, not only because it is inconsistent with the intentions of the new system, but also because the heavy concentration on a few assets might increase risks and destabilize the asset portfolios. The study also drew attention to the difficulty experienced in both Iran and Pakistan in financing budget deficits under a non-interest system and underscored the urgent need to devise suitable interest-free instruments. Iran has, however, decreed that government borrowing on the basis of a fixed rate of return from the nationalized banking system would not amount to interest and would hence be permissible. The official rationalization is that, since all banks are nationalized, interest rates and payments among banks will cancel out in the consolidated accounts. (This, of course, abstracts from the banks' business with non-bank customers.) There are also some small case studies of Islamic banks operating in Bangladesh (Huq l986), Egypt (Mohammad l986), Malaysia (Halim l988b), Pakistan (Khan l986), and Sudan (Salama l988b). These studies reveal interesting similarities and differences. The current accounts in all cases are operated on the principles of al-wadiah. Savings deposits, too, are accepted on the basis of al-wadiah, but 'gifts' to depositors are given entirely at the discretion of the Islamic banks on the minimum balance, so that the depositors also share in profits. Investment deposits are invariably based on the mudaraba principle, but there are considerable variations. Thus, for example, the Islamic Bank of Bangladesh has been offering PLS Deposit Accounts, PLS Special Notice Deposit Accounts, and PLS Term Deposit Accounts, while Bank Islam Malaysia has been operating two kinds of investment deposits, one for the general public and the other for institutional clients.

The studies also show that the profit-sharing ratios and the modes of payment vary from place to place and from time to time. Thus, for example, profits are provisionally declared on a monthly basis in Malaysia, on a quarterly basis in Egypt, on a half-yearly basis in Bangladesh and Pakistan, and on an annual basis in Sudan.

A striking common feature of all these banks is that even their investment deposits are mostly short-term, reflecting the depositors' preference for assets in as liquid a form as possible. Even in Malaysia, where investment deposits have accounted for a much larger proportion of the total, the bulk of them were made for a period of less than two years. By contrast, in Sudan most of the deposits have consisted of current and savings deposits, apparently because of the ceiling imposed by the Sudanese monetary authorities on investment deposits which in turn was influenced by limited investment opportunities in the domestic economy. There are also interesting variations in the pattern of resource utilization by the Islamic banks. For example, musharaka has been far more important than murabaha as an investment mode in Sudan, while the reverse has been the case in Malaysia. On the average, however, murabaha, bai'muajjal and ijara, rather than musharaka represent the most commonly used modes of financing. The case studies also show that the structure of the clientele has been skewed in favor of the more affluent segment of society, no doubt because the banks are located mainly in metropolitan centres with small branch networks.

The two main problems identified by the case studies are the absence of suitable non-interest-based financial instruments for money and capital market transactions and the high rate of borrower delinquency. The former problem has been partially redressed by Islamic banks resorting to mutual inter-bank arrangements and central bank cooperation, as mentioned earlier. The Bank Islam Malaysia, for instance, has been placing its excess liquidity with the central bank which usually exercises its discretionary powers to give some returns. The delinquency problem appears to be real and serious. Murabaha payments have often been held up because late payments cannot be penalized, in contrast to the interest system in which delayed payments would automatically mean increased interest payments. To overcome this problem, the Pakistani banks have resorted to what is called 'mark-down' which is the opposite of 'mark-up' (i.e., the profit margin in the cost-plus approach of murabaha transactions). 'Mark-down' amounts to giving rebates as an incentive for early payments. But the legitimacy of this 'mark-down' practice is questionable on Shariah grounds, since it is time- based and therefore smacks of interest.

In the Southeast Asian context, two recent studies on the Bank Islam Malaysia by Man (l988) and the Philippine Amanah Bank by Mastura (l988) deserve special mention. The Malaysian experience in Islamic banking has been encouraging. Man's study shows that the average return to depositors has been quite competitive with that offered by conventional banks. By the end of l986, after three years of operation, the bank had a network of fourteen branches. However, 90 per cent of its deposits had maturities of two years or less, and non-Muslim depositors accounted for only 2 per cent of the total. Man is particularly critical of the fact that the mudaraba and musharaka modes of operation, which are considered most meaningful by Islamic scholars, accounted for a very small proportion of the total investment portfolio, while bai'muajjal and ijara formed the bulk of the total. It is evident from Mastura's analysis that the Philippine Amanah Bank is, strictly speaking, not an Islamic bank, as interest-based operations continue to coexist with Islamic modes of financing. Thus, the PAB has been operating both interest and Islamic 'windows' for deposits. Mastura's study has produced evidence to show that the PAB has been concentrating on murabaha transactions, paying hardly any attention to the mudaraba and musharaka means of financing. The PAB has also been adopting unorthodox approaches in dealing with excess liquidity by making use of interest- bearing treasury bills. Nonetheless, the PAB has also been invoking some Islamic modes in several major investment activities. Mastura has made special references to the qirad principle adopted by the PAB in the Kilu-sang Kabuhayan at Kaunlaran (KKK) movement launched under Marcos and to the ijara financing for the acquisition of farm implements and supplies in the Quedon food production program undertaken by the present regime. So far no reference has been made to Indonesia, the largest Muslim country in the world, with Muslims accounting for 90 per cent of a population of some 165 million. The explanation is that a substantial proportion, especially in Java, are arguably nominal Muslims. Indonesians by and large subscribe to the Pancasila ideology which is essentially secular in character. The present regime seems to associate Islamic banking with Islamic fundamentalism to which the regime is not at all sympathetic. Besides, the intellectual tradition in Indonesia in modern times has not been conducive to the idea of interest-free banking. There were several well respected Indonesian intellectuals including Hatta (the former Vice President) who had argued that riba prohibited in Islam was not the same as interest charged or offered by modern commercial banks, although Islamic jurists in Indonesia hold the opposite view. The Muslim public seems somewhat indifferent to all this. This, however, does not mean that there are no interest-free financial institutions operating in Indonesia. One form of traditional interest-free borrowing is the still widely prevalent form of informal rural credit known as ijon (green) because the loan is secured on the standing crop as described by Partadireja (1974). Another is the arisan system practiced among consumers and small craftsmen and traders. In this system, each member contributes regularly a certain sum and obtains interest-free loans from the pool by drawing lots. The chances of an Islamic bank being established in Indonesia seem at present remote (cf. Rahardjo 1988).

Finally, in the most recent contribution to the growing Islamic banking literature, Nien-haus (l988) concludes that Islamic banking is viable at the microeconomic level but dismisses the proponents' ideological claims for superiority of Islamic banking as 'unfounded'. Nienhaus points out that there are some failure stories. Examples cited include the Kuwait Finance House which had its fingers burned by investing heavily in the Kuwaiti real estate and construction sector in l984, and the Islamic Bank International of Denmark which suffered heavy losses in l985 and l986 to the tune of more than 30 per cent of its paid-up capital. But then, as Nienhaus himself has noted, the quoted troubles of individual banks had specific causes and it would be inappropriate to draw general conclusions from particular cases. Nienhaus notes that the high growth rates of the initial years have been falling off, but he rejects the thesis that the Islamic banks have reached their 'limits of growth' after filling a market gap. The falling growth rates might well be due to the bigger base values, and the growth performance of Islamic banks has been relatively better in most cases than that of conventional banks in recent years.

According to Nienhaus, the market shares of many Islamic banks have increased over time, notwithstanding the deceleration in the growth of deposits. The only exception was the Faisal Islamic Bank of Sudan (FIBS) whose market share had shrunk from l5 per cent in l982 to 7 per cent in l986, but Nien-haus claims that the market shares lost by FIBS were won not by conventional banks but by newer Islamic banks in Sudan. Short-term trade financing has clearly been dominant in most Islamic banks regardless of size. This is contrary to the expectation that the Islamic banks would be active mainly in the field of corporate financing on a participation basis. Nien-haus attributes this not only to insufficient supply by the banks but also to weak demand by entrepreneurs who may prefer fixed interest cost to sharing their profits with the banks.


The preceding discussion makes it clear that Islamic banking is not a negligible or merely temporary phenomenon. Islamic banks are here to stay and there are signs that they will continue to grow and expand. Even if one does not subscribe to the Islamic injunction against the institution of interest, one may find in Islamic banking some innovative ideas which could add more variety to the existing financial network.
One of the main selling points of Islamic banking, at least in theory, is that, unlike conventional banking, it is concerned about the viability of the project and the profitability of the operation but not the size of the collateral. Good projects which might be turned down by conventional banks for lack of collateral would be financed by Islamic banks on a profit-sharing basis. It is especially in this sense that Islamic banks can play a catalytic role in stimulating economic development. In many developing countries, of course, development banks are supposed to perform this function. Islamic banks are expected to be more enterprising than their conventional counterparts. In practice, however, Islamic banks have been concentrating on short-term trade finance which is the least risky.

Part of the explanation is that long-term financing requires expertise which is not always available. Another reason is that there are no back-up institutional structures such as secondary capital markets for Islamic financial instruments. It is possible also that the tendency to concentrate on short-term financing reflects the early years of operation: it is easier to administer, less risky, and the returns are quicker. The banks may learn to pay more attention to equity financing as they grow older.

It is sometimes suggested that Islamic banks are rather complacent. They tend to behave as though they had a captive market in the Muslim masses who will come to them on religious grounds. This complacency seems more pronounced in countries with only one Islamic bank. Many Muslims find it more convenient to deal with conventional banks and have no qualms about shifting their deposits between Islamic banks and conventional ones depending on which bank offers a better return. This might suggest a case for more Islamic banks in those countries as it would force the banks to be more innovative and competitive. Another solution would be to allow the conventional banks to undertake equity financing and/or to operate Islamic 'counters' or 'windows', subject to strict compliance with the Shariah rules. It is perhaps not too wild a proposition to suggest that there is a need for specialized Islamic financial institutions such as mudaraba banks, murabaha banks and musharaka banks which would compete with one another to provide the best possible services.


al-wadiah = safe keeping
bai'muajjal = deferred-payment sale
bai'salam = pre-paid purchase
baitul mal = treasury
fiqh = jurisprudence
Hadith = Prophet's commentary on Qur'an
hajj = pilgrimage
halal = lawful
haram = unlawful
ijara = leasing
iman = faith
mithl = like
mudaraba = profit-sharing
mudarib = entrepreneur-borrower
muqarada = mudaraba
murabaha = cost-plus or mark-up
musharaka = equity participation
qard hasan = benevolent loan (interest free)
qirad = mudaraba
rabbul-mal = owner of capital
riba = interest
Shariah = Islamic law
shirka = musharaka


Islamic Financial Institutions (outside Pakistan and Iran)
Australia Islamic Investment Company, Melbourne.
Bahamas Dar al Mal al Islami, Nassau Islamic Investment Company Ltd, Nassau, Masraf Faisal Islamic Bank & Trust, Bahamas Ltd.
Bahrain Albaraka Islamic Investment Bank, Manama, Bahrain Islamic Bank, Manama, Bahrain Islamic Investment Company, Manama, Islamic Investment Company of the Gulf, Masraf Faisal al Islami, Bahrain.
Bangladesh Islamic Bank of Bangladesh Ltd, Dhaka.
Denmark Islamic Bank International of Denmark, Copenhagen.
Egypt Albaraka Nile Valley Company, Cairo, Arab Investment Bank (Islamic Banking Operations), Cairo., Bank Misr (Islamic Branches), Cairo, Faisal Islamic Bank of Egypt, Cairo, General Investment Company, Cairo, Islamic International Bank for Investment and Development, Cairo, Islamic Investment and Development Company, Cairo, Nasir Social Bank, Cairo.
Guinea Islamic Investment Company of Guinea, Conakry, Masraf Faisal al Islami of Guinea, Conakry.
India Baitun Nasr Urban Cooperative Society, Bombay.
Jordan Islamic Investment House Company Ltd Amman, Jordan Finance House, Amman, Jordan Islamic Bank for Finance and Investment, Amman.
Kibris (Turkish Cyprus) Faisal Islamic Bank of Kibris, Lefkosa.
Kuwait Al Tukhaim International Exchange Company, Safat., Kuwait Finance House, Safat.
Liberia African Arabian Islamic Bank, Monrovia.
Liechtenstein Arinco Arab Investment Company, Vaduz, Islamic Banking System Finance S.A. Vaduz.
Luxembourg Islamic Finance House Universal Holding S.A.
Malaysia Bank Islam Malaysia Berhad, Kuala Lumpur, Pilgrims Management and Fund Board, Kuala Lumpur.
Mauritania Albaraka Islamic Bank, Mauritania.
Niger Faisal Islamic Bank of Niger, Niamy.
Philippines Philippine Amanah Bank, Zamboanga.
Qatar Islamic Exchange and Investment Company, Doha, Qatar Islamic Bank.
Saudi Arabia Albaraka Investment and Development Company, Jeddah, Islamic Development Bank, Jeddah.
Senegal Faisal Islamic Bank of Senegal, Dakar, Islamic Investment Company of Senegal, Dakar.
South Africa JAAME Ltd, Durban.
Sudan Bank al Baraka al Sudani, Khartoum, Faisal Islamic Bank of Sudan, Khartoum, Islamic Bank of Western Sudan, Khartoum, Islamic Cooperative Development Bank, Khartoum, Islamic Investment Company of Sudan, Khartoum, Sudan Islamic Bank, Khartoum, Tadamun Islamic Bank, Khartoum, Jersey The Islamic Investment Company, St Helier, Masraf Faisal al Islami, St Helier.
Switzerland Dar al Mal al Islami, Geneva., Islamic Investment Company Ltd, Geneva, Shariah Investment Services, PIG, Geneva.
Thailand Arabian Thai Investment Company Ltd, Bangkok.
Tunisia Bank al Tamwil al Saudi al Tunisi.
Turkey Albaraka Turkish Finance House, Istanbul, Faisal Finance Institution, Istanbul.
U.A.E. Dubai Islamic Bank, Dubai, Islamic Investment Company Ltd, Sharjah.
U.K. Albaraka International Ltd, London, Albaraka Investment Co. Ltd, London, Al Rajhi Company for Islamic Investment Ltd, London, Islamic Finance House Public Ltd Co., London.

The list includes Islamic banks as well as Islamic investment companies but it does not include Islamic insurance or takaful companies.

Source: Siddiqi (l988)


Abdallah, A., 1987. 'Islamic banking', Journal of Islamic Banking and Finance, January-March, 4(1): 31-56.

Abdeen, A.M. and Shook, D.N., 1984. The Saudi Financial System, J. Wiley and Sons, Chichester.

Abdel-Magib, M.F., 1981. 'Theory of Islamic banks: accounting implications', International Journal of Accounting, Fall: 78-102.

Aftab, M., 1986. 'Pakistan moves to Islamic banking', The Banker, June: 57-60.

Ahmad, Sheikh Mahmud, l952. Economics of Islam, Lahore.

____, n.d. 'Interest and Unemployment', Islamic Studies, Islamabad, VIII (l): 9-46.

Al-Arabi, Mohammad Abdullah, l966. 'Contemporary banking transactions and Islam's views thereon', Islamic Review, London, May l966: l0-l6.

Al-Jarhi, Ma'bid Ali, l983. 'A monetary and financial tructure for an interest- free economy, institutions, mechanism and policy', in Ziauddin, Ahmad et al. (eds.), Money and Banking in Islam, International Centre for Research in Islamic Economics, Jeddah, and Institute of Policy Studies, Islamabad.

Ali, M. (ed.) l982. Islamic Banks and Strategies of Economic Cooperation, New Century Publishers, London.

____ (ed.) 1984. Papers on Islamic Banking, New Century Publishers, London.

Ariff, M. l982. 'Monetary policy in an interest-free Islamic economy - nature and scope' in M. Ariff, (ed.), Monetary and Fiscal Economics of Islam, International Centre for Research in Islamic Economics, Jeddah.

____ 1988. Islamic Banking in South-east Asia, Institute of Southeast Asian Studies, Singapore.

Bruce, N.C., 1986. 'Islamic banking moves east', Euromoney, July: 142-5.

Chapra, M. Umer, l982. 'Money and banking in an Islamic economy' in M Ariff (ed.), above.

____ l985. Toward a Just Monetary System, The Islamic Foundation, Leicester.

Choudhury, Masul Alam, l986. Contributions to Islamic Economic Theory: A Study in Social Economics, St Martin Press, New York.

Council of Islamic Ideology (CII), Pakistan, l983. 'Elimination of interest from the economy', in Ziauddin, Ahmed et al. (eds.).

El-Asker, A.A.F., 1987. The Islamic Business Enterprise, Croom Helm, London.

El-Din, A.K., 1986. 'Ten years of Islamic banking', Journal of Islamic Banking and Finance, July-September, 3(3):49-66.

Halim, Abdul, l986. 'Sources and uses of funds: a study of Bank Islam Malaysia Berhad,' paper presented to the Seminar on Developing a System of Islamic Financial Instruments, organized by the Ministry of Finance Malaysia and the Islamic Development Bank, Kuala Lumpur.

Hjarpe, Jan, l986. 'Mudaraba banking and taka-ful insurance: the question of "Islamic Banks", their significance and possible impact', in Jan Selmer, and Loong Hoe Tan, Economic Relations between Scandinavia and ASEAN: Issues on Trade, Investment, Technology Transfer and Business Culture, University of Stockholm and Institute of South-east Asian Studies, Singapore.

Homoud, S.H., 1985. Islamic Banking, Arabian Information, London. Huq, Azizul, l986. 'Utilization of financial investments: a case study of Bangladesh', paper submitted to the Seminar on Developing a System of Islamic Financial Instruments, organized by the Ministry of Finance Malaysia and the Islamic Development Bank, Kuala Lumpur.

Iqbal, Zubair and Mirakhor, Abbas, l987. Islamic Banking, International Monetary Fund Occasional Paper 49, Washington D.C.

Irshad, S.A., l964. Interest-Free Banking, Orient Press of Pakistan, Karachi.

Kahf, Monzer, l982a. 'Saving and investment functions in a two-sector Islamic economy', in M. Ariff (ed.) , above.

____ l982b. 'Fiscal and monetary policies in an Islamic economy', in M. Ariff (ed.),above.

Karsten, I., 1982. 'Islam and financial intermediation', IMF Staff Papers, March, 29(1):108-42.

Khan, Abdul Jabbar, l986. 'Non-interest banking in Pakistan: a case study', paper presented to the Seminar on Developing a System of Islamic Financial Instruments, organized by the Ministry of Finance Malaysia and the Islamic Development Bank, Kuala Lumpur.

Khan, M. Fahim, l983. 'Islamic banking as practised now in the world' in Ziauddin, Ahmad et al. (eds.).

Khan, M. S.,1986.'Islamic interest-free banking', I M F Staff Papers, March, 33(1):1-27.

____, 1987 'Principles of monetary policy in an Islamic framework', paper presented to the International Institute of Islamic Economics, Islamabad, Pakistan, July.

____, and Mirakhor, A., 1986. 'The frame-work and practice of Islamic banking', Finance and Development, September.

____ and ____, 1987. Theoretical Studies in Islamic Banking and Finance (Book Distribution Centre, Houston.

____ and ____ forth-coming (1988). 'The financial system and monetary policy in an Islamic economy', Journal of Research in Islamic Economics.

Khan, Muhammad Akram, l968. 'Theory of employment in Islam', Islamic Literature, Karachi, XIV (4): 5-l6.

____ n.d. 'International monetary crisis, causes and cure', The Criterion, Karachi, 6 (2): 5-l9.

Khan, W.M., l985. Towards an Interest-Free Islamic Economic System, The Islamic Foundation, Leicester.

Man, Zakariya, l988. 'Islamic banking: the Malaysian experience', in M. Ariff (ed.), above.

Mannan, M.A., l970. Islamic Economics, Lahore.

Mastura, Michael O., l988. 'Islamic banking: the Philippine experience', in M. Ariff (ed.), above.

Mirakhor, Abbas, 1986. 'Some theoretical aspects of an Islamic financial system', paper presented at a Conference on Islamic Banking sponsored by the Central Bank of the Islamic Republic of Iran, Tehran, 11-14 June.

Mohsin, M., l982. 'Profile of riba-free banking', in M. Ariff (ed.), above. Naqvi, S.N.H., l98l. Ethics and Economics: An Islamic Synthesis, The Islamic Foundation, Leicester.

____, l982. 'Interest rate and intertemporal allocative efficiency in an Islamic economy', in M. Ariff (ed.), above.

Naughton, S.A.J. and Tahir, M.A., 1988. 'Islamic banking and financial development', Journal of Islamic Banking and Finance, 5 (2).

Nienhaus, V., l983. 'Profitability of Islamic PLS banks competing with interest banks: problems and prospects', Journal of Research in Islamic Economics, l(l):37-47.

____, l986. 'Islamic economics, finance and banking - theory and practice', Journal of Islamic Banking and Finance, 3(2):36-54.

____, l988. 'The performance of Islamic banks - trends and cases', paper presented to the Conference on Islamic Law and Finance, convened in the University of London, 8 April.

Partadireja, Ace, 1974. 'Rural credit: the Ijon system', Bulletin of Indonesian Economic Studies, 10 (3): 54-71.

Qureshi, Anwar Iqbal, l946. Islam and the Theory of Interest, Lahore.

Rahardjo, Dawam, 1988. 'Islamic banking in Indonesia?' in M. Ariff (ed.), above.

Rahman, Fazalur, n.d. 'Riba and interest', Islamic Studies, Karachi, 3(l):l-43.

Ready, R.K., l98l. 'The march toward self-determination', paper presented at the First Advanced Course on Islamic Banks, International Institute of Islamic Banking and Economics, Cairo, 28 August - l7 September.

Rosa, D.A., 1986. 'Islamic financial policies and domestic resource mobilisation', Savings and Development, 2:143-53.

Salama, Abidin Ahmad, l986. 'Utilisation of financial instruments: a case study of Faisal Islamic Bank (Sudan)', paper submitted to the Seminar on Developing a System of Islamic Financial Instruments, organized by the Ministry of Finance Malaysia and the Islamic Development Bank, Kuala Lumpur.

Scharf, T.W., 1983. Arab and Islamic Banks, OECD, Paris.

Siddiqi, M.N., l982. 'Islamic Approaches to Money, Banking and Monetary Policy: A Review', in M. Ariff (ed.), above.

____, l983a. Banking Without Interest, The Islamic Foundation, Leicester.

____, 1983b. Issues in Islamic Banking, Islamic Foundation, Leicester.

____, 1985. Partnership and Profit-Sharing in Islamic Law, Islamic Foundation, Leicester.

____, l988. 'Islamic banking: theory and practice', in M. Ariff (ed.), above.

Su'ud, M. Abu, n.d. 'The economic order within the general conception of the Islamic way of life', Islamic Review, London, 55 (2): 24-26 and (3): ll-l4. Udovitch, Abraham L., l970. Partnership and Profit in Medieval Islam, Princeton University Press, Princeton, N.J.

Uzair, Mohammad, l955. An Outline of `Interestless Banking', Raihan Publications, Karachi.

____, l982. 'Central banking operations in an interest-free banking system', in M. Ariff (ed.), above.

Zaidi, N.A., l987. 'Profit rates policy for PLS depositors', Journal of Islamic Banking and Finance, 4 (4): 35-46.

1 Surah al-Rum (Chapter 30), verse 39; Surah al-Nisa (Chapter 39), verse l6l; Surah al-Imran (Chapter 3), verses l30-2; Surah al-Baqarah (Chapter 2), verses 275-8l. See Yusuf Ali's Translation of the Qur'an.

2 Hadith compiled by Muslims (Kitab al-Musaqat).

3 This refers to a Hadith compiled by Muslims (Kitab al-Musaqat).

4 Bank Islam Malaysia Berhad has been offering a 70:30 profit-sharing ratio in favour of depositors (Man l988).

5 In l984 the Islamic Bank of Bangladesh offered rates of return ranging from 4.95 per cent to l4.l3 per cent. The Faisal Islamic Bank of Egypt, Cairo, gave a 9 per cent rate of return on deposits in the same year (Afkar Inquiry, December l985).

6 According to Sharia, profits arising from a mudaraba arrangement can be divided in any proportion between the two contracting parties as agreed upon
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PostPosted: Mon Mar 03, 2008 2:22 am    Post subject: CHINA Reply with quote

A good article from The Globalist Dot Com where I'm one of the subscriber.


Acknowledging China By Jianxiong Zhang | Thursday, February 28, 2008

China's economic boom of the last three decades has raised concerns about resource scarcity, pollution and trade. While China's development has made it one of the world's largest economies, hundreds of millions still live in poverty. Jianxiong Zhang argues that the United States and the European Union must acknowledge China's efforts to address climate change and trade disputes.

In the context of globalization, the economy increasingly influences international relations. This is because strengthening interdependence and intensifying frictions between economies tend to go hand-in-hand. As a result, it is no wonder China is worried about the impacts on its relations with the United States and the European Union.

The scale of China's growth

It is well-known that China's economy has been growing at an average rate over 9% for 27 years now. And, in the past five years, its annual growth rate exceeded 10%.

In 2006, China�s GDP reached $2.6 trillion (in purchasing power terms), or 5% of the world total � ranking fourth in the world.

Growth and poverty

China�s development is as an evolutionary stage, rather than an obstacle to its relations with the United States and European Union.

China has reached the top ranks of economies in the world by GDP � but it still lags behind 109 other countries in terms of per capita income.

China needs to further develop, so as to improve the living standards of its citizens, allowing them to enjoy a life comparable to that in medium-developed countries.

This is their right � and indeed one of their fundamental human rights.

Supporting the world economy

The continual growth in China makes significant contributions to the world economy. Firstly, China�s economy contributed 13.8% of the global GDP growth during the 2003-2005 period.

The rate is second only to that of the United States. That is to say, with China�s continued growth, the world economy will not substantially slide down even if the U.S. economy falls into recession.

Benefits from China

China needs to further develop, so as to improve the living standards of its citizens. This is their right � and indeed one of their fundamental human rights.

Second, cheap goods exported from China are helpful to prevent inflation in its trading partners. Third, the fruits of economic growth in China are shared by industrialized countries in general � and in the United States and the European Union in particular.

They receive a great deal of profits from their place in the international division of labor, and gain significant returns from their financial services, foreign direct investment and patent income from China.

For example, about 20% of revenues from each mobile phone, 30% from each computer and 30-40% from numerically controlled machine tools made in China go to investors or patent owners in the United States, the European Union or other countries.

Concerns from abroad

Kind-hearted people in the rest of the world are happy to see and hail the economic progress in China, for it helps millions of people there escape from poverty. Thus, it brings new impetus to economic growth globally.

However, the United States and Europe are very concerned about the consequences of China�s development. Apart from positive expectations, they wonder what negative impacts China�s development will have on them.

Managing growth

Kind-hearted people in the rest of the world hail the economic progress in China, for it helps millions of people there escape from poverty.

For instance, they wonder whether China will compete for natural resources, energy and markets with them

� and to what extent China�s development will lead to pollution and climate change. A more extreme observation even views China�s development as a �threat.�

As regards climate change, it should be noted that Beijing has already set about tackling the problem.

The Chinese government pursues a policy of �scientific development� and carries out programs to build China into a resource-conserving society, which contain a series of measures to save resources and energy.

Resources in historical perspective

From 1990 to 2005, the energy consumption per thousand dollars of GDP was cut from 2.19 to 1.17 tons of coal equivalent, with an annual reduction rate of 4.1%. This figure, however, as well as greenhouse gases emissions per unit of GDP in China, is still higher than those in the United States and the European Union.

This is largely because the United States and the European Union have been in the post-industrialized stage (where more than 70% of GDP is contributed by service sectors), while China is still in the industrializing stage (where almost half of GDP comes from the industrial sector). This can be changed only by further development � and the change is under way at an accelerating pace.

Tackling climate change

Between close trading partners, disputes are a normal phenomenon. This should not be a factor to undermine relations between them.

The Chinese government set the targets of bringing down energy consumption per unit of GDP by 20%, cutting the total discharge of major pollutants by 10% and increasing forest cover from 18.2% to 20% between the end of 2005 and 2010.

The National Program on Tackling Climate Change released in May 2007 formulates that, by 2010, China will cut CO2 emissions by one billion tons through improving technologies and replacing fossil fuels with renewable energies.

If international cooperation in developing greenhouse gas zero-discharge technologies can be accelerated, the impacts of China�s development on climate change will be further minimized.

The rights of the poor

As for the equitable distribution of energy, as well as natural resources and markets, this matter requires bilateral or multilateral consultations. Such consultations must be carried out on an equal basis.

In this process, two issues should be considered. One is the development right of poor countries. There are quite a few countries in the world where people live a life far below the living standards of industrialized countries.

A sense of equity

If international cooperation in developing greenhouse gas zero-discharge technologies can be accelerated, the impacts of China�s development on climate change will be further minimized.

When distributing the world's resources, rich countries should give more considerations to the interests and rights of poor countries. Up to now, the per capita income in China is just equal to 4.5% of that in the United States, 5% of that Japan, 5.8% of that in the eurozone and 10% of that in South Korea.

There are still 135 million people in China who live on less than $1 per day. There are 750 million such people in the world, of which China accounts for 18%.

The other issue is the principle of equality. According to the World Bank, the 2000 per capita consumption of energy was 3.8 tons of oil in the euro zone, 8.2 tons in the United States � while just 0.9 ton in China. The per capita consumption of energy in the United States is nine times that in China.

Measuring China's growth

At the same time, the per capita rate of CO2 emissions in China was two tons, compared with eight tons in the eurozone and 21 tons in the United States. In 2004, the per capita CO2 emissions in China increased to four tons.

This figure, however, was only 87% of the world average � and 33% of the OECD average.

Accepting disputes, improving relations

Along with China�s development, the trade disputes between it and the United States as well as the European Union are on the rise. Between close trading partners, disputes are a normal phenomenon. This should not undermine relations between them.

The economic structure of China can be changed only by further development � this is happening at an accelerating pace.

Trade disputes occur between the United States and the European Union, the United States and Japan, as well as the European Union and Japan. Since its inception, the WTO dispute settlement mechanism has been mostly used to deal with disputes between the United States and the European Union. The disputes, however, have never undermined the bilateral relationship.

In short, the contributions of China�s development are a net plus � even in light of its negative influences on the rest of the world. The negative effects brought about by development are controllable.

China�s development should be taken as an evolutionary process, rather than an obstacle to its relations with the United States and European Union.
Here's something better from China Daily

China is not decoupling from US Economy
Updated: 2008-01-21 10:14

BEIJING - China's central bank on Sunday poured cold water on the idea that the country's economy can decouple from the United States.

China's exports will be badly hit if US consumption weakens, Zhang Tao, deputy head of the international department of the People's Bank of China, told a financial forum.

Figures due this week are expected to show that China's gross domestic product grew more than 11 percent in the fourth quarter of 2007 from a year earlier, despite a deepening US credit crunch.

But Zhang said he saw mounting risks to US consumer demand. He noted that retail sales unexpectedly fell 0.4 percent in December, while property prices were falling and rising petrol prices were crimping disposable incomes.

"If US consumption really comes down, that's bad news for us," Zhang said. "That will have a pretty severe impact on our exports."

Wang Jian, head of the China Society of Macroeconomics, agreed that China's growing trade with Europe was unlikely to insulate it from a drop in exports to the United States.

If US demand weakened, Europe would export less to America and, in turn, would buy less from China, Wang said.

"Global demand is ultimately driven by the United States," he said.

More US interest rate cuts or a further fall in the dollar in response to a weakening economy would have an impact on Chinese monetary policy, Zhang said without elaborating.

He said the subprime crisis would not divert China from the path of financial innovation.

"It will not change our general direction. However, it serves as a warning that we need to pay attention to risk controls and launch new businesses in a steady, orderly way," he said.

Dai Genyou, director of the central bank's credit bureau department, said higher Chinese interest rates would have little impact on the ability of companies to service their debts. Nor would they derail corporate investment plans, Dai said.
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PostPosted: Sat Apr 12, 2008 5:30 pm    Post subject: Reply with quote

Posted: 13 April 2008 at 1:20am on Global Malaysians Forum

This I must say a very fair article - Thumbs up Mike!

Brigitte; if it's not too much to ask; can you get this guy's e-mail address - if you can do that, ask him if he's ok with myself sending a complimentary e-mail? If he's ok, you can PM me. Thanks


The Star Business - Tuesday April 10, 2008

Finding market bottom tricky- By MICHAEL AUYEUNG
THE comparison of catching falling knives to forecasting market bottoms needs to be updated. Calling for market bottoms is more like catching a bullet with your teeth, only it is not a single bullet but a blast of lead pellets from a shotgun. Predicting an economic bottom is probably just slightly less painful and maybe a tad more precise.

While the above analogies are of limited use, getting the calls right for market and economic floors, and understanding the relationship between the two, is perhaps the most rewarding call in all of fund management.

There is a camp in the fund management industry that decries market timing as foolish and not a very successful approach. There is another camp that believes that asset allocation (tactical and strategic) is responsible for the bulk of the returns from a portfolio.

For the latter group, seeking bottoms is critical because the move off bottoms tends to be the most violent and generates a very rewarding modest risk-high return trade-off over a very short period of time.

In the context of global or regional funds, in which investors tend to stay invested for many years if not decades (like Warren Buffet�s devotees), staying invested in stocks through thick or thin makes good sense. Over the long term, investments in sound companies will generate solid returns due to quality management and strong business models which are given time to bear fruit.

Since investors have similarly long mandates, such strategies will not be affected by flows into or out of the funds during market peaks and troughs. In addition, these multi-market funds always have an option to move parts of their portfolio to different markets when fundamentals in certain markets deteriorate.

In the context of Malaysia-centric or other single market funds where the investments are restricted to just one stock exchange, the �buy and hold forever� approach is far harder to justify, especially when investors redeem in a matter of months. Most local investors will have gone through cycles where hard fought gains over many years have evaporated in a number of months, hence adding to the short redemption approach.

Even for the clever fund manager who adjusts his portfolio to low beta and reduces his stock exposure, the outcome can still be painful. Just look at what has happened to Malaysian funds in the first quarter of 2008. For active tactical managers, market bottoms take on greater importance (as is the parallel of market tops).

Picking market bottoms is really as much an instinctive as it is a fundamental call, and getting the general vicinity right should be deemed a success. There is no one clear signal that says, say, this is the absolute bottom. In fact, bottoms are typically confirmed only many months after they have been formed, but that is of no use for funds seeking out-performance.

There is much anecdotal evidence used either to support or contradict that stock markets are in the bottoming process:

�Relative valuations to other asset classes and to historic levels (bonds and commodities overpriced vs stocks);

�Build-up of liquidity on the sidelines (currently US$3.5tril in money market funds vs normal levels of around US$1.5tril);

�Sentiment gauges showing investors in a panic mode tend to mark bottoms;

�Markets moving up against the flow of bad news;

�Significant companies collapsing - Northern Rock, Bears Sterns;

�Massive volatility � record point swings in markets;

�Brokers rushing to downgrade stocks and index targets after long price retreats locally and globally;

�Prior market bottoms in terms of timing and patterns � current correction on the Dow and the emerging Asian markets are around average reversal durations;

�Signals from other instruments such as the US dollar, commodity prices, and bond yields reversing trends.

Currently, many indicators suggest stock markets may have in fact formed or are forming bottoms globally. However, looking at the underlying conditions, this would be confounding because we have yet to reach the bottom of the economic cycle and risks abound.

Business and consumer outlooks are negative if not dire, and earnings reports from listed companies are sure to get worse before they get better. The whole mess of the mortgage and credit crisis will absolutely see more write-downs and casualties, and the developed economies� property sectors will not be rebounding significantly anytime soon as more negatives reports are a certainty.

Employment numbers have been deteriorating in the US and indications are that more jobs will be lost and the unemployment rate may rise towards 6%.

Against this backdrop, betting that stocks will rise rather than fall seems foolhardy. It is here that the concept of decoupling really kicks in.

Much has been written recently on Asian markets and economies decoupling from those of the EU and US. The extent of this decoupling will be very limited as capital, businesses, and economies globally are more intertwined than ever.

The concept is more of a reality when applied to stock markets diverging from the underlying economic conditions. Understanding this decoupling relationship is extremely critical and rewarding from a tactical asset allocation perspective.

Historically, the relationship between stock markets and economies is a valid one that, although imprecise, is significant and predictive. This divergence of markets and economic data is repeated time and again at inflection points.

Even in the most recent downturn in the US markets, the stock market pulled back well before the wholesale deterioration of economic data.

Today markets are rebounding without any data that would suggest any economic healing has started. (For this reason, stock market indices are contained in the basket of leading economic indicators for most countries.)

The added dimension of this relationship that makes it so critical is the containment of downside risk on entering stock markets at perceived bottoms. If one can discern the economic trends and conclude a reasonable outlook to the future of the economy, then if all else fails, at least economic fundamentals will limit any subsequent fall in stock prices. The eventuality of an economic recovery means that stock prices will move up ahead of better economic data.

Economic data is mostly historic. The stock market is forward looking. Making investment decisions on current data will allow you to pick market bottoms six months after they have occurred and the bulk of price gains have taken place.

The massive policy measures undertaken by the authorities in the US, supported by a few other central banks, suggest better times to come later this year for the US economy. Stock markets seem to concur.

It is near impossible to pick the absolute bottom for a market, but insightful economic analysis, sprinkled with supportive anecdotal evidence should give one confidence to invest when real values emerge. Just make sure you give a reasonable timeframe for the economy to catch up and that there are no shotguns anywhere nearby.

The writer is chief executive officer/chief investment officer of Pacific Mutual Fund Bhd.
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PostPosted: Fri May 09, 2008 3:56 am    Post subject: Reply with quote

You see how tough a deal can be...


Microsoft and Yahoo! No deal
May 8th 2008 | SAN FRANCISCO
From The Economist print edition

Microsoft walks away from Yahoo!, and both companies lose

RATHER as John McCain cannot be displeased to have seen Hillary Clinton and Barack Obama fighting it out, Google has for the past three months enjoyed watching its only two serious rivals, Yahoo! and Microsoft, tear each other to pieces. Yahoo!, once an internet pioneer, has fallen far behind Google in web search and related advertising. Microsoft still dominates desktop computing but lags behind Google as software moves online. So Steve Ballmer, Microsoft's boss, dared ask Yahoo!: what would be wrong with making, if not exactly a dream team, at least a joint effort out of it?

But on May 3rd, after a frustrating marathon of meetings, Mr Ballmer walked away. He had raised his offer for Yahoo! from an initial $44.6 billion on January 31st to about $47.5 billion, some 70% more than Yahoo!'s value at the time of the opening bid. Jerry Yang, Yahoo!'s co-founder and boss, wanted at least $5 billion more. Mr Ballmer wrote him a bitter letter saying that �you and your stockholders have left significant value on the table.� Wall Street's verdict, on May 5th, was to cut Yahoo!'s value to $34 billion.

That the sell-off was not even worse primarily reflects the possibility that a deal may yet happen. Another software company, Oracle, recently dropped a bid for a smaller rival, BEA Systems, after its board rejected the offer, but eventually had its way after BEA's angry shareholders forced their board back into negotiations and a sale. Mr Ballmer's farewell letter to Yahoo!, by recapitulating the negotiations in all their embarrassing detail, provides just the sort of fodder for Yahoo!'s investors to order Mr Yang to resume talks.

Mr Ballmer took particular pains to criticise Yahoo!'s readiness to �make Yahoo! undesirable as an acquisition for Microsoft.� By this he means Mr Yang's apparent plan to outsource Yahoo!'s search-advertising technology to, of all people, Google. In a purely mathematical sense, this could indeed make Yahoo! somewhat more valuable. Google is better than Yahoo! or Microsoft at placing relevant ads next to search results and collects more in revenue for each resulting mouse click.

Yet it is a bizarre tactic. The history of Yahoo! during this decade is of trying, failing, and trying again to catch up with Google in search advertising. Its first big failure was not to bid high enough to buy Google outright. Its next attempt, in 2003, was to buy Overture, the company that pioneered search advertising, but by then Google was pulling ahead. An outsourcing deal with Google was considered and rejected. For the past two years Yahoo! has invested oodles in a project called Panama that was meant, again, to catch Google.

Presumably Yahoo! has been exerting itself so because it believes that the advertising technology is, along with search, the source of competitive advantage in the internet era. That is certainly what Microsoft believes, which is why it bought aQuantive, an online-advertising specialist, and built its own search-ads platform, called adCenter. What Yahoo! and Microsoft lack is volume�in the number of both searches and advertisers bidding to place ads. Teaming up would help to address that problem; but a capitulation by Yahoo! to Google would merely invite antitrust regulators to look at Google's dominance.

Mr Yang could merge Yahoo! with AOL, the web portal of Time Warner, but AOL already outsources its search ads to Google and would be no help at all in catching the leader. Asserting, as Mr Yang does, that Yahoo! all by itself could become �the starting point� on the internet, and its advertising powerhouse, rings hollow.

Things look just as bleak for Mr Ballmer. He has invested billions trying to make Microsoft an internet and advertising superpower. But it seems not to matter. According to Danny Sullivan, a web-search analyst, Microsoft �literally has no brand� when it comes to its online services�nobody has ever been advised �to Live� or �to MSN� a recipe or a cute classmate. The only one having any fun continues to be Google.
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PostPosted: Mon May 12, 2008 12:31 pm    Post subject: Reply with quote

This is one of the 'wake-up' call article.

The Sun

Makin Sens Section - by Tan Siok Choo

East Asia - no longer a follower?

THAT the US appears to be sliding into a recession cannot be denied. What is uncertain is whether East Asia in general, and Malaysia in particular, can avoid following in its wake. While it may be premature to offer a definitive answer to this question, three separate indicators underscore export-dependent East Asia�s growing resilience.

First, a recent article by Bloomberg suggests Japan may escape the recession that appears to be engulfing the US. As one of the world�s largest financial news and data provider notes, since 1970, Japan has followed the US into all five recessions. In 1970, the US accounted for 30% of Japan�s exports. Today, that figure has fallen to only 20%.

Japan�s reduced economic dependence on the US is largely due to the success of manufacturing companies like Toyota in capitalising on buoyant markets, particularly in China and other countries. In the past two years, Japan�s exports to China jumped by 45% while those to Russia doubled.

Additionally, a 5.6% drop in US vehicle sales didn�t stop Toyota�s total unit sales from rising in the first quarter. Furthermore, Toyota is poised to overtake the US-based General Motors as the world�s largest auto company in terms of sales.

Last month, two usually bearish brokers on Japan � Goldman Sachs and Morgan Stanley � backed off from predictions that the world�s second largest economy will go into a recession this year. The catalyst for both brokers� changed view was because revised industrial production figures for February showed output rose to a record rather than fell, the Bloomberg article says.

Even though exports could slow down, corporate Japan is now financially stronger than when its stock and property bubble burst in the late 1980s. The average ratio of corporate liabilities to assets has dropped to about 65%, the lowest level since 1955 from about 80% in the mid-1990s, the Merrill Lynch report says.

Moreover, Japanese companies have soaked up excess production capacity. Reduced debt and streamlined production will enhance corporate Japan�s capability to withstand a slump in the US, Bloomberg notes.

Second, the price of oil has continued its inexorable climb to a record high, even though its biggest market appears to be softening. Last in electronic trading last Friday, US crude futures for June delivery hit an intra-day record of US$126.20 (RM403.84) a barrel.

Admittedly, the escalating price of oil this year may be prompted by concern about possible disruptions in continued supply in countries like Nigeria and Venezuela. That prices continue to skyrocket despite sharply declining demand from the US, the world�s largest consumer of oil, is unusual. In February this year, US demand for oil fell to 19.7 million barrels of oil a day, down by one million barrels from last year�s average.

The International Energy Agency (IEA) says oil use worldwide will increase 2% this year because of growing demand in emerging markets. For the first time this year, emerging markets will consume more crude oil than the US, the IEA notes. Emerging markets will consume 20.67 million barrels of oil a day, an increase of 4.4%. In contrast, demand in the US will contract by 2% to 20.38 million barrels daily.

"The US recession will be a footnote as far as the oil market is concerned. Supply isn�t growing and demand is growing robustly in the developing world," says Jeffrey Rubin, chief economist at CIBC World Markets in Toronto who has correctly forecast higher oil prices since 2000.

Third, shipments of personal computers (PC) grew at a double-digit pace worldwide in the first quarter despite anaemic growth in the US, technology research firm, IDC says. Indeed, global figures for the first quarter exceeded its forecast.

Although growth in US sales slowed to around 3%, overseas gains boosted global first quarter PC shipments 14.6%, IDC notes. That�s because the US accounted for 23% of global shipments in the first quarter compared with 25% a year ago.

"Even if there is a particularly bad US market, it is becoming a smaller piece of the global puzzle," IDC vice-president Bob O�Donnell points out.

Despite these positive indicators, East Asia�s growing resilience cannot be equated with total independence from the US economy.

For a start, if the US economy is in recession, it may take months before the impact is transmitted to East Asia. Additionally, in an increasingly interlinked global economy � particularly in financial markets � it is inconceivable that what happens in the US can be ring-fenced from other emerging economies.

But if the inconceivable does happen � if the US sinks into recession and if East Asia succeeds in decoupling from the world�s largest economy � then a new era in global economic history may have begun.
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PostPosted: Fri Jun 27, 2008 10:00 am    Post subject: global economic prospects-2008-9-nikzafri Reply with quote

Hi everyone!!

It's been a while...dropping by to share a very good article which has caused me some delay in submitting a very important document to the client.

Luckily my client called me up to remind me...

Speeches, Testimony, Papers
Global Economic Prospects 2008/2009: Hoping for a Global Slowdown and a US Recession
by Michael Mussa, Peterson Institute

Paper presented at the thirteenth semiannual meeting on Global Economic Prospects
April 3, 2008

� Peterson institute for International Economics. All rights reserved.


After four years of average annual global real GDP growth of better than 4 1/2 percent, recent data indicate that the pace of advance is slowing in the major industrial countries, with the US economy on the verge of, and perhaps already in, outright recession. So far, the evidence points to less of a slowdown in other industrial countries, while most emerging-market economies appear likely to maintain quite strong, albeit somewhat slower, growth.

Meanwhile, world consumer price inflation (on a 12-month basis) is up from barely 2 percent seven years ago to nearly 5 percent as of February 2008. Among both industrial (except for Japan) and major emerging-market countries, inflation is now running at, or in most cases somewhat above, rates consistent with policy objectives. Driven by persistently rising global demand, commodity prices continue to surge upward across the board, especially measured in US dollars but also in terms of the rapidly appreciating euro.

In this situation, the world economy really needs what is now forecast for 2008/2009: a significant slowing of economic growth, down to 3.8 percent (year over year) in 2008 from 4.7 percent in 2007.1 This slowdown will be led by a decline of demand growth in the US economy, which is both pronounced and extends over a considerable period. Indeed, in view of the exceptionally aggressive easing of macroeconomic policies already in place in the United States and the likelihood of monetary policy remaining highly accommodative so long as US financial markets remain under stress, it is now desirable that real GDP growth for 2008 fall to a forecasted rate of barely more than 1 percent (year over year)�an outcome consistent with a very mild and brief recession. Reflecting some risk of a somewhat deeper and more prolonged recession in the United States, the growth forecast for 2009 (year over year) is set at 2 percent.

For the rest of the world, a mild US recession in 2008 will have a modest negative effect on real GDP growth, with more significant impacts in Mexico and Canada. In countries where the slowdown threatens to become excessive and inflation is under control, some easing of monetary and perhaps fiscal policy is both likely and appropriate. More generally, however, it is too soon to call for a general and significant easing of macroeconomic policies. A general slowdown in global economic growth is needed to cool the clearly apparent upsurge in worldwide inflation.

Some countries, including Australia, China, and Sweden, have recently tightened monetary policies in efforts to forestall inflation. Other countries, including Canada and the United Kingdom, have eased monetary policies modestly in response to weakening economic growth. Quite appropriately, however, no country has so far followed the lead of the Federal Reserve in aggressive monetary easing.

As the custodian of the world's second most important currency, the policy of the European Central Bank (ECB) is particularly noteworthy. Inflation in the euro area is running more than a percentage point above the ECB's announced objective. The euro area economy has recently been growing significantly more rapidly than its potential rate of about 1 1/2 percent. The unemployment rate has fallen half a percentage point below the minimum reached in the last expansion. Key monetary aggregates are surging at rates well above their desired target ranges. In this situation, one would normally have expected the ECB to have raised its key policy interest rate a further 100 basis points since last summer.

Instead, with financial turbulence spreading to some extent from the United States to euro area financial markets and institutions, with evidence that euro area economies are beginning to slow, and with a sharp appreciation of the euro against the dollar, which is likely to slow growth and impede inflation, the ECB has wisely held back from further interest rate increases. With the euro area economy now expected to expand by about 1 1/2 percent this year (in line with potential), the timing and direction of future adjustments in ECB interest rates remain�appropriately�dependent upon the evolving balance of risks for inflation and economic growth.

For Japan, the strengthening of the yen against the dollar in recent months and weakening of exports to the United States, together with likely weakness in domestic demand growth, suggest a further write-down in the forecast for real GDP growth for 2008 to 1.2 percent (from 1� percent forecast last October). This reflects the assumption that the surprising upsurge of GDP growth in the final quarter of 2007 will be partly offset in the first half of this year.

For the industrial countries as a group, real GDP growth this year is now forecast to be 1.5 percent, and growth for 2009 is projected to be moderately stronger at about 1.9 percent.

In emerging-market economies, circumstances vary and so do appropriate policies, but the general prospect is for continued quite strong economic growth, despite the slowdown in the industrial countries.

Is this "decoupling?" Not really. Mexico, Caribbean and Central American countries, and Asian economies that are particularly dependent on exports to the United States are already feeling and will continue to feel the effects of the US economic slowdown. More broadly, however, strong growth of domestic demand in many emerging-market economies will sustain reasonably strong GDP growth, and rising demand for raw materials by key emerging-market economies, most importantly China, will help keep commodity prices strong and aid growth in other emerging-market economies.

Overall, I forecast that growth for developing and emerging-market economies as a group this year will be about 6 1/2 percent, down from almost a 7 1/2 percent advance in 2007. For 2009, I now project slightly slower growth. The slowdown will be more severe, however, if growth in the industrial countries, especially the United States, turns out to be meaningfully below the present forecast. Exports from emerging-market countries would then be hit in volume terms, and prices of commodity exports could take a serious tumble. Some developing countries, especially among the primary commodity exporters, could face serious economic challenges and potential crises.

On this occasion, Arvind Subramanian is available to share his expertise on emerging-market economies, particularly in Asia and especially India. Accordingly, I will limit my remarks on these economies to selected observations on some key emerging-market countries. Then, in view of the departure from the Institute of my colleague Martin Baily and the (at least) temporary absence of Douglas Holtz-Eakin, I will turn to discuss growth prospects in the industrial countries, especially the United States. This should provide background for Morris Goldstein's more in-depth observations on the present financial crisis and proposals for reform.

Sustained Growth in Emerging Markets

China's economy continues to surge forward, so much so that the authorities are tightening policies to cool down inflation. Growth will likely slow from 11 1/2 percent last year to about 10 percent this year and next. On the policy front, the key action that should be taken�but that the Chinese authorities have so far refused�is a significant step appreciation of the renminbi against the dollar and in real effective terms, combined with policies to stimulate domestic demand.

In the rest of emerging Asia, growth will likely moderate somewhat in 2008 and 2009 but stay above 6 percent, with India continuing to grow at nearly 8 percent.

In Latin America, Mexico will suffer spillover effects from the slowing US economy, and growth this year is likely to fall to about 2 1/2 percent before recovering modestly in 2009. In contrast, Brazil should be able to sustain growth of nearly 5 percent, despite the strong appreciation of the real against the dollar. Growth in Argentina and Venezuela is expected to slow from the high rates of recent years, bringing down the growth rate for all of Latin America to about 4 1/2 percent this year and slightly less in 2009.

For Central and Eastern Europe, weak growth in Hungary and Turkey hurt regional performance in 2007 and partly offset strong results in Bulgaria, the Czech Republic, Poland, and Slovakia. For 2008 and 2009, regional growth will likely run about 4 percent, reflecting partly the impact of slower growth in Western Europe.

In the Commonwealth of Independent States, the dominant Russian economy should continue to grow at about 7 percent, and growth rates will likely remain somewhat higher (on average) in the smaller economies.

For the Middle East, high oil prices will help keep growth strong in the energy-exporting countries. The larger and more diversified economies of Egypt and Israel should also maintain growth rates in the 5 percent range.

High commodity prices will continue to benefit many African countries, and growth in the region appears likely to continue at least at a 5 percent rate.

Slowing in Other Industrial Countries

Among the industrial countries other than the United States, growth will slow significantly from the 2 3/4 percent advance of 2007 to barely more than 1 1/2 percent this year. However, aside from the United States, I see significant risk of recession this year only in Japan and possibly Italy. The impact of the yen's recent appreciation and weakening of exports to the United States, together with deteriorating sentiment among Japanese businesses and consumers, could push GDP into a couple of quarters of negative growth, even if year-over-year growth remains slightly positive. And the Japanese policy authorities have little room to provide offsetting stimulus.

In Canada, growth this year will likely fall a little below 2 percent, under the impact of slowing US growth and a strong Canadian dollar. However, solid income growth from strong export revenues should keep domestic demand relatively robust, and the Canadian authorities have considerable room to ease policy should that appear needed to forestall very weak growth or recession.

In the United Kingdom, growth this year is also likely to slow to slightly less than 2 percent. But this is not entirely unwelcome in view of the need to curb inflationary pressures, and the Bank of England has plenty of room to ease further should that appear warranted. The Reserve Bank of Australia has continued to tighten in recent months and would surely welcome the forecasted slowing of growth to 3 percent this year.

In the euro area, as previously noted, the projected slowing of growth this year to 1.6 percent from 2.6 percent last year involves nothing more than slowing to the potential growth rate. The slowdown will affect all countries in the area. The Italian economy looks likely to be extremely sluggish and is at some risk of falling into recession. Growth should remain stronger in Germany, sustained by good export performance in the face of weaker consumer demand. France will lag slightly behind Germany, while Spain will slow considerably due to a sharp downturn in home building. The slowdown will probably be reflected in a small uptick in unemployment and will be unpopular with most politicians. However, with inflation running well above the ECB's tolerance rate of 2 percent, the central bank is likely to see the slowing of growth more as a solution than as a problem.

A Mild US Recession

Despite signs of increasing financial strains, the US economy achieved almost 5 percent annualized growth in the third quarter of last year. Economic data that became available through Christmas indicated that the economy was still expanding through November. The data since late December, however, suggest that economic activity has been no better than flat and probably modestly declining since very late last year. The economic data do not indicate an economy that is crashing into steep recession.

The three most recent monthly employment reports have shown small declines in private-sector jobs. Weekly initial unemployment claims have risen from around 300,000 to slightly over 350,000. Residential investment continues to decline. The boom in nonresidential construction appears to have peaked. Data on durable goods orders and shipments suggest weak or even declining business equipment investment. As should be expected in the face of falling home prices and household wealth, sharp increases in energy and food prices, and stagnating employment, real consumer spending has not increased since November�but it has not declined.

Net exports are probably continuing to improve, but this will not be enough to offset weakness in the other components of final demand. Annualized real GDP growth in the first quarter will likely be modestly negative�probably between minus one-half and minus one percent in the first quarter. (And, if there is a modestly positive result, it will probably reflect an upsurge in inventory investment, which is not a positive sign for future growth.)

The second quarter may see moderation in the pace of decline of residential investment, but the other elements of domestic demand are likely to remain weak. Another quarter of modestly negative real GDP growth now seems to be the most likely outcome. Whether this will be enough to persuade the National Bureau of Economic Research (NBER) to proclaim an official recession is not clear, but I would now put the likelihood of such a recession at over 50 percent.

By June, the tax cuts from the recently passed fiscal package will be flowing into consumers pockets, bumping up consumer spending mainly in the third quarter. Some, not unreasonable, forecasts suggest that the stimulus could induce as much as a 5 percent annualized gain of real consumer spending in the third quarter, implying a considerable temporary boost to GDP growth. My view is more restrained, partly because I expect that businesses will absorb some of any surge in consumption spending (particularly for durables) into reductions in inventories.

On the other hand, businesses have kept inventories quite lean for the past three years, and there is no indication of a general inventory overhang (aside from the stockpile of unsold homes, which is not counted in business inventories). Sharp declines of inventory investment into negative territory have been a feature of all ten postwar recessions. It is a positive sign that the magnitude of any inventory correction in the present episode appears likely to be limited.

In sum, the prospect is that with the benefit of the fiscal stimulus, the US economy will bounce back to moderately positive growth this summer. By then the massive contraction of residential investment, which began two years ago, should be complete�with new home building running just below one million units, less than half of its recent peak level. Growth of consumer spending is likely to be weak after the effects of the stimulus are spent, but inventory investment should bounce back, and net exports may be expected to continue to make positive contributions to GDP growth. During the second half of 2008, it is reasonable to expect growth to rebound to 2 to 3 percent.

The suggested pattern of modestly falling GDP in the first half and moderate rebound in the second half implies that real GDP will show a very meager advance of about one-half percent on a fourth-quarter-to-fourth-quarter basis. Year-over-year real GDP growth would be barely more than 1 percent. In comparison, in the 2001 recession�the mildest of the postwar era�fourth-quarter-to-fourth-quarter growth was 0.4 percent and year-over-year growth was 0.8 percent.

The 2001 recession was followed by an initially weak recovery, with real GDP growing at only a 1.7 percent rate during the six quarters after the official end of recession, and with the unemployment rate continuing to rise to a peak of 6.3 percent in May 2003. On this occasion, I expect that the economy will remain quite sluggish through 2009, with growth proceeding at about a 2 percent annual rate. Weak growth of consumer spending in the face of significant losses of household net worth associated with lower real home values will be the key reason for this sluggishness.

Partly offsetting weak consumer spending growth will be continued improvement in US net exports, reflecting both slow import growth and continued rapid export growth. With the usual lag, the substantial depreciation of the dollar over the past year will contribute to the improvement in US net exports in 2009 and beyond.

We see here what I earlier called "reverse coupling." From 1995 through 2004, relatively strong growth of domestic demand in the United States and the effects of a strong dollar (with lags extending this effect) led to persistent deterioration in US real net exports. Thus, the United States was exporting demand to the rest of the world at a time when domestic demand growth in the rest of the world was relatively sluggish.

This process has been operating in reverse since the summer of 2006. Slower domestic demand growth in the United States, combined with stronger demand growth abroad and the effects of a significantly weaker dollar, have begun to significantly improve US real net exports. Thus, during the past year and a half, the rest of the world economy has been helping to pull the US economy along. This process may continue for several years as consumer spending growth in the United States remains restrained by the effects of lower household wealth, making room for expanding the supply of US net exports without contributing to inflationary pressures in the United States. For this process to continue relatively smoothly, however, the rest of the world needs to sustain reasonably robust demand growth and the United States needs to avoid too sharp a decline in domestic demand. The adjustment of the foreign exchange value of the dollar, which is essential for this process, is now largely complete, except for the needed appreciations of some Asian currencies, most notably the Chinese renminbi.

Turmoil in Global Financial Markets

A key feature and source of uncertainty in the present economic situation is the continuing turmoil in financial markets, especially in the United States but with spillovers to Europe and to a limited extent (so far) to Japan and emerging markets. Global equity markets have sold off amidst the turmoil, but markets for credit instruments and financial institutions dealing in such instruments have been most affected.

Three issues concerning this financial-market turmoil deserve special attention:

(1) What has caused this financial turmoil, notwithstanding strenuous efforts by the Federal Reserve and other central banks to contain it?

(2) What risks does it pose to the global economy?

(3) Have the policy responses been adequate and appropriate?

Regarding the causes of the turmoil, it is noteworthy that it has been most severe in US financial markets and institutions. Europe and, to a lesser extent, Canada and Japan have also been affected. In these other countries, a few institutions (such as the mortgage lender Northern Rock in the United Kingdom) have gotten into trouble on their own, related to their domestic activities. But most of the problems faced by non-US institutions have arisen because of their involvement with financial instruments originating in the United States.

In the United States, the initial underlying difficulties arose from subprime mortgages and financial instruments involving such mortgages. However, the crisis is much broader and deeper and has gone on longer than can plausibly be explained by this underlying cause. Across quite a broad spectrum, credit markets have become illiquid and dysfunctional. Interest rate spreads relative to US Treasury obligations have shot up and remained high and volatile even for higher-quality credits. Markets for important classes of bundled instruments have frozen up, and values for some of these instruments�to the extent that they can be determined�have plummeted. All this turmoil, well beyond what can plausibly be explained by developments in the real economy, indicates that financial markets and institutions themselves are mainly responsible for the crisis.

The extent of this crisis in credit markets is even more remarkable in view of the exceedingly aggressive actions taken by the Federal Reserve and the important but less aggressive actions of other leading central banks. Contrary to the nonsense spoken by many financial-market commentators, the Federal Reserve has not been "behind the curve" in its policy response. In fact, the easing of US monetary policy in the present possible recession has far outstripped the pace of easing in past actual recessions. On top of this, the Federal Reserve has recently taken truly extraordinary actions to extend specific liquidity support to a wide range of US financial institutions.

The official explanation for these extraordinary actions is not that they are motivated primarily by the desire to protect financial institutions from losses but rather to head off the risk of major damage to the general economy spreading from difficulties in the financial sector. So far, however, there is little indication that the general economy is suffering much damage from the credit market turmoil�beyond some deepening of the downturn in US residential investment. In particular, the present slowdown in the US economy and around the world is not much more than what we would normally have expected in view of falling home values, higher food and energy prices, and other developments aside from the turmoil in credit markets.

Does this imply that the Federal Reserve, in its efforts to protect the financial sector, has overreacted to the credit market turmoil? Has it eased too aggressively, unduly raising the risk of inflation down the road? Has its rescue of the financial sector by cutting massively the cost of funds and the provision of specific liquidity support generated far too much moral hazard relative to the value of the protective effect of these actions against real hazards faced by the general economy?

At this point, the answers to these questions are not entirely clear, but two conclusions can be reached with high confidence. First, given the massive easing already undertaken by the Federal Reserve and the likelihood of some modest further easing, the US economy now needs to undergo at least a near recession if the Federal Reserve's easing is not to be excessive. Second, if the Federal Reserve's highly aggressive actions have really been warranted to protect the economy from substantial harm, then deep reforms of the financial system, including the Federal Reserve's policies and practices, are clearly needed to reduce the likelihood of such problems in the future. The Federal Reserve cannot pose only as the hero riding to the rescue of the economy and the financial system. Its role as one of the villains whose earlier actions and inactions contributed to the present crisis needs to be fully and carefully assessed.

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