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2007/07/19

FINANCIAL CONTRACTING IN CURRENCY MARKETS:AN ISLAMIC EVALUATION
Mohammed Obaidullah

The paper attempts to undertake an Islamic assessment of financial contracting in the globalcurrency markets. Some basic currency-related contracts in mainstream finance, such as,spot transactions, options, forwards, futures, swaps are examined in the light of Islamicnorms of financial ethics, such as, freedom from riba, gharar, jahl, qimar and maisir.Thestudy also highlights the views of Islamic scholars on various conventional as well as Shariah-based contractual mechanisms. In cases where there is some degree of divergence of views,the study examines the nature and source of disagreement as also the implications andeconomic significance of the arguments. In view of the overwhelming importance ofcurrency risk management in volatile markets, the study undertakes an assessment of thevarious financial contracts as risk management tools.

1. Introduction

Islamisation of currency markets poses a great challenge to Islamic scholars and thinkers even today. Theelimination of riba, gharar,qimarand maisirare among the major goals of the process of Islamisation offinancial markets. While significant success has been achieved in engineering an alternative Islamic model inspecific segments of the financial markets, such as, the banking and the insurance sector, the same has notbeen the case with the currency markets. A majority of Islamic scholars have held a view that only spottransactions in currencies, both domestic and foreign, are permissible. This view, specifically in relation toexchange of foreign currencies, has been labelled as unduly restrictive and somewhat impractical, by policymakers and regulators in most Islamic economies. Further, with divergent views from other Islamic scholars,the issue is perhaps largely unresolved. The outcome has been that the currency markets all over the globehave continued with “unIslamic” transactions with all the undesirable consequences that follow. Ironically,the Islamic world has realized the urgency of implementing the Islamic and ethical alternative after incurringa heavy cost, as some of the fastest growing.

Islamic economies in South East Asia have been engulfed in an unprecedented financial crisis, primarilybecause of riba-based and maisir-driven contracting that were permitted in these markets.

The purpose of this paper is to identify the Islamic system for currency exchange. Since the financial systemessentially implies the system of financial contracting, the paper focuses on the Islamicity of alternativecontractual mechanisms in the currency markets in the light of Islamic norms of ethics, such as, prohibitionof riba, ghararand maisir. The paper seeks to present a comprehensive analysis of various arguments insupport and against the permissibility of some basic contracts involving currencies. Section 2 discussessome basic forms of contracting from the Islamic legal literature that may have relevance for currencymarkets. These are also compared and contrasted with currency-related contracts found in conventionalmarkets, such as, spot contracts, forwards, futures, options, and swaps. Wealso undertake a survey ofpast studies that have examined the Islamicity of these conventional contracts. In section 3 we explicitlydeal with the issue of prohibition of ribafrom a fiqhipoint of view and examine the various contracts fromthe standpoint of riba prohibition. The central theme of section 4 is the issue of ghararand maisir. Weexamine the various forms of contracting in the light of the Islamic requirement to avoid excessive ghararand minimize the possibility of speculative gains or maisir.

In section 5 we examine the issue of risk management in volatile currency markets which is often used as anargument for tolerating speculative abuse of various conventional mechanisms called currency options,futures, forwards and swaps. Wealso highlight some Islamic alternatives for risk management. Section 6attempts to evaluate the contractual mechanisms from another fiqhiperspective, the issue of swapping onedebt for another or bai al kali bi al kali. Section 7 undertakes a holistic view of all the Shariah relatesissues as also their economic significance and provides a summary of major conclusions.

2. Forms of Contracting

The Islamic law of contracts explicitly deals with exchange of currencies. There is a general consensusamong Islamic jurists on the view that currencies of different countries can be exchanged on a spot basis ata rate different from unity. There also seems to be a general agreement among a majority of scholars on theview that currency exchange on a forward basis is not permissible, that is, when the rights and obligationsof both parties relate to a future date. However, there is considerable disagreement among jurists when therights of either one of the parties, which is same as obligation of the counterparty, is deferred to a future date.

Toelaborate, let us consider the example of two individuals A and B who belong to two different countries,India and US respectively. A intends to sell Indian rupees and buy US dollars. The converse is true for B.The rupee-dollar exchange rate agreed upon is 1:20 and the transaction involves buying and selling of $50.The first situation is that A makes a spot payment of Rs1000 to B and accepts payment of $50 from B. Thetransaction is settled on a spot basis from both ends. Such transactions are valid and Islamicallypermissible.There are no two opinions about the same.

It may be noted here that the real life spot markets for currencies often provide for actual delivery within 48hours or two banking business days due to practical reasons (for example, time differences among variousglobal markets). Some authors, such as M.Akram Khan (1988) have argued that the above practice ofallowing a two day lag cannot be accepted in the Islamic framework.1Others consider this position to betoo rigid and find this practice to be Islamically acceptable on the ground that the so-called time laginvolved in the spot transaction is not a time lag between the delivery of one currency compared to thedelivery of the other, but rather is a lag between the deals date and the execution date. Further, even if thereis a time lag, the same does not affect the price or the exchange rate between the two currencies involved.

The second possibility is that the transaction is partly settled from one end only. For example, A makes apayment of Rs1000 now to B in lieu of a promise by B to pay $50 to him after six months. Alternatively, Aaccepts $50 now from B and promises to pay Rs1000 to him after six months. There are diametricallyopposite views on the permissibility of such contracts. The Fiqh Academies3across the globe have beendeliberating on the permissibility of such contracts. Among the scholars who argue in favor of permissibilityof such contracts, the views of Justice Muhammed Taqi Usmani have received wide attention. On the otherhand, scholars, such as, Dr M Nejatullah Siddiqui have sought to justify the more commonly held view thatonly spot settlement is permissible in case of currency exchange on the ground that if settlement from oneend is allowed to be deferred to a future date, this would become a source of earning riba. Such contractsare however, not very common in the conventional financial markets.

The third scenario is that settlement of the transaction from both ends is deferred to a future date, say aftersix months from now. This implies that both A and B would make and accept payment of Rs1000 or $50,as the case may be, after six months. Such contracts are known as currency forwards and futures inmainstream finance. The predominant view is that the such contracts are not Islamically permissible. TheIslamic Fiqh Academy, Jeddah in its seventh session clearly ruled out the permissibility of such contracts.4According to Justice Taqi Usmani, “it is a well recognized principle of the Shariahthat sale and purchasecannot be effected for a future date.

Therefore, all forward and future transactions are invalid in Shariah. Secondly, because in most of the futurestransactions, delivery of the commodities or their possession is not intended. In most cases, the transactionsend up with the settlement of difference of prices only, which is not allowed in the Shariah. As futures are notpermissible, no rights and obligations can emanate from therefrom. (Further), futures are totally impermissibleregardless of their subject matter. Similarly, it makes no difference whether these contracts are entered into forthe purpose of speculation or for the purpose of hedging.”5 Other contemporary scholars, such as, SubhiMahmassani (1983), M Akram Khan (1988), M Fahim Khan (1995) and Kamali (1996) have alsoexamined the Islamicity of forwards and futures and have found these contracts to be forbidden, the notableexception being Kamali (1996). As Mahmassani notes, “contracts concerning future things (al ashya almustaqbalah) are basically invalid, for such things are non-existent at the time of contract- except for the factthat the majority of the jurists have exceptionally permitted certain contracts such as salam(forward sale) andistisna(contract of manufacture).”6M Akram Khan prefers to make a clear distinction between forwardsand futures as the latter have a “strong element of speculation”. While condemning the latter, Khan observesthat the former are not legally enforceable. The two parties may “agree” or “promise” to transact an exchangebusiness at a future date and that such an agreement is “morally” enforceable.7Mohammed Fahim Khan findscurrency forwards and futures to be totally forbidden and prefers to examine only the case of commodity-relatedcontracts for possible modification and making them acceptable in the Islamic framework. As he states, “thepresent concept and practice of foreign currency futures involves interest as well as violates the Islamicprinciple of delivery with respect to exchange of currencies ..hand to hand.”8Kamali however does not findanything objectionable about futures in general, “futures trading falls under the basic principle of permissibility(ibahah).”9However, even Kamali’s affirmative opinion pertains to futures in general without specifying theunderlying asset. Kamali also explicitly recognizes the need to view currency related contracts differently fromother commodities. While asserting that possession (qabd) is not an essential requirement of sale andtherefore futures may not be deemed prohibited on this ground, he also states that “only in case of sale ofcurrency for currency (sarf) is qabdelevated to a prerequisite of a valid contract.”

Yet another form of contracting which has been described as an Islamic swap11may be as follows. Amakes a payment of Rs1000 to and receives US$50 from B today at the given rate 1:20. Both A and B useand invest the money so received at their own risk. At the end of a stipulated time period, say six months,the transaction is reversed. A repays US$50 to and receives Rs1000 from B. This form of contracting canalso be viewed as an exchange of or swapping of interest-free loans between A and B. This is in contrastto conventional swaps which are generally interest-based and involve swapping of principal (oftennotional) and interest payments. Conventional swaps clearly have no place in the Islamic system.12Asdiscussed and demonstrated later in section 5, Islamic swaps may help both A and B in various ways, suchas, enabling them to manage their currency risk. There are again divergent views on the permissibility ofsuch contracting.

The other common form of currency-related contracting in mainstream finance relates to purchase and saleof currency options. Scholars who consider that currency exchange must be settled on a spot basis rule outthe possibility of any option for either or both parties. The currency option if considered as a promise, is notbinding as the two parties cannot agree in advance to the rate to be applied for currency exchange in futureaccording to the traditional Islamic law.13 Justice Taqi Usmani rules out the acceptability of conventionaloptions which are promises traded as independent contracts for a fee. As he asserts, “such a promise initself is permissible and is normally binding on the promisor. However, this promise cannot be a subjectmatter of sale or purchase. Therefore, the promisor cannot charge the promisee a fee for making such apromise...it makes no difference if the subject matter of the option sale is a commodity, gold, silver or acurrency..the contract is invalid ab-initio.”14 The Islamic Fiqh Academy has also resolved that all forms ofconventional options traded as independent contracts in themselves are not permissible.15These viewshowever, do not rule out the possibility of a sale contract with a stipulated option for either party or both inthe al khiyar al shart (option as condition) framework of the Islamic law of contracting. Whether thepossibility also exists with respect to currency exchange deserves further investigation.

3. The Issue of Riba Prohibition

The need to eliminate ribain all forms of exchange contracts is of utmost importance. This is emphasized by theQuranic verse: “But Allah has permitted sale and forbidden usury” (2:275). The original Quranic prohibition ofusury or ribarelates to loan contracts or riba al-jahiliyyahwhich surfaces when the lender asks the borroweron the maturity date if the latter would settle the debt or increase the same. Increase is accompanied by charginginterest on the amount initially borrowed.16Apart from this pre-Islamic form, ribamay exist in a loan contract, ifit provides any advantage to the lender. Thus, provision for any excess in the amount to be repaid by theborrower over what was borrowed in the contract is a source of usury or riba.

The definition of ribawas later extended to the exchange of currencies and several denominated articles,primarily based on the several hadiths. Onehadith that is widely quoted by scholars because of its concise formis: the holy prophet (peace be upon him) said, “Exchange gold for gold, silver for silver, wheat for wheat,barley for barley, date for date, salt for salt, measure for measure and hand-to-hand; and when thearticles of exchange are different, exchange as it suits you, but hand-to-hand..”18 The prohibition wasfurther extended by fiqhscholars to exchange of commodities other than the six mentioned in the hadith. Ribain any exchange or sale contract is defined19by fiqhscholars as “an unlawful gain derived from the quantitativeinequality of the countervalues in any transaction purporting to effect the exchange of two or more species(anwa), which belong to the same genus (jins) and are governed by the same efficient cause (illah).” Ribaisgenerally classified into riba al-fadl(excess) and riba al-nasia(deferment) which denote an unlawful advantageby way of excess or deferment respectively. Prohibition of the former is achieved by a stipulation that the rate ofexchange between the objects is unity and no gain is permissible to either party. The latter kind of ribaisprohibited by disallowing deferred settlement and ensuring that the transaction is settled on the spot by both theparties.

The prohibition of ribain the exchange of currencies belonging to different countries requires a process ofanalogy (qiyas). And in any such exercise involving analogy (qiyas), efficient cause (illah) plays an extremelyimportant role. It is a common efficient cause (illah), which connects the object of the analogy with its subject, inthe exercise of analogical reasoning. The appropriate efficient cause (illah) in case of exchange contracts hasbeen variously defined by the major schools of Fiqh. This difference is reflected in the analogous reasoning forpaper currencies belonging to different countries.

A question of considerable significance in the process of analogous reasoning relates to the comparison betweenpaper currencies with gold and silver. In the early days of Islam, gold and silver performed all the functions ofmoney (thaman). Currencies were made of gold and silver with a known intrinsic value (quantum of gold orsilver contained in them). Such currencies are described as thaman haqiqi, or naqdain infiqh literature.Thesewere universally acceptable as principal means of exchange, accounting for a large chunk of transactions. Manyother commodities, such as, various inferior metals also served as means of exchange, but with limitedacceptability.These are described as fals in fiqhliterature. These are also known as thamanistalahibecauseof the fact that their acceptability stems not from their intrinsic worth, but due to the status accorded by the societyduring a particular period of time. The above two forms of currencies have been treated very differently by earlyIslamic jurists from the standpoint of permissibility of contracts involving them. The issue that needs to beresolved is whether the present age paper currencies fall under the former category or the latter. One view is thatthese should be treated at par with thaman haqiqior gold and silver, since these serve as the principal means ofexchange and unit of account like the latter. Hence, by analogous reasoning, all the Shariah-related norms andinjunctions applicable to thaman haqiqishould also be applicable to paper currency. Exchange of thamanhaqiqiis known as bai-sarf, and hence, the transactions in paper currencies should be governed by the Shariahrules relevant for bai-sarf. The contrary view asserts that paper currencies should be treated in a manner similarto falsor thaman istalahibecause of the fact that their face value is different from their intrinsic worth. Theiracceptability stems from their legal status within the domestic country or global economic importance (as in caseof US dollars, for instance).

3.1. Analogical Reasoning (Qiyas) for Riba Prohibition

The prohibition of ribaaccording to the above quoted hadith, applies to the two precious metals (gold andsilver) and four other commodities (wheat, barley, dates and salt). It also applies, by analogy (qiyas) to all specieswhich are governed by the same efficient cause (illah) or which belong to any one of the genera of the six objectscited in the tradition. However, there is no general agreement among the various schools of Fiqhand evenscholars belonging to the same school on the definition and identification of efficient cause (illah) of riba.

For the Hanafis, efficient cause (illah) of ribahas two dimensions: the exchanged articles belong to the samegenus (jins); these possess weight (wazan) or measurability (kiliyya).20If in a given exchange, both theelementsof efficient cause (illah) are present, that is, the exchanged countervalues belong to the same genus(jins) and are all weighable or all measurable, then no gain is permissible (the exchange rate must be equal tounity) and the exchange must be on a spot basis. In case of gold and silver, the two elements of efficient cause(illah) are: unity of genus (jins) and weighability. Thus, when gold is exchanged for gold, or silver is exchangedfor silver, only spot transactions without any gain are permissible. It is also possible that in a given exchange, oneof the two elements of efficient cause (illah) is present and the other is absent. For example, if the exchangedarticles are all weighable or measurable but belong to different genus (jins) or, if the exchanged articles belong tosame genus (jins) but neither is weighable nor measurable, then exchange with gain (at a rate different fromunity) is permissible, but the exchange must be on a spot basis.21Thus, when gold is exchanged for silver, the ratecan be different from unity but no deferred settlement is permissible. Further, the possibility of stipulating optionsin the contract for either or both parties is also not lawful. It is stated in al-Hidayathat such stipulations arepreventive of mutual seisin (or settlement), which is an indispensable condition.22If none of the two elements ofefficient cause (illah) of ribaare present in a given exchange, then none of the injunctions for ribaprohibitionapply. Exchange can take place with or without gain and both on a spot or deferred basis.

Considering the case of exchange involving paper currencies belonging to different countries, ribaprohibitionwould require a search for efficient cause (illah). Currencies belonging to different countries are clearly distinctentities; these are legal tender within specific geographical boundaries with different intrinsic worth or purchasingpower. Hence, a large majority of scholars perhaps rightly assert that there is no unity of genus (jins). Additionally,these are neither weighable nor measurable. This leads to a direct conclusion that none of the two elements ofefficient cause (illah) of ribaexist in such exchange. Hence, the exchange can take place free from any injunctionregarding the rate of exchange and the manner of settlement. The logic underlying this position is not difficult tocomprehend. The intrinsic worth of paper currencies belonging to different countries differ as these have differentpurchasing power. Additionally, the intrinsic value or worth of paper currencies cannot be identified or assessedunlike gold and silver which can be weighed. Hence, neither the presence of ribaal-fadl(by excess), nor ribaal-nasia(by deferment) can be established.

The Shafii school of fiqhconsiders the efficient cause (illah) in case of gold and silver to be their property ofbeing currency (thamaniyya) or the medium of exchange, unit of account and store of value.23However, theefficient cause (illah) of being currency (thamaniyya) is specific to gold and silver, and cannot be generalized.That is, any other object, if used as a medium of exchange, cannot be included in their category. Hence,according tothis version, the Shariahinjunctions for ribaprohibition are not applicable to paper currencies. TheMaliki view also considers the efficient cause (illah) in case of gold and silver to be their property of beingcurrency (thamaniyya) or the medium of exchange, unit of account and store of value. However, according tothis view, even if paper or leather is made the medium of exchange and is given the status of currency, then all therules pertaining to naqdain, or gold and silver apply to them. Thus, according to this view, exchange involvingcurrencies of different countries at a rate different from unity is permissible, but must be settled on a spot basis. Asfar as Hanbali view is concerned, different versions attributed to Ahmad Ibn Hanbal have been recorded whichhas been documented in al-Mughniby Ibn Qudama. The first version is similar to the Hanafi version while thesecond version is close to the Shafii and Maliki version.

3.2 Comparison between Currency Exchange and Bai-Sarf

Bai-sarf is defined in fiqhliterature as an exchange involving thaman haqiqi, defined as gold and silver,which served as the principal medium of exchange for almost all major transactions.

Proponents of the view that any exchange of currencies of different countries is same as bai-sarfargue thatin the present age paper currencies have effectively and completely replaced gold and silver as the mediumof exchange. Hence, by analogy, exchange involving such currencies should be governed by the sameShariahrules and injunctions as bai-sarf. It is also argued that if deferred settlement by either parties to thecontract is permitted, this would open the possibilities of riba-al nasia.

Opponents of categorization of currency exchange with bai-sarfhowever point out that the exchange of allforms of currency (thaman) cannot be termed as bai-sarf.25According to this view bai-sarf impliesexchange of currencies made of gold and silver (thaman haqiqi or naqdain) alone and not of moneypronounced as such by the state authorities (thaman istalahi). The present age currencies are examples ofthe latter kind. These scholars find support in those writings which assert that if the commodities ofexchange are not gold or silver, (even if one of these is gold or silver) then, the exchange cannot be termedas bai-sarf. Nor would the stipulations regarding bai-sarfbe applicable to such exchanges. According toImam Sarakhsi, “when an individual purchases falsor coins made out of inferior metals, such as, copper(thaman istalahi) for dirhams (thaman haqiqi) and makes a spot payment of the latter, but the sellerdoes not have falsat that moment, then such exchange is permissible........ taking possession of commoditiesexchanged by both parties is not a precondition” (while in case of bai-sarf, it is.)26A number of similarreferences exist which indicate that jurists do not classify an exchange of fals (thaman istalahi) foranother fals (thaman istalahi) or for gold or silver (thaman haqiqi), as bai-sarf.

Hence, the exchanges of currencies of two different countries which can only qualify as thaman istalahican not be categorized as bai-sarf. Nor can the constraint regarding spot settlement be imposed on suchtransactions. It should be noted here that the definition of bai-sarfis provided fiqhliterature and there is nomention of the same in the holy traditions. The traditions mention about riba,and the sale and purchase ofgold and silver (naqdain) which may be a major source of riba, is described as bai-sarf by the Islamicjurists. It should also be noted that in fiqh literature, bai-sarf implies exchange of gold or silver only;whether these are currently being used as medium of exchange or not. Exchange involving dinarsand goldornaments, both quality as bai-sarf. Various jurists have sought to clarify this point and have defined sarfas that exchange in which both the commodities exchanged are in the nature of thaman, not necessarilythamanthemselves. Hence, even when one of the commodities is processed gold (say, ornaments), suchexchange is called bai-sarf.

Proponents of the view that currency exchange should be treated in a manner similar to bai-sarf alsoderive support from writings of eminent Islamic jurists. According to Imam Ibn Taimiya “anything thatperforms the functions of medium of exchange, unit of account, and store of value is called thaman, (notnecessarily limited to gold & silver).28As far as the views of Imam Sarakhsi is concerned regarding ex-change involving fals, according to them, some additional points need to be taken note of. In the early daysof Islam, dinars and dirhams made of gold and silver were mostly used as medium of exchange in allmajor transactions. Only the minor ones were settled with fals. In other words, falsdid not possess thecharacteristics of money or thamaniyyain full and was hardly used as store of value or unit of account andwas more in the nature of commodity. Hence there was no restriction on purchase of the same for gold andsilver on a deferred basis. The present day currencies have all the features of thamanand are meant to bethamanonly. The exchange involving currencies of different countries is same as bai-sarfwith differenceof jinsand hence, deferred settlement would lead to riba al-nasia.

Dr Mohammed Nejatullah Siddiqui illustrates this possibility with an example30. He writes “In a givenmoment in time when the market rate of exchange between dollar and rupee is 1:20, if an individualpurchases $50 at the rate of 1:22 (settlement of his obligation in rupees deferred to a future date), then it ishighly probable that he is , in fact, borrowing Rs. 1000 now in lieu of a promise to repay Rs. 1100 on aspecified later date. (Since, he can obtain Rs 1000 now, exchanging the $50 purchased on credit at spotrate)” Thus, sarfcan be converted into interest-based borrowing & lending.”

3.3 Defining Thamaniyya

It appears from the above synthesis of alternative views that the key issue seems to be a correct definitionof thamaniyya. For instance, a fundamental question that leads to divergent positions on permissibilityrelates to whether thamaniyya is specific to gold and silver, or can be associated with anything thatperforms the functions of money. Weraise some issues below which may be taken into account in anyexercise in reconsideration of alternative positions.

It should be appreciated that thamaniyya may not be absolute and may vary in degrees. It is true thatpaper currencies have completely replaced gold and silver as medium of exchange, unit of account andstore of value. In this sense, paper currencies can be said to possess thamaniyya. However, this is true fordomestic currencies only and may not be true for foreign currencies. In other words, Indian rupees possessthamaniyya within the geographical boundaries of India only, and do not have any acceptability in US.These cannot be said to possess thamaniyyain US unless a US citizen can use Indian rupees as a mediumof exchange, or unit of account, or store of value. In most cases such a possibility is remote. This possibilityis also a function of the exchange rate mechanism in place, such as, convertibility of Indian rupees into USdollars, and whether a fixed or floating exchange rate system is in place. For example, assuming freeconvertibility of Indian rupees into US dollars and vice versa, and a fixed exchange rate system in which therupee-dollar exchange rate is not expected to increase or decrease in the foreseeable future, thamaniyyaof rupee in US is considerably improved. The example cited by Dr Nejatullah Siddiqui also appears quiterobust under the circumstances. Permission to exchange rupees for dollars on a deferred basis (from oneend, of course) at a rate different from the spot rate (official rate which is likely to remain fixed till the dateof settlement) would be a clear case of interest-based borrowing and lending. However, if the assumptionof fixed exchange rate is relaxed and the present system of fluctuating and volatile exchange rates is as-sumed to be the case, then it can be shown that the case of riba al-nasia breaks down. We rewrite hisexample: “In a given moment in time when the market rate of exchange between dollar and rupee is 1:20,if an individual purchases $50 at the rate of 1:22 (settlement of his obligation in rupees deferred to a future date. then it is highly probable that he is , in fact, borrowing Rs. 1000 now in lieu of a promise to repay Rs.1100 on a specified later date. (Since, he can obtain Rs 1000 now, exchanging the $50 purchased oncredit at spot rate)” This would be so, only if the currency risk is non-existent (exchange rate remains at1:20), or is borne by the seller of dollars (buyer repays in rupees and not in dollars). If the former is true,then the seller of the dollars (lender) receives a predetermined return of ten percent when he convertsRs1100 received on the maturity date into $55 (at an exchange rate of 1:20). However, if the latter is true,then the return to the seller (or the lender) is not predetermined. It need not even be positive. For example,if the rupee-dollar exchange rate increases to 1:25, then the seller of dollar would receive only $44 (Rs1100 converted into dollars) for his investment of $50.

Here two points are worth noting. First, when one assumes a fixed exchange rate regime, the distinctionbetween currencies of different countries gets diluted. The situation becomes similar to exchanging poundswith sterlings (currencies belonging to the same country) at a fixed rate. Second, when one assumes avolatile exchange rate system, then just as one can visualize lending through the foreign currency market(mechanism suggested in the above example), one can also visualize lending through any other organizedmarket (such as, for commodities or stocks.) If one replaces dollars for stocks in the above example, itwould read as:“In a given moment in time when the market price of stock X is Rs 20,

ifan individual purchases 50 stocks at the rate of Rs 22 (settlement of his obligation in rupees deferred to afuture date), then it is highly probable that he is , in fact, borrowing Rs. 1000 now in lieu of a promise to repayRs. 1100 on a specified later date. (Since, he can obtain Rs 1000 now, exchanging the 50 stocks purchasedon credit at current price)” In this case too as in the earlier example, returns to the seller of stocks may benegative if stock price rises to Rs 25 on the settlement date. Hence, just as returns in the stock market orcommodity market are Islamically acceptable because of the price risk, so are returns in the foreign currencymarket because of fluctuations in the prices of foreign currencies.

A unique feature of thaman haqiqior gold and silver is that the intrinsic worth of the currency is equal to itsface value. Thus, the question of different geographical boundaries within which a given currency, such as,dinaror dirhamcirculates, is completely irrelevant. Gold is gold whether in country A or country B. Thus,when currency of country A made of gold is exchanged for currency of country B, also made of gold, then anydeviation of the exchange rate from unity or deferment of settlement by either party is not permissible.However, when paper currencies of country A is exchanged for paper currency of country B, the case may beentirely different. Paper currency of B is not thamanin country A. Nor is the paper currency of A thamanincountry B. The price risk (exchange rate risk), if positive, would eliminate any possibility of riba al-nasiainthe exchange with deferred settlement.

Another point that merits serious consideration is the possibility that certain currencies may possess thamaniyya,that is, used as a medium of exchange, unit of account, or store of value globally, within the domestic as wellas foreign countries. For instance, US dollar is legal tender within US; it is also acceptable as a medium ofexchange or unit of account for a large volume of transactions across the globe. Thus, this specific currencymay be said to possesses thamaniyyaglobally, in which case, jurists may impose the relevant injunctions onexchanges involving this specific currency to prevent riba al-nasia. The fact is that when a currencypossessesthamaniyyaglobally, then economic units using this global currency as the medium of exchange,unit of account or store of value may not be concerned about risk arising from volatility of inter-countryexchange rates. At the same time, it should be recognized that a large majority of currencies do not performthe functions of money except within their national boundaries where these are legal tender.

3.4. Possibility of Riba with Futures and Forwards

So far, we have discussed views on the permissibility of deferring settlement of obligation of only one of theparties to the exchange. What are the views of scholars on deferment of obligations of both parties ? Typicalexample of such contracts are forwards and futures.32According to a large majority of scholars, this is notpermissible on various grounds, the most important being the element of risk and uncertainty (gharar) and thepossibility of speculation of a kind which is not permissible. This is discussed in section 3. However, anotherground for rejecting such contracts may be ribaprohibition. In the preceding paragraph we have discussedthat bai salam in currencies with fluctuating exchange rates can not be used to earn ribabecause of thepresence of currency risk. It is possible to demonstrate that currency risk can be hedged or reduced to zerowith another forward contract transacted simultaneously. And once risk is eliminated, the gain clearly wouldbe riba.

Wemodify and rewrite the same example: “In a given moment in time when the market rate of exchangebetween dollar and rupee is 1:20, an individual purchases $50 at the rate of 1:22 (settlement of his obligationin rupees deferred to a future date), and the seller of dollars also hedges his position by entering into aforward contract to sell Rs1100 to be received on the future date at a rate of 1:20, then it is highlyprobable that he is , in fact, borrowing Rs. 1000 now in lieu of a promise to repay Rs. 1100 on a specified laterdate. (Since, he can obtain Rs 1000 now, exchanging the 50 dollars purchased on credit at spot rate)” Theseller of the dollars (lender) receives a predetermined return of ten percent when he converts Rs1100received onthe maturity date into 55 dollars (at an exchange rate of 1:20) for his investment of 50 dollarsirrespective of the market rate of exchange prevailing on the date of maturity.

Another simple possible way to earn ribamay even involve a spot transaction and a simultaneous forwardtransaction. For example, the individual in the above example purchases $50 on a spot basis at the rate of1:20 and simultaneously enters into a forward contract with the same party to sell $50 at the rate of 1:21after one month. In effect this implies that he is lending Rs1000 now to the seller of dollars for one monthand earns an interest of Rs50 (he receives Rs1050 after one month. This buy-back or repo (repurchase)transaction so common in conventional banking is termed as bai al-einahand rightly rejected by almost allIslamic scholars.33Thus, forward and future contracts can be seen to be clearly unIslamic on grounds ofbeing a source of generating riba.

4. The Issue of Freedom from Gharar

Gharar, unlike riba, does not have a consensus definition. In broad terms, it connotes risk and uncertainty.It is useful to view ghararas a continuum of risk and uncertainty wherein the extreme point of zero risk isthe only point that is well-defined. Beyond this point, ghararbecomes a variable and the ghararinvolvedin a real life contract would lie somewhere on this continuum. Beyond a point on this continuum, risk anduncertainty or ghararbecomes unacceptable34. Jurists have attempted to identify such situations involvingforbidden gharar. A major factor that contributes to gharar is inadequate information (jahl) whichincreases uncertainty. This is when the terms of exchange, such as, price, objects of exchange, time ofsettlement etc. are not well-defined. Ghararis also defined in terms of settlement risk or the uncertaintysurrounding delivery of the exchanged articles.

Islamic scholars have identified the conditions which make a contract uncertain to the extent that it isforbidden. Each party to the contract must be clear as to the quantity, specification, price, time, and placeof delivery of the contract. A contract, say, to sell fish in the river involves uncertainty about the subject ofexchange, about its delivery, and hence, not Islamically permissible. A number of hadithsforbid contractsinvolving uncertainty.

An outcome of excessive ghararor uncertainty is that it leads to the possibility of speculation of a varietywhich is forbidden. Speculation in its worst form, is gambling. The holy Quran and the traditions of the holyprophet explicitly prohibit gains made from games of chance which involve unearned income. The termused for gambling is maisirwhich literally means getting something too easily, getting a profit withoutworking for it. Apart from pure games of chance, the holy prophet also forbade actions which generatedunearned incomes without much productive efforts.

Here it may be noted that the term speculation has different connotations. It always involves an attempt topredict the future outcome of an event. But the process may or may not be backed by collection, analysisand interpretation of relevant information. The former case is very much in conformity with Islamic rationality.An Islamic economic unit is required to assume risk after making a proper assessment of risk with the helpof information. All business decisions involve speculation in this sense. It is only in the absence of informationor under conditions of excessive ghararor uncertainty that speculation is akin to a game of chance and isreprehensible.

4.1 Gharar & Speculation with Currency Forwards, Futures and Options

Considering the case of currency forwards and futures first, where settlement by both the parties isdeferred to a future date, these are forbidden according to a large majority of jurists on grounds ofexcessive gharar. In such contracts the two parties become obliged to exchange currencies of twodifferentcountries at a known rate at the end of a known time period. For example, individuals A and Bcommit to exchange US dollars and Indian rupees at the rate of 1: 22 after one month. If the amountinvolved is $50 and A is the buyer of dollars then, the obligations of A and B are to make a payments ofRs1100 and $50 respectively at the end of one month. The contract is settled when both the parties honortheir obligations on the future date.

Traditionally, an overwhelming majority of Shariahscholars have disapproved such contracts on severalgrounds. The prohibition applies to all such contracts where the obligations of both parties are deferred toa future date, including contracts involving exchange of currencies. An important objection is that such acontract involves sale of a non-existent object or of an object not in the possession (qabd) of the seller.This objection is based on several traditions of the holy prophet.37There is difference of opinion on whetherthe prohibition in the said traditions apply to foodstuffs, currencies, or perishable commodities or to allobjects of sale. There is, however, a general agreement on the view that the efficient cause (illah) of theprohibition of sale of an object which the seller does not own or of sale prior to taking possession isgharar, or the uncertainty about delivery of the goods purchased.

Is this efficient cause (illah) present in an exchange involving future contracts in currencies of differentcountries ? In a market with full and free convertibility or no constraints on the supply of currencies, theprobability of failure to deliver the same on the maturity date should be no cause for concern. Further, thestandardized nature of futures contracts and transparent operating procedures on the organized futuresmarkets38is believed to minimize this probability. Some recent scholars have opined in the light of theabove that futures, in general, should be permissible. According to them, the efficient cause (illah), that is,the probability of failure to deliver was quite relevant in a simple, primitive and unorganized market. It is nolonger relevant in the organized futures markets of today39. Such contention, however, continues to berejected by the majority of scholars. They underscore the fact that futures contracts almost never involvedelivery by both parties. On the contrary, parties to the contract reverse the transaction and the contract issettled in price difference only. For example, in the above example, if the currency exchange rate changesto 1: 23 on the maturity date, the reverse transaction for individual A would mean selling $50 at the rate of1:23 to individual B. This would imply A making a gain of Rs50 (the difference between Rs1150 andRs1100). This is exactly what B would lose. It may so happen that the exchange rate would change to 1:21in which case A would lose Rs50 which is what B would gain. This obviously is a zero-sum game in whichthe gain of one party is exactly equal to the loss of the other.

Currency options provide a right without obligation to the purchaser of the option to exchange currencywith a counterparty at a predetermined exchange rate within or at the end of a stipulated time period. Forexample, individual A may purchase an option to exchange $50 for equivalent rupees at the rate of 1:21 atthe end of one month. If the exchange rate on the maturity date is 1: 20, this implies a gain (he would gainby exchanging Rs1000 for $50 in the market and then exercising his option to exchange the dollars forRs1100 and thus, make a profit equal to Rs100 minus the option premium). This would be the loss to theseller of the option. However, if the US dollar appreciates against Indian rupee say, to 1:23, he would bebetter off by not exercising his option. His losses would equal to the premium paid for purchasing theoption. This would be the gain of the seller of the option. In this exchange, the counterparty, in all probability,would have diametrically opposite expectations regarding future direction of exchange rates. Again likefutures, this is a zero-sum game.

This possibility of gains or losses (which theoretically can touch infinity in specific cases) encourageseconomic units to speculate on the future direction of exchange rates. Since exchange rates fluctuaterandomly, gains and losses are random too and the game is reduced to a game of chance. There is a vastbody of literature on the forecastability of exchange rates and a large majority of empirical studies haveprovided supporting evidence on the futility of any attempt to make short-run predictions. Exchange ratesare volatile and remain unpredictable at least for the large majority of market participants. Needless tosay, any attempt to speculate in the hope of the theoretically infinite gains is, in all likelihood, a game ofchance for such participants. While the gains, if they materialize, are in the nature of maisiror unearnedgains, the possibility of equally massive losses do indicate a possibility of default by the loser and hence,gharar.

4.2 Gharar with Complex Products of Financial Engineering

Another dimension of ghararis complexity which raises a question mark on the permissibility of a host ofproducts of financial engineering involving currencies. Many such contracts have embedded conditions andcan be extremely complex with the risk-return possibilities that are difficult to assess. Elimination of forbiddenghararrequires that the contracts are simple and the parties to the contract have complete knowledge ofthe countervalues being exchanged. Complexity brings in jahl,is a source of potential conflict betweenparties to the contract and hence, is frowned upon.

The Islamic swap contract highlighted in section 2 is perhaps unnecessarily complex. It amounts a compositecontract equivalent to two simultaneous bai salamcontracts entered into by both the parties. It can also beseen as a composite contract involving mutual loans (qard). There is no reason why the two contractscannot be separately executed at the same time if there is a matching need. The requirement to identify amatching need and tie up the two contracts is perhaps unnecessary.

5. The Issue of Risk Management

Currency markets across the globe are characterized by excessive volatility. In these volatile markets,economic units are faced with a need to manage currency risk. Conventional risk management tools, suchas, currency options, forwards, futures and swaps are generally believed to add to the efficiency of thesystem by serving as tools of hedging and risk reduction. It is therefore pertinent to examine the hedgingargument from an Islamic point of view.

5.1 Currency Options

Currency options provide a right without obligation to the purchaser of the option to exchange currencywith a counterparty at a predetermined exchange rate within or at the end of a stipulated time period. As asimple illustration of how currency option may enable a party to hedge against currency risk, we mayreconsider the earlier example with some modifications. Assume that individual A is an exporter from Indiato US who has already sold some commodities to B, the US importer and anticipates a cashflow of $50(which at the current market rate of 1:22 mean Rs 1100 to him) after one month. There is a possibility thatUS dollar may depreciate against Indian rupee during these one month, in which case A would realize lessamount of rupees for his $50 ( if the new rate is 1:20, A would realize only Rs1000 ). Hence, A maypurchase an option to exchange $50 for equivalent rupees at the rate of (say)1:21.5 at the end of onemonth (and thereby, is certain to realize Rs1075). In this case, A is able to hedge his position and at thesame time, does not forgo the opportunity of making a gain if his fears do not materialize and US dollarappreciates against Indian rupee (say, to 1:23 which implies that he would now realize Rs1150. He wouldobviously prefer not to exercise his option. The premium paid for purchasing the option is akin to cost ofinsurance against currency risk. In this exchange, the counterparty, in all probability, would havediametrically opposite expectations regarding future direction of exchange rates and would sell this optionwith the hope of gaining the option premium.

Conventional options as independent contracts are not admissible in the Islamic framework and there is anear consensus among Islamic scholars on this issue. However, the Shariahdoes provide for introductionof options as conditions in the framework of al khiyar al shart.In this framework, either or both parties tothe contract retain an option to confirm or rescind the contract within a stipulated time period. Studies havehinted at the possibility of designing Islamic contracts with embedded options within this framework.40Inthe context of currency exchange however, this possibility has been ruled out with the overwhelming viewin favor of spot settlement and binding nature of the currency exchange contracts. However, as discussedthroughout this paper there may a be case for permissibility to settlement of foreign currency exchangecontracts from one end. In this context, the views of Imam Shams Sarakhsi seem to admit the possibility of options: “ In an exchange involving falsand dirhams when there is a stipulated option (khiyar al shart) foreither of the parties and both parties depart after taking possession (qabd) of countervalues, then suchexchange is valid. This is so because, the settlement is deemed to be complete and the contract is bindingfor the party which does not retain any option....and possession (qabd) of at least one of the countervaluesis required here...the same is not true for bai-sarf.”41If the domestic currency because of its property offull thamaniyyais viewed similar to dirhams and foreign currency because of its property of very limitedthamaniyyais viewed similar to fals, then exchange involving a foreign currency may perhaps provide forembedded options. The issue certainly deserves further research and investigation.

5.2 Currency Forwards and Futures

It is generally believed by conventional thinkers in mainstream finance that futures and forwards are toolsfor risk management or hedging. Hedging adds to planning and managerial efficiency. In the context ofcurrency markets which are characterized by volatile rates, such contracts are believed to enable theparties to transfer and eliminate risk arising out of such fluctuations. Todemonstrate this possibility with thesame example as with options, individual A may enter into a forward or future contract to sell $50 at therate of 1:21.5 at the end of one month (and thereby, realize Rs1075) with any counterparty havingdiametrically opposite expectations regarding future direction of exchange rates. In this case, A is able tohedge his position and at the same time, forgoes the opportunity of making a gain if his expectations do notmaterialize and US dollar appreciates against Indian rupee (say, to 1:23 which implies that he would haverealized Rs1150, and not Rs1075 which he would realize now.)

While hedging tools improve planning and hence, performance, it should be noted that the intention of thecontracting party - whether to hedge or to speculate, can never be ascertained. There is little empirical datato prove or disprove any hypothesis relating to the intention of the contracting parties. There may indeed bean element of circular reasoning in the hedging argument and a confusion between micro-level andmacro-level concerns. In volatile markets, firms or individuals at a micro level may justifiably haverecourse tosome tools of risk reduction. However, permissibility to forwards and futures by enablingspeculative transactions, may actually lead to greater volatility in exchange rates, thus, aggravating theproblem at a macro level. The consequent instability brought into the system may at times prove to be toocostly for the economy as has been demonstrated in the case of the South East Asian economies. Thisperhaps is the economic justification why hedging with futures and forwards is not permissible in the Islamicframework.

5.3 Bai-Salam

It may be noted that hedging can also be accomplished with bai salam in currencies. As in the aboveexample, exporter A anticipating a cash inflow of $50 after one month and expecting a depreciation ofdollar may go for a salamsale of $50 (with his obligation to pay $50 deferred by one month.) Since he isexpecting a dollar depreciation, he may agree to sell $50 at the rate of 1: 21.5. There would be animmediate cash inflow in Rs 1075 for him. The question may be, why should the counterparty pay himrupees now in lieu of a promise to be repaid in dollars after one month. As in the case of futures, thecounterparty would do so for profit, if its expectations are diametrically opposite, that is, it expects dollarto appreciate. For example, if dollar appreciates to 1: 23 during the one month period, then it wouldreceive Rs1150 for Rs 1075 it invested in the purchase of $50. Thus, while A is able to hedge its position,the counterparty is able to earn a profit on trading of currencies. The difference from the earlier scenario isthat the counterparty would be more restrained in trading because of the investment required, and suchtrading is unlikely to take the shape of rampant speculation.

5.4 Islamic Swaps

The fourth form of contracting as highlighted in section 2 is supposed to be the Islamic variant of theconventional swap transactions. The conventional swaps have been generally observed to be unIslamic asthey clearly involve interest payments. Islamic swaps (al-muragaha al-Islamiyah)as highlighted insection 2are in use by several Islamic banks. A close look at the nature of contracting reveals that the sameessentially involves an exchange of two interest-free loans (qard) in different currencies which are repaidby both the parties at the end of a stipulated time period. It is easy to see that such swaps partially enablethe parties to hedge their currency risk. For example, bank A in India has liquid funds denominated in USdollars and currently it expects the US dollar to weaken against Indian rupee over the next six months.Bank B in US with its liquidity in Indian rupees has diametrically opposite expectations. It expects theIndian rupee to weaken against the US dollar over the next six months. Thus, both the banks are exposedto and perceive currency risk. An Islamic swap between the two banks may help both the banks topartially reduce their risk. It may comprise the following.

Today: A lends - 1 million US dollars - B borrows
and A borrows - 20 million Indian rupees - B lends
After six months A repays - 20 million Indian rupees - to B
and A is repaid - 1 million US dollars - by B

In the absence of the swap, bank A would have continued with its dollar liquidity or generated some dollarincome by investing the same. With rupee being the reporting currency and with continued fall in the valueof dollar against rupee, the bank would have faced a loss due to the currency rate changes. With the swapnow, the bank would be able to make rupee investments for the time period and generate rupee income. Atthe end of the time period, the bank reverses the transaction and gets back its dollar liquidity.A similarsituation exists with respect to bank B which can now hedge its rupee resources against the fall in the valueof rupee against dollar (dollar being the reporting currency). The major difference of this type of swap fromits conventional counterpart is that in case of the latter, the interest payments along with the principal isswapped. In case of Islamic swap, only the principal is being swapped since the incomes to be generatedon the investments are not predetermined.

Islamic swaps can also be explained using the earlier example with some modifications. Assume now thatindividual A is an exporter from India to US who has already sold some commodities to a US importer andanticipates a cashflow of $50 (which at the current market rate of 1:22 mean Rs 1100 to him) after onemonth. There is a possibility that US dollar may depreciate against Indian rupee during these one month, inwhich case A would realize less amount of rupees for his $50 ( if the new rate is 1:21, A would realize onlyRs1050 ). Let us also assume that B is another exporter from US who anticipates a cashflow of Rs1100after one month and has diametrically opposite expectations regarding future direction of exchange rates. Itis worried about a possible fall in the value of rupee against dollar which would mean a reduced dollarrealization. Now A and B may agree to enter into an Islamic swap under which A lends Rs1100 to B nowand borrows US$50 from him. (A and B are neither gaining or losing with this exchange and can alwaysfind the rupees and dollars to exchange, since the current exchange rate is 1:22). At the end of the onemonth A and B receive their respective dollars and rupees from the counterparties. When they reverse theearlier transaction and repay to each other it would imply an exchange rate of 1:22 again. Thus, A and Bwould be able to ensure that their future receipts are hedged against adverse currency rate movements.

Islamic swaps may perform many other useful functions besides serving as a tool of risk management, suchas, reducing cost of raising resources, identifying appropriate investment opportunities, better asset-liabilitymanagement and the like. These are also the benefits with conventional swaps. Islamic swaps are differentin that they do not involve interest-related cashflows. However, Islamic swaps are not free from controversiesand there is no consensus regarding their acceptability as would be discussed below.

6. Exchange of Debt for Debt (Bai al kali bi al kali)

The exchange of debt for debt, bai al dayn bi al-dayn or bai al-kali bi al-kaliis generally found to beprohibited by Islamic scholars. It is a widely recognised principle of Shariahthat in any exchange contract,“seisin of one of the parties is an indispensable requisite, lest the contract prove to be an exchange of debtfor debt.”42Such exchange of debt for debt can take various forms and scholars give a numberof instances involving such exchange.

For example, individual A borrows Rs100 from individual B for a period of three months. After one month,individual B purchases an equipment from individual C which is to be delivered after one monthin exchange ofthe loan to A. Another example may be that individual A sells an equipment to individual Bfor Rs100 payable in one month and then repurchases from B the equipment for Rs120, payable after twomonths. In both the examples, the exchanges are prohibited. The first case involves excessive gharardueto uncertainty over delivery. The second case, also known as bai al-einah, clearly involves riba. Both arealso examples of exchange of debts.

Some contemporary scholars do not agree on the precise interpretation of bai al kali bi al kali. Forinstance, Kamali notes “general consensus (ijma) is said to have materialized on the prohibition of bai alkali bi al kali...but evidence shows that such an ijmais unfeasible..the legal schools have recorded divergentrulings, which means that the claim of ijmaon this issue is unfounded.” He also notes that “its precisemeaning is also subject to doubt, as kaliis somewhat unfamiliar even to native Arab speakers.”

Some authors have attempted to demonstrate that bai al kali bi al kali refers only to riba jahiliyah orpre-Islamic riba. Shaikh Mahmud Ahmad (1992) notes that Imam Malik explains the meaning of such baiin these words: “A person sells cloth or some other goods on the promise of payment by the buyer afterone month. A month passes and the buyer, being unable to make the payment, asks the seller to sell hisdebt of one month for a debt of two months, and raise the quantum of debt. This is the sale of debt inexchange for another debt.”(italics added)

Any contract where the settlement by both the parties is deferred to a future date is a clear case ofexchange of debt for debt. The same is the case with currency forwards and futures. When A and Bcontract to exchange Rs1000 and $50 at the rate of 1:20 at a future date, say 3 months, then it can beeasily seen that A’s debt of Rs1000 payable to B after 3 months is being exchanged for B’s debt of US$50payable to A after 3 months. Thus, according to a majority of scholars who consider such exchange ofdebts as another type of bai al kali bi al kali, forwards and futures are both unacceptable in the Islamicframework on this ground.

Are Islamic swaps unacceptable also because they involve exchange of debts and fall under the categoryof bai al kali bi al kali? Available opinion seems to reject Islamic swaps on different grounds. Accordingto Mufti Muhammed Taqi Usmani, it is one of the principles of Shariahthat two financial transactionscannot be tied together in the sense that entering into one transaction is made a precondition to entering intothe second. Keeping this principle in view, the swap transaction is not permissible because the loan ofUS$50 is made a precondition for accepting the loan of Rs1100. He however goes on to say that “this ismy first hand opinion about this transaction....it needs further study and research.”46Some scholars justifya prohibition of conditional loans based on a hadithnarrated by Abdullah bin Umar “whoever advances aloan should not make it conditional with the exception of return of the loan.”47Mahmud Ahmed however,quoting Allama Wahid-uz-Zaman interprets the above hadith as that a lender should not impose anycondition which confers any advantage on the lender. Defending another financial product which has thiscommon property as Islamic swaps, he asserts that “under the above arrangement, exactly identical valuesare exchanged and no advantage exceeding the loan value received is conferred by the borrower on thelender

In fact, both the parties to the contract are simultaneously lenders as well as borrowers, and there is nothingthat one lends to the other which is anything less or more than either of them borrows from the other. Unlessthe borrower is forced to give some kind of advantage to the lender in addition to the loan value hereceives, the arrangement cannot be called conditional loan of a variety which is forbidden.”487.

7.Summary & Conclusion

In this paper we have attempted an assessment of various conventional forms of contracting, such as, spottransactions, options, forwards, futures, swaps and various complex and composite products of financialengineering in terms of the overwhelming need to eliminate any possibility of riba, minimize gharar, jahland the possibility of speculation of a kind akin to games of chance.

It is obvious that spot settlement of the obligations of both parties would completely prohibit riba, andgharar, and minimize the possibility of speculation. However, this would also imply the absence of anytechnique of risk management and may involve some practical problems for the participants.

At the other extreme, if the obligations of both the parties are deferred to a future date, then suchcontracting,inall likelihood, would open up the possibility of infinite unearned gains and losses from whatmay be rightly termed for the majority of participants as games of chance. Of course, these would alsoenable the participants to manage risk through complete risk transfer to others and reduce risk to zero. Itis this possibility of risk reduction to zero which may enable a participant to earn riba. Future is not a newform of contract. Rather the justification for proscribing may be new. If in a simple primitive economy, itwas prevention of ghararrelating to delivery of the exchanged article, in today’s’ complex financial systemand organized exchanges, it is perhaps the prevention of speculation of kind which is unIslamic and whichis possible under excessive ghararinvolved in forecasting highly volatile exchange rates. Such speculationis not just a possibility, but a reality. Independent currency options are also not permissible on this ground.Forwards and futures are prohibited also on the ground that these involve bai al kali bi al kalior exchangeof debt obligations.

Islamic swaps though may be beneficial in some ways, are not free form controversy. Viewed asa composite oftwo bai-salamcontracts, the tying up seems unnecessary. Risk management is possiblewith delinked bai-salamcontracts too. This would be simpler and more efficient. Islamic swaps may alsobe questionable, when these are seen as tying up of two interest-free loans.

The form of contracting with deferment of obligations of one of the parties to a future date falls between thetwo extremes of spot and future contracts. While Shariah scholars have divergent views about itspermissibility, our analysis reveals that there is no possibility of earning ribawith this kind of contracting.The requirement of spot settlement of obligations of at least one party imposes a natural curb on speculation,though the room for speculation is greater than under the first form of contracting. The requirement amountsto imposition of a hundred percent margin which, in all probability, would drive away the uninformedspeculator from the market. This should force the speculator to be a little more sure of his expectations bybeing more informed. When speculation is based on information it is not only permissible, but desirabletoo. Bai salamwould also enable the participants to manage risk. At the same time, the requirement ofsettlement from one end would dampen the tendency of many participants to seek a complete transfer ofperceived risk and encourage them to make a realistic assessment of the actual risk.

There is perhaps a case for reconsideration of the definition of thamaniyya. Money is what money doesand the acceptability of specific currencies as medium of exchange, unit of account and store of valuevaries widely across geographical boundaries. Such an assessment is of utmost importance as many of theShariah-related injunctions and prescriptions regarding the exchange mechanism, such as, permissibility ofbai-salam in specific currencies, are dependant upon this crucial issue.

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