Fiscal Policy and Deficit Financing: Islamic Perspectives

Abstract

Using deficit financing by increasing borrowing at lower interest rates has the potential to increase debt to levels that are not sustainable and can create further economic problems in the longer term. To understand the Islamic perspective on deficit financing, two features of government spending need to be recognized. First, government spending can be distinguished as current and capital expenditures. Second, the objectives of fiscal policy and government spending can be viewed as redistribution of income, expenditures to provide government services, provision of public goods that markets fail to provide, and providing infrastructure that enhance the productive capacities in the economies. While current spending should be covered by zakāh (distributive role) and taxes (providing government services and public goods), capital expenditures on infrastructure can be funded by issuing ṣukūk. During recessions, the government can use counter-cyclical spending of zakāh and tax revenues to increase current spending and issue ṣukūk to raise funds for investments to enlarge capital expenditures in infrastructure projects. This approach of moving the economy out of recession puts a limit on excessive debt by linking the funds raised with the real economy and helps increase the productive capacity in the longer term by filling the infrastructure gaps.