situation and the overall monetary requirements of the economy, keeping an eye on

1. situation and the overall monetary requirements of the economy, keeping an eye on the macro economic situation. Thus, the central bank decides what corrective measures it should take. For example, if the central bank feels that inflationary pressure is building up in the economy and this is the time to reduce the monetary reserves of commercial banks, then it would sell the securities in its portfolio. These government securities are bought by dealers in government bonds, financial institutions, commercial banks, and individual investors. The payment to the central bank is usually by means of cheques which are presented to commercial banks for clearance. Thus, the reserves of commercial banks are reduced. Similarly, if the central bank wishes to pump more money into the system, it will buy government securities from the open market. There are two main difficulties in the application of open market operations in an Islamic economy. One of these difficulties is conceptual and the other is institu- tional. The conceptual difficulty is that almost all financial instruments such as gov- ernment securities, short-term bonds, treasury bills etc. are interest based instru- ments and are incompatible with Islamic banking. Hence, "the open market opera- tions will require fundamental changes to become applicable in the Islamic setup". [Uzair, in Mohammad Ariff (ed.), 1982, p. 219.] The institutional difficulty is the rather underdeveloped nature of the financial markets in Muslim countries. In fact, there are only a few Muslim countries in which the central bank could make use of open market operations. Considering the state of the financial markets, it is held that the scope of open market operations is "much more limited" in Muslim countries than in developed countries. [Uzair, 1978, p.45.] Siddiqi in his first book on interest free banking, envisaged that the govern- ment could issue commercial shares based on the principle of profit sharing. The central bank of the country may be authorized by the government to deal in the sale and purchase of these commercial shares. The purchase and sale of commercial shares by the central bank would be analogous to the open market operations of the central bank in the interest based system. If the central bank decides to expand the supply of money in the system, it would announce the purchase of commercial shares which would be held by individuals and business institutions including com - mercial banks. The central bank may purchase these commercial shares either at the current market price or may even offer a price higher than the market price. The shareholders would be paid in cash for their shares by the central bank. This would increase the supply of money in the system. Similarly, the supply of money could be contracted by selling commercial shares. Thus, in Siddiqi's model of interest free banking, the open market operations of the central bank could be conducted without much difficulty [Siddiqi, op.cit., 124 - 127.] The CII Report also accepts that there is little scope for the use of open market operations in an interest free context, at least for the present, because of under 23