Finance and growth: Particular role of Zakat to levitate development in transition economies

Abstract

Abstract Financial institutions in transition economies maintain higher liquidity at the cost of economic growth. This study offers an alternative policy tool to achieve higher liquidity without compromising economic growth. We show that Zakat—an obligatory Islamic charity with a fixed rate of 2.5%—can be an alternative to the interest rate and that its use as a policy tool promotes economic growth. Instead of considering zakat as a fiscal tool—an alternative to tax—we present it as a monetary policy tool to substitute the interest rate. We provide a framework based on the endogenous growth model, which allows the use of Zakat as a tool to overcome liquidity constraints in transition economies. We also construct an index‐based varying zakat rate adjusted for economic fundamentals, such as economic growth, for each economy. We provide empirical evidence using system generalized method of moments (GMM) in a simultaneous equation model on a panel data of 38 countries for the period 1996–2015. The results show that zakat rate has a significantly positive impact on economic growth. Furthermore, as a policy tool, Zakat has a statistically significant positive impact on FDI and domestic investment, while reducing corruption (CR). The results are robust for various regions and income classifications in different transition economies. The overall findings corroborate that zakat can help achieve the dual objectives of enhanced liquidity and higher levels of economic growth.

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