In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the percentage change in a general price index (normally the Consumer Price Index) over time.
Dr. Monzer Kahf, a prominent economist and counselor, said:
Interest is an increment in a loan or debt, which is prohibited. Therefore any increment in a loan contract is prohibited, whether the contract is providing a loan by a bank to a customer or depositing certain amount money by a customer for a contractual increment, even if the inflation came at the end of the year to be equal to or more than the inflation rate.
Kindly notice that inflation is known only at the end of the period and when a contract is created, only an expected rate of inflation may be included in the rate charged in the contract. Also notice that when there is unexpected high inflation, people tend to “escape” or run away from cash or cash commitments. They do not deposit in banks and they do not give loans in cash unless they expect a return that exceeds the rate of inflation. Any contractual increment in a loan is riba and it is prohibited.
On the other hand, once inflation rate becomes known (although it is very difficult to agree on what the rate of inflation is and there is no single country in the world that has a 100 percent accurate calculation of inflation rate and thus, all countries with no exception announce always different rates of “estimated” inflation, because to know it exactly you need information about every single good and service throughout the period under study and the composition of the basket of purchases of every single household; all these are impossible to obtain and therefore, all figures are mere approximations) the already existing debts can be adjusted accordingly. This is a matter that can be decided by a court and most likely, in many cases, they can be adjusted for inflation from a sharia point of view by an experienced court. This adjustment is not considered interest as it falls under what is known in economics as indexation. In other words, in your hypothetical question, any charge of an increment in a loan contract is interest even when there is expected inflation, whereas an increment decided by a judge in dispute solving about the effect of inflation is not considered interest.