By Fazeel Najeeb
On Wednesday, 5 March the IMF published on its website a statement issued by Mr Philippe Karam who led the IMF staff team that visited the Maldives from 20 February to 5 March for the 2019 Article IV consultation.
One of the key messages in the statement is that the fixed exchange rate, the rufiyaa’s peg to the U.S. dollar, has served the Maldives well and remains appropriate. The statement also says that the IMF staff welcomes the MMA’s plans “to review the current exchange rate regime with the aim to strengthen exchange rate stability, accumulate foreign reserves and increase resilience to external shocks.” The statement adds that updating the exchange rate management to better meet the needs and challenges of the Maldivian economy is desirable.
If the peg has worked well and continues to be appropriate, why, one may ponder, review the exchange rate regime?
In the 2017 Article IV consultation, the IMF Executive Board, the organisation’s highest decision-making organ, “took note of the weakening external position [of Maldives] and agreed that strong fiscal adjustment, combined with a tighter monetary stance and more flexibility in the pegged regime, could better support the peg and help build foreign reserves.” In simple language, strong fiscal adjustment means sharply reducing government budget and/or increasing government income, tighter monetary policy stance means MMA acting on removing excess rufiyaa liquidity circulating in the economy, and more flexibility in the pegged regime means widening the exchange rate band which is currently at MVR 10.28-15.42.
Where does the MMA stand on the IMF Executive Board’s recommendation of a tighter monetary policy stance and more flexibility in the pegged regime? The answer is in MMA’s Strategic Plan 2018-2022, an impressive document published in 2018. In it, goal 1 is to strengthen monetary policy to maintain price stability. Under this goal are four broad strategic objectives, one of which is to design and implement strategies for de-dollarisation and to develop the foreign exchange market, and under this objective are four policy measures, one of which is to review the current exchange rate regime in order to maintain exchange rate stability.
Providing for more flexibility in the pegged regime, as recommended by the IMF Executive Board, and reviewing the exchange rate regime, as committed to by the MMA may be described as two different but related matters. Broadening the exchange rate band is a matter of determining the degree of flexibility that has to be provided at the time in question; it does not necessarily require a review of the regime.
The commitment to review the regime, therefore, may be a public recognition implied by the MMA that there is reason, perhaps in the spite of an oligopolistic foreign exchange market, to at least assess the appropriateness of the peg. An accompanying resolute policy statement in the strategic plan appears to cement such a conclusion. The policy statement declares that:
“We [MMA] will work to enhance our monetary policy transmission mechanism through de-dollarisation and by pursuing the most appropriate exchange rate regime for the Maldives to maintain price stability. In line with these changes, our monetary policy instruments will be redesigned by establishing added incentive mechanisms for local currency. Legislative and operational changes will be considered to develop a well-functioning foreign exchange market.”
Here the use of the phrase “by pursuing the most appropriate exchange rate regime” leaves open for interpretation that there exists a possibility that the pegged system would be continued if it was found to be appropriate after MMA’s planned review of the current exchange rate regime. However, this interpretation appears to be negated when the policy statement goes on to state an intention by the second sentence, that “In line with these changes [emphasis added], our monetary policy instruments will be redesigned by establishing added incentive mechanisms for local currency.” This appears to suggest that “these changes” will be made, since continuing with the peg cannot be described as a change. “These changes” is, of course, open for interpretation. Finally, the third and last sentence in the statement, “Legislative and operational changes will be considered to develop a well-functioning foreign exchange market” appears to allude to a flexible exchange rate, given the use of the phrase “a well-functioning”.
One could argue that the pegged system may be described as “well-functioning”. The IMF has always said that the fixed exchange rate system has served the country well and it remains appropriate for the economy.