Comment: Fixing the economy will be painful

In my last article, I spoke about the seemingly intractable problems that our Maldivian economy faces – most notably the fact that we have spent far too much than is sustainable given our level of economic activity.

The theme here is to talk about how to deal with these problems and the challenges we face in doing so. No doubt explaining the problems – especially with the benefit of hindsight – is much easier than suggesting remedies. Moreover, given the extent of our past excess and misdeeds, the remedies required are likely to be both bitter and painful.

Our immediate problem is how to reduce our fiscal deficit. On a theoretical level – this is quite simple.

Approximately 50 percent of our expenditure is on paying government salaries and allowances – and we can cut down foreign travel, close down our embassies, turn off air conditioners at our offices – but ultimately unless we make some inroads into this important component of public spending – it will be impossible to do anything meaningful.

No doubt, all efforts must be made to reduce waste before we start slashing either incomes or jobs. The higher salary levels must take bigger cuts than the lower paid staff – as the government has already done so.

In reality however, this is both a political and a logistical nightmare. We all know members of family or friends struggling to make ends meet on the current civil service salaries. Laying off a large chunk of the population at a time of an economic crisis seems counterproductive to regenerating the economy.

Logistically, it is complicated because a system of voluntary first-come-first-serve resignations, particularly if the government is willing to forgive their education ‘bonds’, would mean that the most capable civil servants would depart first, leaving us with the least dynamic people actually running government. In an increasingly polarised community, it would be difficult to distinguish between people fired on the basis of professional incompetency or political allegiances.

Difficult though these policies may be, a country that has a third of its total work force working for the government is simply not sustainable. The key therefore becomes how to do this in a manner that has the least negative impact on our economy. For this – three broad initiatives are required.

First and foremost, significant opportunities for retraining must be made available. This must be combined with a public relations campaign on how retraining should be for anyone at any stage of their career. It must also be based on market requirements – with significant impact on developing skills necessary for our economy.

The tourism sector, foreign languages, technical skills, accountancy and business skills are just some of the options. More initiatives can be introduced to both existing and new private providers of training through public-private partnerships.

Other policies that must be pursued include the allocation of reduced rent or free land for private education providers, tax exemptions on educational material, as well as rebates of fees for those who successfully pass courses and find employment.

Secondly, access to credit for starting small businesses must be expanded. The key obstacles to this – particularly the high costs of borrowing from a narrow financial sector – must be addressed. The high costs of borrowing are partly due to the fact that the legal options for banks in the case of non-performance are uncertain.

Furthermore, without a credit information system, there is a significant missing component that makes people more disciplined when paying back their loans.

Last but not least, the fact that we realistically have one-and-a-half banks in the country (BML and to some extent SBI), the market mechanisms forcing these firms to be both efficient and customer orientated is missing. We need to encourage more banks to set up shop in the Maldives – and allow people access to a wide variety of banking products.

Finally, significant incentives must be provided for the private sector to start employing more Maldivians. This must be done first and foremost by revising our labour law. The existing legislation is overly burdensome and expensive for businesses – and more flexibility must be allowed.

With the coming of a new taxation mechanism, significant leeway must exist for the government to provide rebates and other incentives for those who employ more Maldivians. Start-up companies must also be provided with exemptions – particularly in strategic sectors deemed important for long-term growth.

However, even if we can introduce these policies – and this is a big ‘if’ given our intractable inability to get anything done within this political system – let us also not kid ourselves into thinking it would not involve a significant amount of hardship.

Even with countless retraining facilities, or access to credit or even benefits for private sector to employ locals – there will be a group of people simply unable to maintain their existing living conditions and as such their situation will no doubt deteriorate. One must assume that the current ‘pickiness’ of the local population to defer certain kinds of jobs to foreigners must also be revisited.

For those vulnerable groups, basic levels of protection – particularly in terms of access to healthcare and education – must be allowed. The current trajectory of the Government’s Madhanaa (health insurance) policy must therefore continue – and perhaps must be provided at subsidised rate to those unable to find jobs.

On a more fundamental level therefore, what we are looking at is a paradigm shift in the role of the state. If you take a long-term view of the Maldivian economy – it was effectively characterised by a system of subsistence fisheries and small scale agriculture – with the government earning revenue from trading of the excess products generated from these primary industries.

The country therefore had a system of governance that effectively involved a (selectively) benevolent state providing welfare for those that it deemed worthy – especially through jobs. Furthermore, the direct arm of the government – being mostly in Male – was felt on a smaller percentage of the people because the population of the country was more evenly distributed.

With the emergence of tourism however, we saw a dynamic private sector go on to take the driving seat of the economy. The state no longer has, or should have, the resources to provide direct employment to the people on such a large scale. No doubt, a basic level of protection to all must be provided – and what constitutes this basic level will continue to be debated for years to come. The role of the state must now become that of the regulator and the facilitator – allowing jobs, productivity and wealth to originate and be distributed according to forces of a dynamic market system.

All comment pieces are the sole view of the author and do not reflect the editorial policy of Minivan News. If you would like to write an opinion piece, please send proposals to [email protected]


Comment: The Maldivian Economic Situation

Economics is often referred to as the ‘dismal science’, partly because it mostly concerns us when things start to go bad.

In this sense, economics is a lot like medicine or public health. And so it is highly appropriate that we start comparing economic remedies to medicine – like what the President did when he asked the donor community for a ‘spoonful of sugar to help the medicine go down’.

You may find yourself asking what exactly is the sickness for which we have to take such a bitter medicine. So what I will attempt to do in this first part of the article is to try and explain to you exactly what happened to our economy – in as plain, jargon-free, language as I can.

In the second part of the article (to follow soon) I will try and show you the remedies we need to take and to shed light on how to avoid getting into a similar mess in the future.

In order to understand our recent economic history, you must first know the three ways in which a government can affect the economy: fiscal policy (how much it spends from its taxes, revenues or borrowings) or monetary policy (how much money it prints) and exchange policy (how it allows goods and services to come in or go out of the country). So lets look at how our Governments – both Gayyoom and the MDP – have used these levers over the last few years.

The Big Wave

The key defining moment to start is the Tsunami of 2004 where we faced a previously unimaginable event that brought economic activity to a virtual standstill. The tsunami, however, happened in the context of two other very key social phenomena. Firstly, there was an emergence of a movement calling for political change that proved especially resilient and vocal. Secondly, there was a dramatic increase in global prices – food and oil prices especially.

The response to this was naturally a large spending program to rebuild the country. No doubt, the initial spending by the Government went to Tsunami affected purposes. However by 2006-07 the Government started doing two things.

First, it increased the size of the civil service from about 24,000 to about 32,000 people, and secondly increased their average salaries from about MRF3,000 to MRF11,000. As a result, government spending went from 35% of GDP in 2004 to about 60% of GDP in 2006.

I need to take a few more moments just to put this level of spending into perspective. Firstly, it is mentioned above that we expanded the civil service to be almost 32,000 people – that is almost 11 per cent of the total population of the country!

The comparative figure for other small island countries (like in the Caribbean) is at four per cent. Furthermore, the public sector wage bill (ie. all the salaries and allowances paid to this 11 per cent of people) accounted for almost 50 per cent of all our expenditure and almost 70 per cent of all our revenue.

Of course, all this expenditure is fine if we can actually pay for it. The question then becomes – where did the money for all of this increased expenditure come from?

It came from three sources – grants, loans and the additional revenue from leasing out a number of new resorts. The understandable impact this had on the supply of money was a three-fold increase.

One notable side-effect of this was a rising inflation of more than 20 per cent over the years: a factor that contributed to MDP making controlling inflation a major policy pledge. However all of this would have been manageable but for the third policy lever of a government – the exchange rate.

You would no doubt know that we in the Maldives have a pegged exchange rate – ie. it is fixed by a central authority to a specific currency at a specific value (in this case Rf12.85).

A policy of increasing public spending, and thereby increasing our supply of Maldivian rufiyaa AND keeping a fixed exchange rate, can only work if we also keep increasing our foreign currency stock. This is because the pegged exchange rate works on the assumption that if somebody comes to the MMA or Bank with any amount of rufiyya looking to buy US$, we should be able to cater to this.

With increased rufiyaa in circulation there was a large increase in demand for USD, but there was no real increase in supply of foreign reserves. This caused the ‘real’ exchange rate to shoot above Rf12.85, and thereby cause even worse inflation. As trust in the system started to disappear, those who actually had US$ no longer trusted to put the money into local banks.

All of this enormous stress on the system was there well before the greatest global economic collapse since the 1930s struck.

The Global Financial Crisis (GFC)

The two specific impacts of the GFC were two fold.

First there was a ‘credit crunch’ – the flow of finances between international banks stopped because none of the banks trusted each other. Financing to all those many resorts that were given out started drying up so our reserves fell even more. Secondly, tourist numbers started retrenching – and those tourists that did come spent a lot less.

It was about this time that the historic change in government took place and the MDP came to power. To their horror, they soon came to realize that they inherited a fiscal situation far worse than they had imagined.

This was due to the fact that government spending is often done through contracts that have long-term implications. Governments sign contracts that burden future governments to payments – both in terms of principal and interest payments.

The amount that the MDP government had to pay in interest alone – for projects that they themselves had nothing to do with – rose from three to eight per cent of GDP between 08-09.

Here therefore we need to introduce the final basic concept – that of the fiscal deficit. This simply is the difference between what we earn and what we spend divided by our GDP.

In 2008, this was at about -12.5 per cent, but the worrying thing was that given the fall in revenue projected by the GFC, this was projected to rise to almost 33 per cent in 2009.

Once again let’s put these figures in perspective. The highest the fiscal deficit reached in the USA – in 1945 straight after the Second World War – was at about 20 per cent.

Obama’s hugely expensive budget this year will increase his to just over 11 per cent. In Sri Lanka, the IMF refused financing to the current President because his latest fiscal deficit reached 10.5 per cent!

However way you look at it, we are in a desperate, desperate situation.

Don’t Blame it on the Sunshine

A key question you may therefore have is – who is responsible for this mess? Was it pure malice? Incompetence? Or did we just get unlucky?

Those who seek to justify the acts of the former regime would say that yes, they expanded the domestic money supply, but what you must also keep in mind is that they had just successfully bidded out 60+ resorts.

Even if you take a conservative estimate, we are talking about almost US$3 billion of investments.

Even assuming 50 per cent Maldivian staff, this is about 7,200 new jobs in the resorts alone. The total bed capacity increase was expected at 12,000 – so that is about US$4.2 million PER DAY in revenue. As such, an expansionary fiscal and monetary policy was justified on grounds of the revenue, returns and most importantly, reserves from this resort expansion. They could never have been expected to foresee the Global Financial Crisis coming.

On the other hand, critics would argue that in the years of Gayyoom’s presidency, especially in his last two years, rational economics was not the order of the day. Rather, the preoccupation of the regime was to stay in power at all costs.

If that meant bringing 10,000 extra staff and increasing their salary four-fold, as well as signing up to countless and often pointless public expenditure projects by borrowing large sums of money at exorbitant interest rates – so be it.

Critics would argue that if the Government were interested in anything other than self-preservation, they would have at least invested the money more wisely. It was reckless spending for purely political aims with no thought to the future health or wellbeing of the economy.

My own personal viewpoint is that we should leave the blame game for another day – if we take it up at all. The challenges to our economy, and by definition our fragile democracy, are far too great to waste time pointing fingers. I understand that political points have to be scored, but there are no elections in sight for at least 3-4 years.

We have arrived at a situation where we need to politically co-exist if we are to heal our economy. For now, leave aside your talk of past corruption or the future hell that awaits us if we do not veil our sisters. We have jobs to create, youth to educate, industries to develop and opportunities to exploit. I for one would like to look back on these days as a time when we all, blue and yellow supporters alike, did some pretty remarkably constructive things in the Maldives.

All comment pieces are the sole view of the author and do not reflect the editorial policy of Minivan News. If you would like to write an opinion piece, please send proposals to [email protected]