The currency peg allowed the Maldives to have some of the highest living standards in South Asia by preventing excessive deficit spending, reports Lanka Business Online.
“Currency debasement and inflation are key to expanding the state at the expense of the larger society.
The Maldives also started active open market operations recently, ostensibly to mop up excess liquidity, but it can make it almost impossible to maintain a peg.
A well functioning open market operations system automatically sterilises interventions by a central bank (dollars sales by the monetary authority) with injections of local money forcing a balance of payments crisis, even in the absence of excessive deficit spending.
In 1997 many East Asian nations which had good fiscal management ran into currency crises due to sterilized interventions by central banks.
A fixed peg can only be maintained with unsterilized interventions and no deficit monetisation.
One of the triggers of Maldives current troubles was a large increase in the salaries of state workers. However the archipelago was also hit by a tsunami in 2004 and also suffered a downturn in tourism, a key source of state revenue, amid a global recession.”