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.

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