Oval butterfly fish—among many tourist attractions in Maldives but, with global crisis, tourism receipts have slumped (photo: Amos Nachoum/Corbis)
Global Economic Crisis
The small island nation, located in the Indian Ocean, was hit hard by the global economic crisis which followed years of unsustainable government spending.
The global slump caused sharp declines in receipts from tourism, traditional exports, and capital inflows which hurt the balance of payments and fiscal revenues, driving the economy into recession. The external shocks aggravated existing fiscal imbalances caused by ballooning government spending over the last five years, and led to reserve losses as the authorities defended the exchange rate peg to the U.S. dollar.
However, over the last few months the government has committed to, and started to implement, significant measures to stabilize the economy and bring public debt back to manageable levels. These include reducing public spending, tightening monetary policy, and strengthening the health of the financial sector.
“The authorities are well aware of the seriousness of the situation, and have put together a very significant adjustment program aimed at bringing the Maldivian economy back on a path of sustainable growth and poverty reduction,” said Rodrigo Cubero, the IMF’s mission chief for Maldives.
Putting the fiscal house in order
Between 2004 and 2008, government expenditure almost doubled as a share of GDP. Without reforms it was on course to reach 69 percent of GDP by the end of this year. A key driver has been the rapidly increasing wage bill for civil servants, which has risen fourfold since 2004 and now accounts for over 40 percent of total fiscal expenditure and about 28 percent of GDP.
“These shares are among the highest in the world, and well above the average for other small island economies,” said Cubero.
In a bid to address the deficit, in October the country’s Civil Service Commission introduced temporary wage cuts of 10–20 percent for civil servants. The authorities’ adjustment plan also contemplates staff reductions of about 9,000 positions. More than one-third of this will be achieved through transfers of workers to the private sector as part of a process of privatizing some public services. The government has also raised electricity tariffs to bring them in line with production costs, putting an end to a very costly and regressive subsidy.
Boost to reserves
The fiscal adjustment will also be complemented by monetary tightening. The authorities have already halted deficit monetization―printing money to finance the fiscal deficit―and introduced open market operations to absorb excess liquidity.
IMF financing will help shore up foreign reserves. The money is being provided by a combined 36-month Stand-By Arrangement worth over $78 million and an arrangement under the Exogenous Shocks Facility—aimed at providing breathing space to countries that have faced external shocks.
The Maldivian authorities are committed to maintaining the rufiyaa—the Maldivian currency— pegged at 12.8 to the U.S. dollar. The government believes the peg has provided a credible nominal anchor for this highly open economy. The planned fiscal and monetary adjustment aim to support the viability of the peg.
Help for the vulnerable
A key objective of the IMF-supported program is to protect the poor and most vulnerable sectors of the population from the severe impact of the global crisis, as well as from the consequences of the needed fiscal and monetary tightening.
The government plans to improve the targeting of food, medicine, and other subsidies to the poor, while the universal subsidy for electricity, which disproportionately benefited the better off in the country, has now been replaced by a targeted system. Also, projected adjustments in public sector wages and allowances have been designed so lower earners are hit less hard, and the coverage of the pension system has been broadened.
“The program aims to protect social spending and lay the foundations for sustained poverty reduction,” said Cubero.
Looking ahead
Under the authorities’ program, the fiscal deficit is expected to fall from a projected 29 percent of GDP in 2009—one of the highest levels in the world—to under 18 percent in 2010 and to about 4 ¼ percent of GDP in 2011. The improvement also reflects an expected recovery in the global economy, tourism and financing inflows, and domestic economic activity from 2010.
While the fiscal adjustment confronting Maldives is significant, the consequences of inaction would have been severe.
“Without the reforms that the Maldivian government is putting in place, the country could have been facing added pressures on reserves, high inflation, shortages of essentials including food, and a budgetary crisis which would have prevented the government from meeting all its obligations, including paying public sector wages,” said Cubero.
“The resolve of the authorities to take the necessary measures to address the critical economic situation, restore macroeconomic stability, and put the Maldivian economy back onto a sustainable path is commendable. It merits the support of the international community,” he added.
