Maldives Reserves - What is the adequate level?

The Gross International Reserves (GIR) of Maldives, held at Maldives Monetary Authority (MMA) stood at USD 938 million as at February 2019. This is a USD 228 million increase (32%) compared to the level in February last year.

What is Gross International Reserves? What does it consist of? For a small, open economy like the Maldives, what is the adequate level of foreign currency reserves?

The GIR held at MMA consists of reserve assets that are in control of MMA as the central bank, and can be readily used in order to meet the financing needs of the balance of payments. The main, and most significant component of the GIR is the total foreign currency deposits of MMA, and the government. Part of GIR also consists of foreign currency reserves of commercial banks held at MMA.


With Maldives Rufiya pegged to the US dollar, we have an exchange rate with an upper band of
MVR 15.42 per US dollar. If any central bank or a monetary authority has a fixed official rate, such authority must be at all times, willing to accept and supply foreign currency at the said rate. Otherwise, whenever there is a shortage of USD in the market,there will emerge a parallel market where trading may occur outside the official rate. Hence, the central bank will need to intervene in the market to ensure that the market is cleared. That is when, the level of reserves becomes important.

The GIR held at MMA by the end of February 2017 was at $516 mil, and increased by 37% by the end of February 2018. Like it was highlighted in the beginning, a further 32% increase by February 2019, with a total GIR of $938 million. What does this mean? Of course the total reserves has increased in absolute terms in the past two years. But the important piece of information that we need is the source of such increase. Whether this is a result of an increased foreign currency revenue of our country? We may easily show an artificial, temporary boost in total reserves even by incurring huge foreign currency debts. We may also enter into temporary currency swap arrangements, and as a result, show a higher level of gross reserves. The important factor is that we should be gradually accumulating reserves from our revenue, and in that way obtain a sustainable balance that could benefit the balance of payments.

When conditions in the economy improves, in terms of increasing foreign currency revenues, and by maintaining a sustainable level total spending, we will be in a position where there will be positive impact on the existing exchange rate. Just like when the conditions worsen we are forced to devalue the currency, when the conditions improve, we should also be able to allow an appreciation of our currency.

Towards a sensible interest rate regime..

The interest rate in any economy plays a vital role in the financial sector. As it is the cost of borrowing money, or the compensation that we receive for the service of lending money. When we lend money to someone, we are obviously taking a risk, and that demands a price, or compensation. And, it is very important that this rate is determined in a sensible manner.

There are some factors that determine the interest rate in the economy. Like any other price, interest rate is also mainly determined by the demand and supply of credit. When there is a huge demand for credit, the rate of lending will tend to increase. Likewise, availability of funds is also a factor that determines the price. Excess liquidity in the banking system and the financial sector in general, shall lead to a lower interest rate, as there will be increased competition to provide credit.

As Maldives financial sector is dominated by commercial banks, bulk of lending is done by the banks, and the financial sector can be described as a ‘bank-based’ sector. For this reason, banks have exercised their ‘monopoly power’ and established a high lending rate which ranges between 8 – 13%. On the other hand, the deposit interest rate is as low as 2.25%. Despite the high interest rates in the banking sector, there is continuous frustration from the private sector on the issue of ‘access to finance’. The World Bank ‘Doing Business Report’ also always reports negatively on the issue. Any report on the financial sector of Maldives would highlight on it. In short, there exists a huge financing-gap in the real sector of Maldives, as the required, and desired amount of investments are not financed through the banking sector. And why should they?

The existing stock of Government Treasury Bills stands at MVR 11.7 billion. The risk-free one month T-Bill rate is 7.50%, while the 364 day rate is 9.0%.  So, if you can get 9% for one year, risk free government security, why would the banks ever think of lending to the ‘high risk’ private sector?

In order to make some sense out of this ‘outrageous’ interest rates, or in order to explain these high rates, we may need to look into certain fundamentals of the macro economy. In August 2010, the one-month T-Bill rate was below 4.50% while the 91-day T-Bill rate was below 5.50%. This was a time when T-Bills were auctioned in the market on a weekly basis. Hence, it is a rate determined through a market mechanism. The year 2010 was an year when Government budget had a deficit of 14.3% of GDP, and the annual total revenue of the Government was at MVR 6.5 billion. Fiscal dominance, fiscal discipline, high government demand, you can come up with all the technical terms to explain/justify.

However, at the end of 2014, the fiscal balance stood at only 3.4% of GDP, and total revenue for the year recorded almost MVR 15 billion. And yet, the one month T-Bill rate is fixed at 7.50%??? Do we still use the terms 'fiscal dominance', and 'lack of fiscal discipline', and high demand to justify these rates?

I think its time we moved towards a sensible interest rate regime. Its time MMA took the lead, and provide sound financial advice to the finance minister.

Why China matters

We at Maldives achieved a major milestone in 2013 when we recorded more than one million tourists by the end of the year. The world achieved the one billion mark in 2012 when it recorded more than a billion tourists crossing international borders for the first time, from 995 million in 2011. According to the World Tourism Organization (UNWTO), international tourism receipts reached more than one trillions US dollars in 2012, when it recorded US$ 1,075 billion worldwide. In 2012, China became the number one source market in the world, and recorded a total spending of US$ 102 billion on international tourism.

In 2013, China outbound tourists reached 97.3 million from 83.1 million in 2012. How much are we able to attract from this? Less than 1%. In fact, in 2012 we recorded 229,551tourists from China visiting Maldives, which is 0.28% of the total Chinese who traveled abroad during the year. In 2013 we attracted 331,719 visitors from China, which is only 0.34% of the total. So, even if we are able to attract 1%, we are looking at about a million tourists from China. The question is can we get there?

Looking at the arrival statistics of China tourists into Maldives, we had only 41,511 tourists from China in 2008, however, we had a 46% growth in 2009, and a 96% growth in 2010 when we recorded 118,961 by the end of 2010. Now China has become our number one source market, overtaking the European markets. A Maldivian airline, Mega Maldives Air played a key role in this development. An estimated 35% of the total Chinese arrivals are contributed by Mega, and in 2013 it is estimated that more than 95,000 Chinese visited Maldives via Mega Air. The state owned airline ‘Maldivian’, operated by Island Aviation, has also started flights to China, in addition to the Chinese local airlines like the ‘China Eastern’.

Well, I guess the point that I’m trying to make; as we talk about Chinese tourists, since China is expected to grow, we need to make further adjustments and come up with innovative plans to increase our share, to at least double the arrivals from China, and target to achieve at least one million from China by specified time period. That way, will be able to double our earnings from tourism.

Maldives Tax system review: What is the optimal tax rate on tourism?

We have been taught in school that the objectives of a tax are to raise government revenue, discourage the consumption of certain types of goods, and most of all to redistribute income and wealth. Government needs to raise revenue so that it can achieve its development objectives, and finance the services to be provided to the public and in the form of public goods, like roads, bridges, airports and ports. Some types of goods like alcohol, cigarettes, and environmentally harmful products are taxed heavily in order to discourage people from using or consuming such goods. Redistribution of income and wealth among the population is an important objective of taxation, as the government collects a higher percentage or a higher amount of money from the rich, and provides social-security benefits or subsidies to the poor, so that the income gap between the rich and the poor can be narrowed.

An efficient and effective tax system in trying to achieve those objectives mentioned above, also should be targeting to maximize social welfare by having the optimal tax structure. If the government’s fiscal policy ignores the concept of ‘optimal tax’, it can actually harm the aggregate production efficiency of the economy. In other words, if the government is careless and over-burdens the businesses by ‘over-taxing’, it can actually decrease the economic activities or production, leading to lower tax revenue over the medium to longer term. Hence, in order to increase the government revenue in the shorter-term we should not be recklessly increasing the tax rates or playing with the tax system.

Prior to the introduction of GST on general goods and services, we had the import tax or the import duties, which required the importer to pay a certain percentage of the value of the goods to Customs as duty, before even the goods are being cleared or sold to the customers. We replaced the import duties with GST, so that importer will not be paying any tax to the government before selling a product. When the customer buys the product, tax is paid and the seller collects it, pays it to the government. We have seen that total government tax revenue has actually increased, and increased significantly since the tax reforms brought in 2011. Has it hurt the aggregate production efficiency? In some areas yes. And with the proposed new changes to the tax rates, it may hurt even more. In the short term it can increase the government revenue, however, in the longer term it can do more harm, as total production may fall, and so can the total tax revenue in the medium term.

The issue of Withholding Tax (WHT) needs special mention, as I have been tackling this issue from the business side, both in my own business and also others whom I am advising. Under Section 6 and 7 of Business Profit Tax (BPT) Law, businesses are required to pay 10% of all the payments made to any foreign party for business services obtained.  The total amount of revenue raised through WHT comes to about 3% of total tax revenue of the State. It may be a huge burden for some individual companies to pay tax on the company’s expenditure paid to a foreign company, and at the same time pay tax on the net profit of the company. Most of the time, the foreign company will not allow to deduct the 10% tax from their payments. Hence, individual companies may face bankruptcy or incur a loss that threatens the continuity of the business. Had the government removed the WHT from the law and let go of the 3% revenue, many individual companies will benefit from it, and actually be paying more than 3% collectively as Business Profit Tax and GST.

Then comes the issue of Bed Tax. High-end resorts sell rooms for as high as $2,000 per night, and still pays $8 to the government. It’s just 0.4% of the room rate. However, a guest house selling a room for $50 per night also pays $8 per night as bed tax, but which is 16% of the room rate. Of course, it’s the guest who bears the tax. But for Tom Cruise who comes to ‘One & Only’, $2,008 plus GST may not be much for a night. However, for Markuss who is from a lower income level, even $58 plus GST may be too much for a night, especially, comparing this price to the same standard rooms in other countries. Most of all, considering the fact that Bed tax is very ‘unfair’ as both the rich and the poor pay the same amount, makes the tax regressive in nature. For this reason, it cannot be considered as part of an optimal tax structure.

GST on the other hand is more equitable, as a certain percentage is paid on the room rate and other prices, and those with higher incomes and who pays more for their services, will pay more as tax. At present, GST rate for tourism sector is 8%. Most of the resorts, hotels, and guest houses will also include service charge (normally 5-10%) in their prices, and add on GST. With this, guests will be paying more than 18% on top of the prices quoted for room and other services. If we increase the GST rate to 12%, with service charge, guests will be paying 23% more on top of the quoted prices. And if we continue charging bed tax that’s an additional $16 per night for a couple, and makes it 39% in addition to room rate. In the case of hotels in Colombo, it comes to about 26% with service charge and taxes. Which means, with bed tax, and GST of 12%, our tourism product will lose competitiveness, and may actually lead to Maldives becoming less attractive to tourists; especially mid-market tourists. In that case, total national income and total tax revenue may decrease over the medium and longer term. So, the tax rate or tax system should not be played as we wish, so as to increase short-term revenues. It has to be carefully analyzed, its impacts identified,  its optimal level determined, so that social welfare is maximized.

Maldives tourism tax policies

Back in 2011, the Government introduced a comprehensive tax system; whereby a Goods and Service Tax (GST) was introduced generally on all consumer goods and services for the first time in the history of Maldives. That is when so many international donors and development partners have been advising and recommending to introduce such a tax system long long ago, even when I first joined the Ministry of Finance in 1995. There have been many reports and documents by international donors like World Bank, ADB, and IMF on the importance of introducing Business Profit Tax, and GST. Well, I’m not sure exactly the reason, but the fact remains, it was not done!

When the new tax system was formulated, we were embarking on a huge economic reform program. This program was prepared after careful and consistent research of the Maldives economy, and after considering the recent international developments and its impact on the Maldives economy. We did a lot of work in terms of in-depth study of the Maldives exchange rate regime, and the dynamics of the Maldives economy. During my work at Maldives Monetary Authority (MMA) research division, I wrote a paper in 2010 on the real exchange rate of Maldives.

It was obvious from our research and analyses, that we had to increase our fiscal revenue, and that we cannot continue with huge fiscal deficits. Almost everybody working with us, those in MMA and those in Ministry of Finance agreed that monetization is not an option, and relying on printing Rufiya can never be a means of deficit financing. Printing Rufiya can only lead to increased inflation, and thus pressure on the dollar.

I was working as a State Minister at Ministry of Finance, and we worked real hard during those one year, when we actually saw the drafting of the bill, passing of the law, and enforcement of the law by collecting the tax money. We spend days and nights educating and creating awareness on the new tax laws. We did presentations to the MPs first, so that they can pass the bills after having a understanding of what they are actually passing. We educated the Police, MNDF, political party members, school children, and the general public through various presentations, TV and radio interviews.

We met with almost all the major resort owners, and briefed them on the state of the economy, and almost all of them supported us, and were prepared to provide their cooperation in bringing the economic reforms.

We had a lot of support from the MIRA, and we worked very closely with the entire team there. We abolished the import duties of many consumer goods being imported into the country, and we reduced the import duties of various other items. To compensate,  we introduced GST on general goods, with exclusions on very basic food and other consumer goods and services.

We proposed the abolition of the $8 bed tax after a grace period, so that the tourism sector will be taxed at a rate of 8%. We considered the price elasticity and the income elasticity of our tourism product, and worked on the optimal tax rate that cannot harm the competiveness. Hence, the following tax rates were passed for the tourism sector when it actually became law.

From the introduction until 31^st December 2011 – 3.5%

1 January 2012 to 31^st December 2012 – 6%

1 January 2013 onwards – 8%

Resorts, hotels, tour operators and travel agents always had the complaint of too many changes and within such a short period of time. And this complaint will always be there and it’s a valid one too. As holiday bookings are made so many days in advance, and also promotional materials are printed beforehand, any changes to the tax regime or the tax rate has to be known at least one year in advance. The 3.5% in 2011 made sense, as many businesses actually absorbed it and paid from their profits, in order to not to burden the agents or the customers. The rates in 2012 and from 2013 onwards were being given enough notice, and we all had certainty that it won’t change. Our understanding when we were working on the new tax policies was that tax rates will not and should not be going up after this, and it actually should be going down year by year, as we move on to fiscal surpluses.

We believe that even without increasing the tax rates, we can still have high tax revenues as we expand our production, and as we make new investments. As we cannot continue increasing the tax rates on tourism every time a new government comes into power and every time a new government project or pledge has to be fulfilled. Any changes to the tax rates has to be brought after careful analysis of its impacts on the tourism competitiveness, and the impact on the overall tax revenue in the medium to longer term. Rather we need to focus our attention in increasing more businesses, investing on tourism infrastructure so that we can increase the arrival numbers so that tax revenue can increase.

Guest House Business - my journey

Back in 2009, I started a new venture, along with a very close friend, Mohamed Shihan. Back then, it was something very new, something that nobody has started yet. We called this venture ‘WhiteShell’as we rented a small house right on the beach of Maafushi. As the Government opened up to allow guest houses in local inhabited islands, we were the first to submit our registration. As a result, WhiteShell Beach Inn, is the first guest house to be registered on a local island. So we became the pioneers in it.

Initially, we invested about MVR 300,000 so that we could have 4 rooms fully furnished with AC, and very basic facilities. A small restaurant and a kitchen, and 4 employees. I was working full time in the public sector, as an Economist in MMA, during my weekends, I was busy with setting up of the business, and marketing it. As I did not have enough funds for a professional webpage development, I had to learn on developing websites, and tried my luck with it. Developed our first web site, uploaded it, and started the online marketing of it. Initial months of losses were borne by the monthly salary that I earned, and loans from my partner in business. We made sure the staff were paid on time, and utility bills paid every month. Some of my friends, and people from the tourism sector advised me that it would be a failure, as it is tourism without alcohol, pork, and bikini.

Six months in business, with the various online marketing efforts, we were able to get guests from Russia, Poland, Germany, France, and UK. With my efforts, I was able to put ‘Maafushi’ as a separate destination on various online booking sites, and travel sites. Before completion of the first year, I was able to rent the adjoining house, and later the house next to it, so that before the end of the second year, we were selling 10 rooms, and was running a successful beach restaurant. For the first one and half years in business, we were able to prove to everybody (especially those in Maafushi), that local island tourism can be successfully run for mid-market tourists, and it can be done without having alcohol, pork and bikini. During those months that we were the only guest house in the island, guests enjoyed their time on the beach, and Maafushi, without bikini (in covered clothes, of course), and there were no complaints from the locals. This was because, before the guests booked their holiday with us, they were given the information that it’s a local island and that government regulation does not allow swimming in bikini, just like they are aware that alcohol is not available. Hence, guests were fully informed and aware, and there was no room for complaints or unsatisfaction. Moreover, we got additional revenue because of this regulation; as guests preferred to spend their day in picnic islands, snorkeling, of fishing, and other activities, and that’s additional revenue for us!

Come 2013, we have altogether 20 guest houses in Maafushi now, and 144 rooms. Which means even if we didn’t consider the family rooms, that’d be 288 beds, and with 65% occupancy a 68,328 bed nights per year. Assuming average duration of stay is 4 days, that’s a 17,000 guests per year. With conservative estimates and past revenue records, it is estimated that about $9.7 million will enter the local Maafushi economy, and the guest houses will be paying the State as bed tax and GST a total of $1.3 million (equivalent to MVR 20 million). The income per head from guest houses alone is $4,425 per head in Maafushi. The total income per head of Maafushi after adding incomes from other sectors will be probably the highest in the country. It is a perfect example of making economic growth more inclusive, and a case study for Inclusive Development. In fact, I did present a paper last year in Islamabad, during a South Asia Economic Summit.

With the 20 guest houses, more than 100 locals are being employed in various jobs, ranging from speedboat crew, receptionists, waiters, room boys, accountants, and guest relations officers. Majority of youth are actively engaged in economic activities, without having to spend their times in coffee shops or elsewhere, as they did before. Women with children are able to earn at least MVR 10,000 a month doing laundry services. Last month we spent from our hotel MVR 17,000 for laundry, which is done by a local family.

We, the WhiteShell have played a key role in the expansion, and the success of Maafushi as a tourism destination by leading by example, and also assisting others in the setups. And thanks to MATATO, as we have recently been awarded the Maldives Travel Awards as the Leading Guest House, from the category which they have introduced this year.

There is no doubt that this newly developed industry provides huge economic benefits to the local community and the government in the form of taxes. It also provides other positive externalities like the guest houses taking charge of cleaning the beach area and streets, and taking care of waste disposal. The MWSC (water company), and STELCO are making huge profits from Maafushi, as the per unit rates are relatively higher in Maafushi compared to Male’. With the recently installed more that 144 air condition units, Maafushi is spending heavily on electricity. (There's still more to be done in terms of using efficient energy sources). 

There are many challenges as well, of course. With starting of many new guest houses, many have come to believe that bikini is not a problem, and guests are being told so as well. Less seem to complain though, as almost everybody benefits from the industry. We are yet to find an amicable solution to the issue, with serious discussions with the island council, tourism ministry and the guest house owners. Other social issues/problems can also be addresses in a similar manner. Which means, there’s still a lot of work to be done in order to make the business sustainable, environment friendly, and in order to make the this model a success in other islands. Wish you all a very happy new year!

Spend what you have

Given the utilized resources in the country, are able to raise Rf10 billion as government revenue within a year. That’s the maximum we can spend on all the expenditures of the state; including the executive, judiciary, parliament, and other independent institutions. We cannot afford as a country to spend beyond Rf10 billion in any year given the present circumstances. However,  when we are able to increase the number of economic activities, by making new investments on resorts, hotels, and others, then we may be able to raise additional revenue through tax, and then we can spend more. Trying to increase existing tax rates will not be a solution, as private businesses will be discouraged to make new investments, and also it may affect our tourist arrival, as our tourism product is not as inelastic as we may think. 

Our present behavior of spending beyond our means, have led to accumulation of short term debt exceeding Rf6 billion from local banks. Recently, government has also started raising finance from private businesses by selling T-bills to private companies other than commercial banks. Again we are restricting the amount that would have been invested for future incomes. What is more alarming is that government is borrowing at more than 8.5%, for such short-term.

We cannot continue like this for long. We need to reduce expenditure, so that it can match with what we get through tax revenue. 

Budget 2013

The Government has submitted yet another huge budget for 2013, with an estimated deficit exceeding Rf4 billion, amounting to 6% of GDP. This estimate is based on many changes to the revenue component of the government. Some of the major changes proposed include, revising the import duties, and revision to the GST rate for tourism sector, leading to an increase up to 15% from the tourism sector.

As it has always been said in various forums and writings, we are as a nation living beyond our means. The most basic structural issue with our budget is that over 70% is spent on recurrent expenditure, and from that most goes to the salary and allowances. We have the highest percentage of the population as state employees from the whole world, and the CSC will always justify this. Fact is, last year and this year we have spent/will spend more than Rf4.1 billion only on salary and allowances. It alarming, when the 2013 budget has planned to spend Rf5.7 billion for this component!

As for the financing of the deficit, there's an external borrowing of Rf 771 million, and domestic borrowing of Rf 1.25 billion. This is at a time when we have to spend about $73 million for debt repayments within next year and at a time when our external debt will exceed 40% of GDP by the end of 2013.  This is also at  a time when our domestic market has almost reached its maximum in terms of lending to the government at the huge cost of crowding out the private sector investments, and at a time when outstanding treasury bills exceed Rf5 billion, and the interest rate exceeds 7.8%.

The government has an outstanding debt to MMA of about Rf3.7 billion, and recently MMA has paid $50 million on behalf of the government to SBI for the repayment of US Dollar bonds issued to the government. The equivalent Rufiya amount of 771 million, if government has not yet paid to MMA, the outstanding debt already would have reached Rf4.4 billion. Assuming the remaining $50 million is repaid by MMA in February 2013, it would reach Rf5.2 billion.If nothing is done to repay this debt to MMA, this will be direct monetization.

We will only be able to manage our macro economy on a sustainable path, by rectifying this major structural issue of state employment, and other current expenditures. As and when we increase salaries and government expenditure, the total Rufiyaa expenses in the economy increases, and prices of goods and services go up, without actually increasing the real value of money. In the end, even with so much Rufiyaa in our hands, we are able to buy less. Politicians will never understand this.

Inflation

Maldives economy, as we all know, is a very much import-based economy. We have been importing all our basic necessities, and luxuries. Our main income earner, the tourism industry, also heavily depends on the imported food items, and imported fuel to run the business. The local economy also is heavily dependent on the import prices of commodities, and most important of all, the price of oil. Hence, our inflation has also fluctuated based on such factors as the world oil price and world commodity prices. Of course, the demand side also plays a major part in these fluctuations. There hasn't been a recent published study yet on the actual determinants of inflation in Maldives, so, we wouldn't know how much contribution is from the demand side, or what would be the 'core' inflation in Maldives.

We've had relatively low inflation in 2006 at 3.5%, at a time when world oil price was below $64 per barrel. It was also an year when we had a government deficit of 4.8% of GDP. The following year, in 2007, inflation rose to 7.4%, interestingly when our budget deficit fell to 3.6%, and when world oil prices remained below $50 per barrel. Inflation hiked in 2008 to 12.3%, at a time when the world oil price reached above $137. Our fiscal deficit also hiked to 11.2% during the same year.

Year 2009. Oil price fell to as low as about $30 per barrel, while our fiscal deficit reached a record high of 21% of GDP. Our inflation rate: at a modest 4%. This was also a time when US Dollars was traded in the black market above the official rate.
Fiscal deficit followed a declining path in 2010 and 2011, while oil price had a rising trend, and so did our inflation rate. We also had a devaluation of Rufiyaa, adding on to the inflation in 2011, when it reached 12.8%.

Based on the above observations, it is rather difficult to conclude the actual determinants of inflation, or the factors that contribute most for inflation. Obviously, world oil price plays a major role, and then again, the budget deficit, and how it is financed matters too.

But one this is for sure. The aggregate demand in the economy does play a major role in higher inflation. And this demand mainly comes from the purchasing power of the people in terms of local currency. When the Rufiyaa circulation increases in the economy, people demand more goods and services, and thus leads to higher prices. This being said, the easiest and the simplest way to curb inflation would be to control the increasing rate of Rufiyaa circulation.