Trapped by the Dollar: Why the Maldives Must Break Free

Every day in the Maldives, the cracks in an outdated exchange rate policy grow wider. Ahmed, who runs a small online store, scours Viber groups to buy dollars at inflated rates, risking scams by anonymous sellers just to keep his business afloat. Mariyam searches desperately for enough dollars to cover urgent medical bills abroad, while Ibrahim, hoping to capitalize on the demand for foreign currency, finds his bank account frozen for operating without a proper exchange license. Even as thousands of tourists arrive daily, many Maldivians are left asking why the dollar remains so scarce and the exchange rate so stubbornly high.

These are not isolated stories; they are the lived realities of many Maldivians trapped by a currency peg that no longer serves their interests. The fixed exchange rate policy, once seen as a pillar of stability for a small, tourism-dependent economy, now acts more like a straitjacket, limiting the nation’s ability to adapt to an ever-changing global economy. The time has come for the Maldives to rethink its decades-old peg to the US dollar and consider a more flexible, managed floating exchange rate that reflects the country’s current economic realities.

By making this change, the Maldives could foster sustainable growth and greater resilience, freeing itself from a system that constrains rather than protects. The stories of Ahmed, Mariyam, and Ibrahim are a wake-up call—a reminder that the costs of sticking with the status quo are becoming too high to ignore.

The Drawbacks of the Fixed Dollar Peg

Since the global financial crisis of 2008, the Maldives has faced significant challenges due to the misalignment between the MVR and the US dollar. This misalignment, which has varied in severity over the years, has created substantial economic challenges:

• Persistent Exchange Rate Misalignment: The gap between the official pegged rate and the market rate has widened considerably, with a current discrepancy of around 20%. This gap reflects a broader lack of confidence in the fixed exchange rate, pushing businesses and individuals to rely on black market transactions to access foreign currency.
• Significant Balance of Payments Challenges: The Maldives is facing significant balance of payments challenges, with a current account deficit of USD 1,400.9 million in 2023 and only a marginal improvement projected to USD 1,394.6 million in 2024. Adopting a more flexible exchange rate regime could enable the country to adjust more swiftly to external shocks and fluctuating global demand conditions ^{1 2}.
• Inflexibility in Responding to Economic Shocks: The COVID-19 pandemic further highlighted the limitations of a fixed exchange rate. The Maldives was unable to adjust its currency to reflect changing economic conditions, deepening currency misalignment due to fiscal deficits, increasing debt obligations, and currency printing to cover budget shortfalls. Fixed exchange rates often prevent countries from using monetary policy effectively to respond to shocks, leading to overvaluation and economic crises ^{3 4}.
• Distorted Business and Financial Practices: The fixed peg encourages distortions in accounting and financial practices, particularly in the tourism sector, where most transactions occur in US dollars. Under the current system, businesses are not incentivized to bring foreign earnings into the country or convert them to MVR, which promotes dollarization and weakens the local currency’s role. Moving to a more flexible exchange rate would compel businesses to use MVR more actively, aligning their financial practices with the country's economic goals.

Outdated Arguments for a Fixed Peg

Supporters of the fixed peg often cite stability as essential for a small, tourism-driven economy like the Maldives. However, these arguments are increasingly unconvincing:

• Flawed Comparisons with Gulf Nations: Unlike the Maldives, Gulf countries such as Saudi Arabia and the UAE maintain their dollar pegs due to their reliance on oil exports priced in USD and their substantial foreign reserves. The Maldives does not share these characteristics.
• Misinterpretations of China's Strategy: China, often cited as an example, does not maintain a hard peg to the USD. Instead, it employs a managed floating regime that allows the yuan to fluctuate within a controlled range to balance competitiveness with stability.
• Overstated Fears of Speculative Attacks: Fears of market manipulation, similar to those seen in the 1997 Asian financial crisis, are overblown. Today’s global financial environment features stronger regulatory oversight and more robust market infrastructure, reducing such risks. Countries like Thailand, heavily impacted by the crisis, have since adopted managed floats and achieved greater resilience and growth.

Learning from Other Nations’ Successes

To understand why the Maldives might benefit from shifting away from a fixed peg, consider the experiences of other countries:

• Seychelles: In 2008, amid a severe economic crisis, Seychelles transitioned from a fixed peg to a managed floating exchange rate. This shift was part of a comprehensive reform package that included tightening fiscal policies, liberalizing the exchange rate, and restructuring external debt. Within three years, these measures restored macroeconomic stability and resilience, demonstrating that a flexible exchange rate, supported by sound policies, can help small economies recover from crises and adapt to global changes⁵.
• Thailand: After the 1997 Asian financial crisis, Thailand moved from a fixed peg to a managed float, allowing the baht to reach a more realistic market value. This flexibility enabled quicker economic recovery and strengthened resilience against external shocks, proving that a managed float can act as a buffer, helping economies stabilize and grow in unpredictable global environments^{6 7}.

These examples show that combining a shift to a managed floating exchange rate with broader economic reforms can enhance stability, restore confidence, and support long-term growth—a strategy the Maldives should consider.

Reassessing Dr. Azeema Adam’s Arguments

Dr. Azeema Adam, the former Governor of the Maldives Monetary Authority (MMA), advocates for maintaining the fixed exchange rate regime in her thesis, "Exchange Rate Issues in the Maldives"⁸. Her analysis, primarily reflecting the economic conditions of 1990-2010, highlights the perceived stability a fixed peg provides in a highly dollarized and import-dependent economy. While this argument was valid given the economic realities of the Maldives at the time, it may be less applicable to the rapidly changing global economic landscape.

However, Dr. Adam's thesis primarily focuses on the advantages of a fixed peg, with limited exploration of alternative regimes such as a managed float, which could offer a balance between stability and flexibility. Her emphasis on stability does not fully account for the potential drawbacks of inflexibility, particularly in the face of recent economic shocks like the COVID-19 pandemic. This suggests a missed opportunity to consider how a more adaptable exchange rate regime might better serve the Maldives' current and future economic needs.

Moreover, while her work provides a valuable historical perspective, it underestimates the impact of evolving global dynamics and internal economic changes in the Maldives post-2010. Given today's interconnected and volatile markets, a more flexible and responsive approach may be necessary. Therefore, it is time to re-evaluate her conclusions in light of these contemporary economic realities and consider new exchange rate strategies that combine both stability and adaptability.

Balancing the Risks and Opportunities of Transition

Transitioning to a managed floating exchange rate is not without its challenges. The shift could bring about initial volatility, inflationary pressures, or capital flight, particularly in a small, open economy like the Maldives. However, these risks are not insurmountable. A phased approach, supported by tight monetary policy, enhanced financial sector supervision, and collaboration with international financial partners, could help mitigate these dangers.

For example, tightening monetary policy could help manage inflationary pressures, while better financial supervision would prepare banks and businesses for potential currency fluctuations. Additionally, gradual implementation could provide a buffer against abrupt economic shocks, allowing time for necessary adjustments. As seen in countries like Canada during the 2014-15 oil price shock, a well-managed transition can maintain stability and even lay the groundwork for future growth⁹.

Unlocking Financial Innovation and Opportunities

Adopting a more flexible exchange rate would also encourage banks to integrate currency exchange into their core operations, fostering new financial activities such as hedging, arbitrage, and foreign exchange trading. These innovations would provide businesses and individuals with more reliable access to foreign currency, create jobs, and spur the development of related industries, further diversifying the Maldivian economy.

Conclusion: A Necessary Shift for Economic Resilience

The Maldives' current fixed peg to the US dollar is increasingly misaligned with its economic realities. Clinging to this outdated policy exacerbates inefficiencies and limits the country's ability to respond to global changes. The IMF’s assessment of high debt risks and declining reserves further underscores the urgency of re-evaluating the existing exchange rate policy.

With the right policies in place—such as controlling internal USD transfers and setting holding limits—the Maldives can transition smoothly to a more adaptable exchange rate regime. Embracing this shift would align the Maldives with global best practices, fostering economic stability, growth, and prosperity in an ever-changing world. The time for change is now, and the Maldives must act with courage, clarity, and commitment to secure its future.

Footnotes

1. Ghosh, A. R., Ostry, J. D., & Chamon, M. (2014). Exchange Rate Regimes and External Adjustment: Does Flexibility Matter? International Monetary Fund. Retrieved from IMF. ↩
2. Obstfeld, M., & Rogoff, K. (2018). Exchange Rate Dynamics Redux. Oxford Economic Papers, 129(617), 408-423. Retrieved from Oxford University Press. ↩
3. Frankel, J. A. (1999). "No Single Currency Regime is Right for All Countries or at All Times." NBER Working Paper Series. National Bureau of Economic Research. ↩
4. Edwards, S. (2000). "Exchange Rate Regimes, Capital Flows, and Crisis Prevention." NBER Working Paper Series. National Bureau of Economic Research. ↩
5. Rojid, S., Afif, A., & Sacerdoti, E. (2013). "Seychelles: How Classic Policies Restored Sustainability." World Bank. ©2013 International Bank for Reconstruction and Development/ The World Bank. ↩
6. International Monetary Fund (2001). "Exchange Rate Regimes: Is the Bipolar View Correct?" IMF Working Paper. Available at: IMF Website. ↩
7. International Monetary Fund (2018). "Thailand: Financial Sector Assessment Program." IMF E-Library. Available at: IMF Website. ↩
8. Adam, Azeema (2011). "Exchange Rate Issues in the Maldives." Ph.D. Thesis. University of Queensland. ↩
9. Schembri, L. (2020). "Exchange Rate Regimes in Canada: Lessons from the 2014-15 oil price shock." Bank of Canada. ↩