DTIS, Volume I - Enhanced Integrated Framework (EIF)

crisis. Accordingly, the Rufiyaa was devalued by 8.5 per cent in 2001 to avert a foreign
currency shortage.
Although the authorities acknowledge the adverse impact of an over-valued exchange
rate on economic diversification and competitiveness, they are also concerned about the
inflationary effects that a devalued currency may have on an economy heavily reliant on
imports.
Together with the structural changes in the economy, the exchange rate regime may point
to a situation that resembles the so-called ‘Dutch disease.’ Although the disease is
generally associated with the spending of revenue generated from a natural resource
discovery, it can occur from any development that results in large inflows of foreign
currency. With tourism accounting for 80 per cent of FDI receipts in the Maldives, the
tourism sector has had a similar effect. The impact has been most prominent on the
Maldivian fisheries sector, which has experienced slow growth and reduced welfare
impacts.
IV. Inflation and Financial Sector Trends
The exchange rate peg and conservative management by the Maldives Monetary
Authority (MMA) over financial flows has resulted in low single digit and even below
zero inflation rates during the last five years. However, one of the effects of
reconstruction and rehabilitation following the tsunami was a sharp increase in inflation
to 8 per cent during the first half of 2005, which had decreased to 6.6 per cent by the end
of July 2005. The MMA forecast is that inflation will continue to decrease during 2006
and 2007 to previous levels.
Overall there was a sharp growth in liquidity and credit during the first half of 2005 as
lending for reconstruction and rehabilitation picked up after the tsunami. (see Table 2.3
below). This expansion in credit was largely facilitated by an increase in borrowings from
overseas by the commercial banks, also leading to an abrupt down turn in net foreign
assets (NFA) of the banking system.
Table 2 3: Inflation, Interest Rates, Liquidity Trends and Debt
2000 2001 2002 2003 2004 07/2005
Exchange rate pegged (Rf per US$) 11.77 12.24 12.8 12.8 12.8 12.8
Inflation (per cent change in CPI) -1.2 0.7 0.9 -2.9 6.4 6.6
Interest level (per cent p.a.) 17 - 24 8 -13 8 -13
Net foreign assets (million Rf) 1662.9 2,613.4 3,366.6 2,813.7
Public sector credit (million of Rf) 1,344.9 1,002.2 741.5 1,168.9
Private sector credit (million of Rf) 2,100.8 2,244.4 3,541.3 4,306.7
Other items (million of Rf) -1,142.1 -1,316.3 -1,622.6 -1,555.8
Broad money (M2) 3,966.4 4,543.7 6,026.9 6.703.4
External reserves in months of import 4.1 4.1 3.8 3.2
External debt/GDP (per cent) 33.9 33.6 40.4 39.3 38.4
Debt service ratio ª) 4,2 4.1 4.3 3.7 3.8 5.6
ª) Ratio of debt service to exports of goods and non-factor services
Source: Economic Statistics, MMA, December 2004 and update, July 2005
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