This is an English translation of Aman Haleem's analysis for Adhadhu.
The U.S. central bank, the Federal Reserve, has raised interest rate by 0.25 percent, bringing the benchmark rate to a range of 3.75 to 4 percent. Given that this is happening in a distant nation, one might wonder why it matters to us.
However, this decision by the Federal Reserve creates a "ripple effect" that impacts the entire global economy.
The U.S. dollar serves as the world's primary reserve and invoicing currency, with the vast majority of international trade conducted in dollars. When U.S. rates rise, the dollar is drawn back to the United States like water into a sponge. This occurs because investors begin moving their capital into U.S. markets, seeking the safety and higher returns now offered there.
As global dollar liquidity tightens, the cost of borrowing increases worldwide. The dollar strengthens against most other currencies, driving up the costs of international trade and shipping. For an import-dependent country like the Maldives that relies heavily on foreign currency, this translates into significant financial pressure and additional challenges.
Rising costs of external borrowing
Should the Maldivian government need to tap into international financial markets to cover expenditures or service existing debt, the cost of doing so will now be substantially higher.
The Fed’s interest rate serves as the global floor; no bank or financial institution will offer loans or financing at a rate lower than this. Because investors can achieve high returns from ultra-safe U.S. investments, they demand even higher rates to lend elsewhere.
This increase in the cost of foreign debt will simultaneously hike the cost of debt servicing. This adds further strain to a budget that is already struggling to balance. Unless the government manages its dollar inflows more effectively and exercises fiscal prudence, the situation is poised to deteriorate further.
Exacerbating the dollar shortage
Long before the Fed’s rate hike, the Maldives was already grappling with a severe dollar shortage following a downturn in tourism. While the official exchange rate remains unchanged, the value of the Maldivian Rufiyaa has depreciated in practical terms.
The risk to the Maldives—driven by reduced dollar inflows into the banking system due to tourism fluctuations, difficulties in sourcing foreign exchange, and a strengthening dollar—is a further decline in future dollar availability. This presents an added complication just as the government attempts to resolve the dollar crisis through stricter enforcement measures.
The government cannot hold prices down indefinitely against the laws of demand and supply. When the supply of a high-demand commodity tightens, its value naturally rises.
The Maldives Monetary Authority (MMA) has indicated that current reserves are insufficient to maintain the existing peg. Consequently, as the dollar shortage intensifies, the MMA will find it increasingly difficult to defend the exchange rate without adequate reserves.
Further constraints on card transactions
Due to the scarcity of dollars, banks in the Maldives, most notably the Bank of Maldives, have imposed stringent limits on foreign currency transactions via debit and credit cards. This has caused hardship for Maldivians.
Banks have limited card usage because the volume of incoming dollars has decreased. The Fed’s latest move is expected to further reduce these inflows. Much like the MMA, banks cannot sell dollars they do not have.
As the shortage worsens, banks may be forced to review and tighten these limits further. This will make it even more difficult to use cards for essential needs, such as medical treatment, travel, and education expenses, which are already difficult to fund.
Hardship for businesses and rising prices
The dollar shortage has left businesses unable to process Telegraphic Transfers (TTs). Merchants have been complaining that even when they have the funds, TTs are not being cleared.
Furthermore, business owners report that since they cannot obtain dollars from banks, they are forced to purchase dollars at premium rates. They also note that recent government measures aimed at curbing the black market have resulted in dollars becoming completely unavailable.
Amidst this scarcity, the Fed’s rate hike also drives up the cost of goods globally and increases the cost of loans used for business expansion or operations. While businesses initially absorb these costs, they eventually pass them on to consumers with a markup, leading to a general rise in the price of goods and services.
---
These challenges raise serious questions about the nation's economic future. As the situation worsens, the government must adopt a clear and disciplined fiscal policy to manage debt and stabilise the economy.
However, based on the current administration's track record, it appears that addressing these issues may be beyond the government's capability or a challenge it is unprepared to navigate.
