The discussions in coffee houses have shifted from party politics and the mundane to the economy. Most of them are now centered around the rising inflation and the impending doom that has been predicted on broadsheet papers, online news sites and social media. Even the number of customers in cafes, hotels and the likes have decreased substantially indicating a decrease in spending power. Once where coffee houses were full to the brim, during this period of the month, there are now empty tables. All of these are anecdotal evidence claimed by many that inflation is rising.
On shops and supermarket shelves prices of food have increased. Where once you could fill a week’s supply of food for a nuclear family of 4 for under 500, it needs double that. In addition to the pass through in the parallel market dollar rate to shelf pricing, retail stores complain that there has been a fall in sales revenue. Together with these impacts, the economic pessimism that is permeating society and the silence on the part of the government to address the economic situation is contributing to the downturn in the economy.
According to the Maldives Bureau of Statistics, inflation today is 2.33%. One of the reasons for the headline inflation figures to remain low is the impact of subsidies for electricity, health, housing, and basic commodities like rice, flour and sugar to name a few. Recent government statistics point out that there is an expectation that inflation for this year would be 3.78%. On a positive note, inflation figures estimated by the IMF and Statista (2024) predict that, if the economy is handled properly, this rising inflation can be curtailed. But can it be? The specter of even higher inflation is looming given the situation of the economy and the lack of evidence of any official corrective measures.
What are these remedial measures that would signal a path to recovery? Most of the coffee house discussants, tourism industry experts and professionals alike blame the rise in inflation on the excesses of the government. Subsequent budget deficits, by past governments, have contributed to the current economic mess. The rhetoric of the current government, peppered in every public conversation, is that the ongoing mess is a problem created by our ancestors, who have overspent over and above what the government can raise in taxes and revenue. In addition to the rhetoric, this government has also continued to increase spending. In the end, according to Milton Friedman, the people will have to pay these excess spending through additional taxes, or borrowings or through inflation.
Among the solutions bandied around for additional government spending is an increase in taxes. The last time Majlis increased taxes on goods and services (GST) from 6 to 8% in 2023, MMA estimated that the impact on inflation would be more than 2.2%. These additional taxes would then be inflationary. Other taxes that could be increased with less impact on inflation would be those that are levied on the tourism industry. However, as these also have increased just recently (2023) there is little scope to increase it in the shorter term. However, adjustments in taxes alone will not help address the current economic situation: meaning reducing the impact on inflation. These tax measures must be followed with an adjustment on government expenditure. As an example, after the expansion in government spending during the Covid 19 pandemic and the following year, the UK government undertook fiscal policy adjustments to bring down inflation through increases in taxes together with a reduction in public spending. This frugality helped tame inflation.
The last avenue that remains to solve the current budget deficit is to borrow more as a way out of this situation. However, with the country being classified by IMF and other multilateral agencies as highly likely to default, the prospect of borrowing is very narrow. In addition, with the downgrade of sovereign ratings by both Fitch and Moody’s to junk status, Maldives is locked out of private markets.
Both raising taxes and resorting to borrowing cannot solve the current economic problem if it is not followed with spending cuts. The government has talked about reducing expenditure by tackling the increasing cost of subsidies mainly by introducing targeted schemes. This is a solution that has been on past 3 budget plans and not implemented. A reduction of expenditure through subsidy targeting and hence reduction, will impact inflation. As mentioned earlier, inflation remains low due to the impact of subsidies. Experts reckon that any adjustment or reduction in subsidies will impact inflation by 2-3%.
In the government’s narrative, any reduction in government expenditure will hurt the government. This has not been the case in many countries where a reduction in government expenditure ultimately led to the increase in the government’s popularity.
For example, Seychelles when faced with a severe debt crisis in the 2000s, implemented austerity measures such as reducing public sector wages, eliminating subsidies and improving tax collection. The government of James Michel was re-elected in 2011. Likewise, Germany after the financial crisis in 2008. Despite the austerity measures, Chancellor Angela Merkel was re-elected.
Also, Sweden in the 1990s, after a financial crisis, the government implemented spending cuts among other measures to restore economic stability. The Social democrats, who spearheaded the reforms were elected in the next election.
One of the main drivers of inflation in the Maldives is the increase in money supply. As in other countries the fastest solution to tackling the Covid 19 crisis was through increasing the money supply when all other sources of revenue had dried up. In other countries, the following years were spent on either reducing expenditure to levels before the pandemic or by mopping up the excess liquidity in the market. Maldives, on the other hand, increased government expenditure substantially there exacerbating an already inflationary scenario.
Currently, this administration is loath to implement any reduction in expenditure. In fact, there has been an increase in expenditure and the government expects to kick the can down the road by either increasing taxes or borrowing its way out. Now those two options look highly unlikely given the reasons explained above. For the public, with no indication of corrective measures on the part of the government, this would mean that they would finally have to pay for the government’s excesses through higher inflation.
