President Ibrahim Mohamed Solih, in his presidential address on 7 February 2019, stated that his Administration aims to raise the foreign currency reserves to USD1 billion by the end of 2023. For a short period last year it seemed the target had been reached with Gross International Reserves reaching USD985 million after which it again dropped to USD853 million in February 2021. A critical, often debated, question is 'what level of foreign exchange reserves is adequate for an open economy such as the Maldives and what measures to use to assess the nation's reserve adequacy?" More importantly, with the Maldives' de-facto fixed exchange regime, the level of foreign exchange reserves is a key indictor in assessing the stability of the exchange rate and also essential in evaluating its external position and financial vulnerabilities.
This important statistic is compiled and published by the Maldives Monetary Authority (MMA) and it used to publish two indicators of international reserves which are Gross International Reserve and Usable Reserves. But, from October last year, MMA stopped publishing Usable Reserve statistics and has started publishing reserves statistics using international reserves and the foreign currency liquidity concept and showing details of reserves using the International Monetary Fund (IMF)’s reserve data template. As per MMA statistics, Gross International Reserves (GIR) or Official Reserve Assets are those external assets that are readily available to and controlled by MMA for meeting balance of payments financing needs, for intervention in exchange markets to affect the currency exchange rate, and for other related purposes (such as maintaining confidence in the currency and the economy, and serving as a basis for foreign borrowing).
The definition used in recent publications of the MMA is almost the same as in its previous publication last year, and when compared to the IMF’s Balance of Payment Manual (6th edition) definition, this is very similar to the IMF’s international reserves concept as well. In most of the IMF’s publications and academic analysis when assessing a country’s international reserves, special attention is put on to the external reserves that are ‘readily available’ and in ‘full control’ of the central bank for meeting balance of payments financing needs and for ‘intervention in exchange markets.' Such external reserves are vital for Maldives as there is always a need for the MMA to continuously intervene to stabilize and maintain the exchange rate peg. At a closer examination of the components of GIR, it can be argued that not all the components meet these criteria and this was the need for an alternative definition introduced by the IMF to Maldives, known as Usable Reserves.
Usable Reserves is the amount of funds from GIR that is available for foreign exchange intervention. It is calculated by deducting the short term foreign liabilities from GIR where the short-term foreign liabilities mainly comprise of foreign currency deposits of commercial banks at MMA. In fact, the Usable Reserve concept is something that is unique to the Maldives which was introduced by IMF as one of the performance criteria during the Fund’s Program in 2010. This unique measure was used as a criterion in addition to GIR since Maldives had a very high Minimum Reserve Requirement (MRR) at 25% in 2010 for both domestic and foreign currency deposits and this resulted a large part of GIR consisting of foreign currency deposits of commercial banks. But in 2015, in order to facilitate private sector lending and to reduce the cost of borrowing for commercial banks, MRR was drastically reduced from 25% to 10% and it currently stands at 7.5% for local currency and 5% for foreign currency. As a result, there was a proportional reduction of commercial banks' foreign currency deposits in the Gross Reserve and one can argue that Usable Reserve is not warranted anymore.
However, this reserve indicator seems more important since MMA has started borrowing funds from the Reserve Bank of India (RBI) under a swap agreement to shore up sudden depletion in foreign reserves and GIR is often ‘window dressed.' This framework of currency swap known as the ‘SAARC Currency Swap Facility’ was established in 2012 by India for SAARC member countries and the Maldives first used it in 2017 with a borrowing of US$100 million. In April 2020, MMA borrowed US$150 million, under the US$400 million currency swap agreement signed in July 2019 between India and the Maldives. Furthermore, in December 2020, the MMA utilized the reminder of the US$400 million swap facility.
This was one of the reason why the MMA’s Gross Reserve reached a record level of US$985 million at the end of December 2020. Using the MMA’s reserve data template, an estimate of the Usable Reserve can be computed by adjusting predetermined short-term net drains. The predetermined drains are the known or scheduled contractual obligations of the MMA in foreign currencies. After adjusting to predetermined drains, the Usable Reserve is estimated to be around US$170 million at the end of last year and as can be seen from the chart below, Usable Reserves on average declined from US$262 to US$210 during 2019-2020.
Normally, such central bank swap facilities act like a credit line and such reciprocal currency arrangements are short-term arrangements that allow the counterparties temporary access to the foreign currencies they may need for a short term. As a result, in most cases, the MMA would not be in a position to sell these funds to stabilize the foreign exchange market. These funds act more like a confidence booster for the market and may not be considered as foreign reserves that are readily available for meeting balance of payments financing needs. However, given that there are various swaps agreement and details of these agreements are not available, the exact nature of these funds cannot be clearly be concluded and is prone to different interpretation and speculation. With Maldives having a sovereign rating and also being involved in the international bond market, the need for more transparency by the MMA is vital and it is important that the MMA publishes as much information about such dealings. Moreover, the MMA needs to start publishing more data about the various Reserve Adequacy metrics as per IMF guidelines.
One such important reserve adequacy ratio which the MMA had also stopped publishing since 2018 was reserve in months of imports. This is one of the most traditional indicators of reserve adequacy and is likely to remain relevant as a simple way of scaling the level of reserves by the size and openness of the economy. The measure is based on months of prospective imports, with three months’ coverage typically used as a benchmark. By using data from the IMF and the World Bank, the most recent reserves using both GIR and Usable Reserves have been estimated (See Table below). Though the GIR’s import coverage reached a record level at the end of last year, when adjusted with predetermined short-term net drains; the Usable Reserves’ import coverage on average remained at 1.1. It can be concluded that, except for this artificial once-off increase in the GIR to imports ratio in 2020, both GIR and usable imports ratio has almost remained the same during 2016-2020.
Key lessons should be learnt from the experiences of countries such as Thailand in previous crises like the Asian financial crises in 1997-98. Reserves adequate to cover more than five months of imports prior to the crisis was not enough in preventing the crisis in Thailand. In the absence of key data such as short-term borrowings, speculation against the Thai baht was one of the factors which exacerbated the crisis. This shows the importance of timely data on significant economic indicators, including foreign debt, both short and long term. A research study by Matthieu Bussière, Gong Cheng, Menzie Chinn, and Noëmie Lisack examining emerging-market performance during the crisis of 2008, found that the ratio of reserves to short-term debt strongly predicted GDP growth during the global downturn and highlighted the importance of monitoring short-term debt and the need to maintain international reserves in relation to short-term external debt. The “Greenspan-Guidotti” rule of 100 percent cover of Short-term Debt is the most widely-used standard of adequacy for emerging countries.
Using the data available by IMF estimates (refer to Table), it can be seen that Reserves over Short-Term External Debt has been falling and seems to be in distress. For GIR it has fallen from an average 290% to 270% while for Usable Reserves it decreased more drastically from an average 115% to 70% during 2016-2020. Prior to the Asian crisis in 1997-98, countries such as Indonesia and Korea had ratios of short-term foreign debt reserves at 180% and 190% respectively. Though the Maldives' ratios are above that of those countries, one needs to be cautious when using these statistics since data on private sector external debt is not accurately captured by authorities yet and IMF’s short term debt estimates are based on proxy variables. As such, the MMA and relevant government institutions need to formulate policies to capture this vital data. It also needs to publish the available data such as short term public debt on a timely manner, for financial markets to make accurate risk assessments of the financial conditions of the Maldives.
With the Maldives’ recent five-year U.S. dollar-denominated Sukuk, or Islamic bonds, yielding a rate of almost 10%, up from the 7% bond issuance in 2017, it appears that the international financial market is already factoring in the additional risk in investing in the Maldives. And if consistent and timely data on important indictors such as international reserves are missing, risk of more speculation and market adjustment by themselves is inevitable.