The market is officially black.

The Finance Minister last month in his budget presentations to the parliament nonchalantly declared that a black market in US Dollars was in operation in the Maldives. Listening to that what worried me most was not the fact that a black market was actually in operation, that I knew even before his declaration, but how cool and unconcerned he sounded in his declaration. He sounded as if he was talking about a black market for tickets in SAFF Championship.

What are the implications of that news? What can it do to investor confidence? What are the effects to the economy of a low investor confidence?

In Maldives our currency Rufiyaa is pegged to US Dollars. We have maintained a fixed currency regime for a very long time. Through the economic ups and downs over the years, the Central Bank overall has done a good job maintaining the peg in the past. But that should not make us overconfident in an ever evolving and a dynamic global economy where a single economic trigger anywhere in the world can have drastic and lasting effects all over the world.

The emergence or creation of a black market in a fixed exchange rate economy in itself signals among many things; that the Central Bank is having difficulties with its foreign currency reserves.

Typically, a government wanting to maintain a fixed exchange rate does so by either buying or selling its own currency on the open market. This is one reason governments maintain reserves of foreign currencies. If the exchange rate drifts too far below the desired rate, the government buys its own currency off the market using reserves. This places greater demand on the market and pushes up the price of the currency. If the exchange rate drifts too far above the desired rate, the opposite measures are taken.

In the past we have seen that governments attempts to maintain a high local currency to the peg has resulted in severe financial crisis around the world. This was seen in Mexican (1995), Asian and Russian (1997) financial crises; an attempt to maintain the peg against the natural economic conditions resulted in the currencies eventually becoming overvalued. That meant that the government could not meet the demands to convert the local currency into the foreign currency at the pegged rate. With speculation and panic, investors scrambled to get out their money and convert it into foreign currency before the local currency was devalued against the peg; foreign reserves eventually became depleted. In Mexico’s case the government was forced to devalue peso by 30%. In Thailand, the government eventually had to allow the currency to float, and by the end of 1997, the baht had lost its value by 50% as the markets’ demand and supply readjusted the value of local currency.

Subsequent to the declaration by the Finance Minister in April I expected a response or a reaction from the Central Bank MMA. I expected them to formulate measures to build or maintain investor confidence in our country. I expected them to denounce the black market operations and take actions against such operations. I expected them to inform public about the difficulties the country is having in foreign currency issues and about the attempts that are being made to solve the problem. So far nothing has been said by MMA.

In the April 2009 issue of Monthly Economic Review published by MMA, not a single word was said about the current foreign currency difficulties, but merely just stated as follows:

“The Maldivian Rufiyaa, which is pegged to the United States dollar, stood unchanged since the 9 percent devaluation in July 2001, with the buying and selling rates remaining at 12.75 and 12.85, respectively”.

Nothing out of the ordinary this country is experiencing. Everything seems normal and calm … as far as the government and the central bank is concerned.