Sept 13, 2008 (LBO) – The Maldives can maintain its dollar peg despite a steep rise in inflation if budgets improve and the island’s newly re-constituted monetary authority does not print money to finance fiscal deficits, the International Monetary Fund (IMF) has said. –break—
Inflation was projected at 15 percent for 2008 up from 7.4 percent, but IMF said the country’s dollar peg could be maintained if budgets improved.
“The Maldives appears to have adequate room to maintain competitiveness under the peg despite the recent rise in inflation, provided imported inflation is not exacerbated by fiscal slippages,” the monetary watchdog said.
Exchange rate pegs are broken when governments use large volumes of central bank credit (printed money) to finance budget deficits.
Attempts to maintain pegs (defend the currency with foreign reserve sales) without raising interest rates could then result in a full-blown currency crisis and very high levels of inflation, as had happened in Pakistan and Vietnam in 2008.
Central banks are prevented from raising interest rates and forced to print money by finance ministries. The lack of central bank independence is known as fiscal dominance of monetary policy.
The IMF said a new cen