By Riaz Shareef, PhD (UWA), 12 June 2008
The MMA Governor asserted that a ‘currency crisis’ is imminent and the Trade and Development Minister argued that we should introduce taxation—all eyes are pointing at the current financial sector imbalance. Jihad and Jaleel are prominent economists in the country, who I know and have deep respect for. In the past, both of them have seen through similar phases in the domestic financial sector.
This time it is different! Both of them are saying it in public and there is public scrutiny, particularly in the blog-sphere already. I take liberty to present my assessment.
Jihad is concerned that if there is insufficient cash inflow in the fiscal account to offset government expenditure, will result in unsustainable inflation. Furthermore, he warns that there might be a bank run on the foreign exchange reserves, which would put pressure on our exchange rate (Rf to US$) to devalue. Any devaluation would result in inflation. I would say, the current bilateral exchange rate is significantly over-valued.
I’m not aware of the parliamentary question presented to Jaleel. However, he declared to introduce taxation, perhaps to introduce a goods and services tax to replace import duty. It is because import duty distorts international trade and reduces welfare of the Maldivians. That is standard textbook international economics, which I do not believe applies to the Maldives, simply because we do not engage in conventional international trade.
In the Maldives, there are no domestic industries that need protection from foreign competition. The Maldivian economy is a 100 per cent import-based economy—our total consumption and production is import-based. Almost all our imports are subject to an import duty, of which some are exempt; the power of exemption rests with the President. As the economy expands, imports rise and hence, the proceeds of import duties increase. Import duty receipts account for a substantial proportion of revenue in Government Budget, which is the only tool of macroeconomic management in the Maldives.
Import duty in the Maldives is a revenue generating phenomenon to finance the Budget, as opposed to a protectionist measure to safeguard domestic industry from foreign competition. That was the original reason for the introduction of import duties. Then, it was called import tariffs.
Implementation of broad-based taxation is the World Trade Organisation (WTO) argument. Mind you, we are signatory to the WTO and they put undue pressure on us to eliminate import duties. I’m not entirely sure of the benefits for us of being a member of the WTO. Often times, the agendas of large multilateral agencies do not serve any purpose for small economies like the Maldives. The WTO taxation argument is not valid, because it is based on the conventional wisdom that taxes are welfare-reducing and hinder globalisation. Even with the current levels of import duties, most goods that are available in the domestic market are relatively competitive. In comparison to most regional countries, there is more choice of internationally traded goods in the Maldives—thanks to our tourism industry.
Our principal international trade is tourism, which is an invisible export, a service and does not have to cross borders for trade to occur. The international tourism consumer has a choice between tourism in her country-of-residence and other international destinations. A direct or indirect tax on the Maldives’ tourism product will not reduce the welfare of the Maldivian, because such a tax is a manifestation from outside the jurisdiction of the Maldives.
Theoretically, the tourism tax (or bed tax on Maldives’ tourism product) is paid by the tourist at the time of purchase of the package holiday. That is when the tourists pay for their bed-nights in the Maldives. Technically, they had paid their tax before they arrive.
However, in practice each tourist resort pays the tax to the Inland Revenue (on behalf of their guests) from the bar sales proceeds on the resort or an overdraft from a bank. An increase in the tourism tax will increase the welfare of the Maldivian, provided that the tax receipts are equitably distributed. What is so bizarre is that most tourists do not know that there is a bed-night tax, although it is a statutory obligation.
An immediate measure would be to increase the current tourism tax (or bed-night tax) to US$10. The entire industry would cry out loud, saying such a measure would be detrimental to the industry. It would not! Such a measure will reduce resort profits, which is perfectly justified, in view of foreign exchange retention.
Maldives’ tourism industry is unique and founded on laissez-faire from its inception in 1972 to date. Our tourism industry’s clientele is up-market and middle-to-high income from the world’s most affluent countries—the G8. To spend an extra US$10 or US$50 per bed-night will not be a concern to someone who is willing to pay between US$200 and US$1,000 per bed-night, respectively. The future prospects of the economic fundamentals of the principal tourism source countries are steady, implying stability to our tourism industry’s growth outlook.
A medium-term measure to the current financial imbalance would be to change the current tourism tax to an ad-valorem tax—a bed-night rate based tax. Five per cent on the price of bed-night sold would be an ideal tax rate to start and then gradually increase with changes to economic fundamentals in the tourism source countries. Prudently, it should increase annually. For instance, at 5 per cent, a low-end resort selling a bed-night for US$ 200 would charge a bed tax of US$ 10 per bed-night, while a high-end one selling a bed-night for US$ 1,000 would charge a bed tax of US$ 50 per bed-night. Such a tax would be more equitable. With such a strategy we do no have to depend on Ghulhi-Falhu fiscal policy measures, which is a temporary remedy to an on-going problem.
The current tourism tax rate does not differentiate between high- or low-end resort clientele. In fact, high-end clientele are paying less tax as a proportion to their total package cost. That property is a severe distortion and welfare-reducing for the economy. Maldives is different; unique and need not abide by conventional tax practices. We have to design economic management techniques unique to our economy, so that we get the greatest benefit to the broader community. We don’t have to bend over backwards, when it comes to international relations. We need to grow up.
The ad-valorem tax measure explained above was formulated and presented to the Maldives by the IMF in 1994. This was done intelligently because it was a minor modification to an already established measure, with anticipated gains. I am not aware of a tourism tax like ours anywhere else in the world, so it is unique to us. Had we introduced the measure as it was suggested by the IMF in 1994 or around then, I’m confident we would not be in the financial mess that we are in today.
Tourism is the engine of our economic growth. I am sure our tourism industry has the potential to sustain our economic development for a foreseeable future, if we plan and manage it. Please don’t throw the kitchen sink at it. We all know that our tourism industry can withstand many unexpected shocks. Our tourism industry reverted back to its mean growth path within 17 months after the 2004 tsunami, which is an impressive record for a small economy. I have no doubt that we could generate substantial income from our tourism industry and build sizeable foreign exchange reserves to secure Rufiyaa to be one of the strongest currencies in the region. But don’t let some Maldivians know that we have foreign exchange reserves!
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