What is Causing Inflation in Maldives?

The most recent inflation figure published by authorities in the Maldives is the inflation of March 2007 and it stood at 3.93% (moving average). The overall trend is that the prices have been increasing since the beginning of the year. The highest weight is given to “other food” item (food other than fish and beverages) in the CPI calculation. It accounts for one fourth of an average Maldivian’s consumption. The CPI index for ‘other food has been increasing significantly since June 2006, although its’ price growth has decelerated in the first quarter of 2007. Housing and utilities represents 5% of the CPI weights and is increasing at a steady (around 5%) rate every month. Household equipments has an accelerating trend in the prices every month August 2006. Health prices were increasing at high levels last year but since December the prices are increasing at a speed above 10%. Communication prices are on a declining trend since June 2006. Prices of hotels and restaurants are increasing sharply although it accounts for just 1% of the CPI weights. Tobacco and narcotics accounts for 2.8% of the weights and it is also increasing at a high rate.

In general, the Maldivians are feeling the current inflation due to the increase in prices of food, housing and utilities and health prices. The inflation felt in the economy could be higher than what numbers suggest as depicted by media and comments from public regarding continuous increase in price of some of the daily and basic commodities in the Maldivian market.

What could be causing inflation in the Maldivian economy? Rest of this article would try to get an explanation for this question.

Deficit budget?
Milton Friedman stated that inflation is a monetary phenomenon and economic theorists who have opposing theories also agree with Friedman. It means that inflation can only be triggered by money creation or by increasing money supply. Therefore a budget deficit by itself does not create inflation and inflation driven by a budget deficit depends on how the deficit is financed. A budget deficit can be financed by borrowing domestically, borrowing from abroad or by printing money. Domestic borrowing will not trigger inflation as money supply would not be affected. However, increasing foreign debt or printing money would cause inflation as it would increase money supply.

The Maldivian budget is forecasted to be at a deficit of MRf3.7 billion in 2007 to be mainly financed by foreign debts. However the deficit for the first quarter of 2007 stood at MRf438.8 million and is mainly financed domestically through issuing T-bills (according to MMA’s Quarterly Economic bulletin March 2007).

If this claim is right, then budget deficit would not have caused inflation or at least the budget would not be the primary cause of cause of inflation.

Revenue increasing proposals such increasing import duty or implementing a tax system can also cause inflation through higher costs. The budget has revenue proposal such as increasing import duty on certain items and increasing work permit fee. This would indeed increase the costs of various business sectors. However it is not clear that these policies have been implemented yet. When they are not implemented there would not be any cost push inflation caused by the budget.

A Surge in aggregate demand?
A budget deficit (including the fiscal deficits of recent past) may cause inflation indirectly through increasing income of the people. A budget deficit would cause national income to increase. The Maldives has also recorded a huge 19% increase in real GDP. These factors would increase the demand for commodities from people and if the supply is not sufficient enough, it may result in relative increases prices of certain commodities and hence in turn (if those commodities are weighted high in CPI) inflation.

A shortage in supply of some commodities?
Of course a shortage in supply of goods would cause to drive the prices. But this would only cause the relative prices of those commodities to rise, not the general price level. This is claimed to be the case by some reports in media as there has been only increase prices of some food items. But on the other hand prices of such goods may increase due to the inelastic nature of demand for such goods. It could still be caused by a factor that is causing inflation and necessities are being affected more than other types of goods.

Import data shows that there has been an increase in imports of food items in the first quarter of the year compared to the first quarter of last year. But has such imports has decreased compared to the previous quarter (last quarter of 2006) slightly. Therefore it implies that demand for goods has grown considerably in recent months the import supply of such goods is not sufficient to offset the increase in demand.

Public expectations
Inflation can be fueled by public expectations of inflation. The deficit budget has increased speculation among various businessmen in the Maldives that sooner or later some revenue boosting policies in the budget are going to raise their costs of business activities. This might have caused them to increase the prices of goods as soon as possible as it has to be done in a near future when those policies are implemented. The budget received huge criticism but it was credible. Most people believed that activities in the budget would be done. This might have caused an expectation regarding an increase in costs during the year which made businessmen be proactive and hence increase the prices.

This might also be coupled with speculations about future commodity supply in the world market as there has been a shortage of supply of good as some traders say.

Money growth?
Monetary data indicated that there has been increase in money supply. Monetary base and M1 increased at a decelerating rate but M2 has grown by 18% during the first quarter of 2007. MMA states that this rise is accounted by increase in foreign currency deposits from tourism. A steady money growth would keep inflation stable but excessive increase in money supply would cause price instability – meaning undesirably high rate of inflation. An 18% growth in M2 after a 12% increase in the previous quarter could increase income but it is unlikely that it is the most important factor that is causing current surge in general price level.

World market influences?
The Maldives is an economy highly dependent on imports and foreign trade. Therefore trends in world market are translated into the Maldivian economy. Increase in world prices of commodities would cause the prices in Maldives to increase too. This would again be supported by fixed exchange rate system. As the local currency would not fluctuate, an increase in foreign price would directly be seen in the Maldives. Commodity prices in the importing countries might have increased to cause the Maldivian prices to surge and this has been cited by some traders as well. Higher oil prices would also increase the costs of many Maldivian businesses and hence various other commodities. Therefore factors that are in the world market could cause inflation to rise.

Conclusion
In conclusion, inflation in the Maldives is caused by a variety of factors. These include increase in demand for goods excessively, world market trends and public expectations. The budget of 2007 might not have directly contributed to inflation although expectations resulting from it may fuel inflation.