De-dollarisation in the Maldives: Considerations Before Policy Intervention

Before pursuing policies aimed at reducing the economy's reliance on the US dollar, it is essential to understand why dollarisation exists in the first place; and under what conditions successful de-dollarisation has been managed elsewhere.

Comparisons are often made with countries such as Malaysia, Singapore, and Sri Lanka, where visitors routinely exchange foreign currency for local currency and conduct transactions in the domestic monetary unit. While this observation is factually correct, it risks oversimplifying the underlying economic, institutional, and monetary conditions that make such arrangements possible. De-dollarisation is rarely the result of administrative measures alone. Rather, it is typically the outcome of sustained confidence in domestic institutions, sound macroeconomic management, credible monetary policy, deep and liquid financial markets, and a stable exchange rate environment.

The key question, therefore, is not whether the Maldives should pursue de-dollarisation, but whether the necessary preconditions for successful and sustainable de-dollarisation are in place.

Why Local Currency Dominates in Other Countries

The use of local currencies in countries such as Malaysia, Singapore, and Sri Lanka is primarily a market outcome rather than the result of policy compulsion. Foreign visitors exchange their currencies because businesses, consumers, and financial institutions overwhelmingly transact in the domestic currency. This reflects confidence in those currencies and the monetary systems that support them.

Importantly, these countries operate within financial systems where exchange rates are either market-determined or managed through market mechanisms. Their central banks influence exchange rate outcomes through monetary policy, reserve management, and foreign exchange interventions, but do not primarily rely on administrative restrictions to create demand for the domestic currency.

The Maldives imports the overwhelming majority of goods consumed domestically thus much of its economic activity remains directly linked to foreign-currency transactions.

Additionally, these economies possess relatively robust domestic markets. A substantial proportion of economic activity occurs internally, generating natural demand for domestic currency as a medium of exchange, store of value, and unit of account.

The Maldives presents a fundamentally different economic structure. As a small island economy with a limited domestic production base, it imports the overwhelming majority of goods consumed domestically. Consequently, much of its economic activity remains directly linked to international trade and foreign-currency transactions.

Limitation of the Individual Visitor Analogy

The experience of individual visitors is often cited as evidence that foreign currency can easily be replaced by local currency. However, this observation captures only a small component of overall foreign exchange activity.

Individual visitors typically engage in retail-level transactions such as accommodation, food, transportation, and leisure spending. These transactions represent only a fraction of the foreign exchange flows moving through an economy.

The bulk of international transactions occur between businesses, financial institutions, investors, and governments. These include:

• Import payments

• Export settlements

• External debt servicing

• Foreign direct investment

• Portfolio investment flows

• International banking transactions

• Cross-border commercial contracts

These transactions are generally denominated in internationally accepted currencies, particularly the US dollar, because such currencies provide liquidity, lower transaction costs, established payment infrastructure, and reduced settlement risk.

As a result, observations of how individual visitors exchange money offer only limited insight into the broader role that foreign currencies play in an economy such as the Maldives.

Exchange Rate Credibility and Market Confidence

A particularly important consideration for the Maldives is the nature of its exchange rate regime.

For de-dollarisation to succeed, confidence in both the currency and the exchange rate framework must be sufficiently strong.

Where exchange rates are primarily determined by market forces, currency demand and supply help reveal the underlying equilibrium value of a currency. Central banks can intervene to smoothen excessive volatility, but market signals remain visible.

However, when exchange rates are largely administered a risk emerges if the official rate diverges significantly from market perceptions of value.

In such circumstances, efforts to increase compulsory use of the local currency may unintentionally weaken confidence. Economic agents may interpret such measures as attempts to suppress underlying market pressures rather than address them. Such policies can increase demand for foreign currency rather than reduce it.

For de-dollarisation to succeed, confidence in both the currency and the exchange rate framework must be sufficiently strong that economic agents willingly hold local currency assets and conduct transactions in that currency without coercion.

Implications for Foreign Investment

In the Maldives, the stock of foreign direct investment exceeds the country's annual GDP, making the views of international investors an important consideration in any de-dollarisation strategy.

Foreign investors typically assess investment destinations on the basis of several key considerations:

1. Currency convertibility

2. Exchange rate stability and predictability

3. Ease of profit repatriation

4. Availability of foreign exchange

5. Institutional credibility

Policies that are perceived as limiting access to foreign currency or increasing exchange rate uncertainty can elevate the perceived risks associated with investing in the country. This may reduce the attractiveness of the investment environment and discourage new capital inflows.

Country comparisons should also consider differences in institutional development and central banking experience.

For a small and highly open economy that depends heavily on external financing, maintaining investor confidence is particularly important. A poorly designed or poorly communicated de-dollarisation strategy could undermine confidence, increase the cost of financing, and ultimately reduce foreign investment inflows.

Institutional Capacity

Cross-country comparisons should also consider differences in institutional development and their central banking experience.

Malaysia's central bank was established in 1959, Sri Lanka's in 1950, and Singapore's in 1971. The Maldives Monetary Authority (MMA) was established in 1981. While all these institutions have evolved significantly over time, the former institutions have had considerably longer periods to build monetary policy frameworks, develop financial markets, strengthen regulatory systems, and manage exchange rate regimes across multiple economic cycles.

In the case of the Maldives, although the country has over four decades of central banking history, much of this period was characterised by direct executive influence over monetary institutions. For a significant part of its history, the President also served as Governor of MMA. It was only following the institutional reforms of 2007, which separated the roles of Finance Minister and Governor, that the position of Governor became institutionally independent. Nevertheless, even under the existing legal framework, the President retains the power to determine the value of the Maldivian Rufiyaa against the US dollar.

More importantly, Malaysia, Singapore, and Sri Lanka operate within financial systems that are substantially larger and deeper than that of the Maldives. Their policy frameworks evolved within environments characterised by broader domestic markets, diversified economies, and more developed financial institutions.

An often-overlooked aspect of the de-dollarisation debate is the role of financial market development.

This is not an argument about competence. Rather, it reflects a well-established principle in institutional economics; policies that succeed in one environment may not produce the same results in another if the supporting institutions and market structures differ.

The Missing Foundation

An often-overlooked aspect of the de-dollarisation debate is the role of financial market development.

The Maldives' financial system remains relatively small, concentrated in banking and credit intermediation, with limited capital market development. By contrast, Singapore and Malaysia possess some of the largest local-currency bond markets in Asia, while Sri Lanka maintains a sizeable domestic government securities market that serves as the benchmark for financial pricing and liquidity throughout the economy.

At the end of 2024, Singapore's local currency bond market exceeded SGD 849 billion (approximately USD622 billion), of which government securities accounted for approximately SGD 307 billion (USD225 billion). Meanwhile, Malaysia's local currency bond market exceeded MYR 2.1 trillion, with sovereign securities amounting to approximately MYR 1.2 trillion (about USD270 billion). These markets provide a large supply of local-currency assets that households, banks, pension funds, insurers, and investors can hold with confidence. They also provide governments and corporations with reliable access to domestic funding.

These countries have also developed active secondary markets, benchmark yield curves, functioning interbank markets, institutional investor bases, and sophisticated market infrastructure. Government securities are issued through competitive auctions and traded actively in secondary markets, allowing market forces to determine interest rates and establish credible pricing benchmarks across the financial system.

Sri Lanka, despite its recent economic crisis, continues to maintain a market-based government securities ecosystem comprising Treasury bills and Treasury bonds across a wide range of maturities. These instruments play a central role in monetary policy operations, financial market pricing, and liquidity management throughout the banking system.

The Maldives differs substantially from these comparator countries.

Maldives’ financial system remains predominantly bank-based and credit-driven. The government securities market remains largely dependent on administrative issuance arrangements rather than a fully market-based framework. Secondary market activity is limited, there is no meaningful corporate bond market, institutional investor participation remains narrow, and a complete market-determined sovereign yield curve has yet to emerge.

This distinction matters because de-dollarisation ultimately requires citizens, businesses, and investors to hold their wealth in domestic-currency assets. Deep local-currency bond markets provide a mechanism through which economic actors can save, invest, hedge risks, and preserve purchasing power in the domestic currency.

Without these financial market foundations, economic actors will naturally continue to rely on foreign currencies to perform functions that domestic financial markets cannot adequately provide. In such an environment, efforts to reduce dollarisation through administrative measures may prove difficult to sustain because the underlying demand for foreign currency remains unchanged.

Only when confidence in the domestic currency is firmly established will de-dollarisation become both sustainable and beneficial.

Consequently, strengthening domestic financial markets, developing a market-based government securities market, expanding interbank market activity, creating benchmark yield curves, and fostering local-currency investment opportunities may be more important prerequisites for successful de-dollarisation than policies aimed directly at restricting foreign currency use.

The De-dollarisation Outlook

De-dollarisation should be viewed as an outcome rather than a starting point. History demonstrates that durable reductions in dollarisation are usually achieved not through administrative restrictions, but through the establishment of credible institutions, modern and liquid financial markets and sound macroeconomic management.

For the Maldives, the central challenge is therefore not just reducing the use of the US dollar. It is creating an environment in which households, businesses, investors, and financial institutions voluntarily prefer the Maldivian Rufiyaa because it reliably fulfils the fundamental functions of money.

This requires strengthening monetary credibility, enhancing exchange rate transparency, deepening domestic financial markets, modernising the government securities market, and expanding opportunities for saving and investing in local currency.

Only when confidence in the domestic currency is firmly established will de-dollarisation become both sustainable and economically beneficial. Under such conditions, de-dollarisation will not need to be imposed. It will emerge naturally as the market's preferred choice.