16 March 2018

18 Years Later: Should Timor Drop the U.S. Dollar?

On 29 January 2018, the Institute of Business (IOB) hosted a national seminar entitled Bele ka lae Timor-Leste iha moeda rasik? Perspectiva no desafius?, where representatives of government, academia and civil society shared ideas regarding the possibility of Timor-Leste implementing its own currency. Juvinal Dias from La’o Hamutuk gave a presentation alongside Minister of Finance Rui Gomes, Director of the Economics and Statistics Division of the Central Bank Gastão de Sousa, and Monash University Professor Brett Inder. Click on each name to download their presentation.

The following article reflects La’o Hamutuk’s presentation.

In 2000, while the UN Transitional Administration (UNTAET) was governing Timor-Leste, UNTAET, the IMF and some Timorese leaders recommended dollarization. At that time, several currencies were circulating in Timor-Leste’s economy. The Indonesian rupiah was widely used in markets and rural areas, Australian dollars circulated among businesses patronized by expatriates, employees of UN agencies were paid in U.S. dollars, and some Timorese citizens received pensions in Portuguese escudos. As no official currency exchange facilities existed, all foreign exchange was essentially “black market,” with no consistency of rates.

The transitional administration chose the U.S. dollar for various reasons. The Indonesian rupiah was very unstable; it had crashed in 1997-1998 and remained volatile in the coming years. The Portuguese escudo was being phased out in Portugal and replaced by the euro. The IMF and others pushed for dollarization to try to make the Timorese economy more stable, through price predictability, regulated foreign exchange and reduced reliance on the black market. The U.S. dollar was already used by UNTAET, was relatively stable on the global market, backed by a strong economy, and was the reference currency for the world oil market.

Benefits to using the U.S. dollar

International exchange rate stability

The value of new currencies often fluctuate as the global market tries to determine their worth relative to all other currencies. Currency values are based on existing credit history, long term monetary policy decisions and economic performance. New currencies are untested in their responses to different economic conditions, and therefore in the short-term it is difficult to determine the proper exchange rate.

In the case of Timor-Leste, national institutions have not yet proven that they can resist the temptation to print more money during economic hard times. Our currency could become more stable over time, as the Central Bank establishes a good policy record, but until the value would likely fluctuate.

Structure for young institutions

One challenge often faced by newly independent countries is having inexperienced institutions. The biggest risk is the potential use of cheap and quick fixes for the economy – such as printing money to reduce a budget deficit or providing credit to banks – which could have devastating impacts on inflation and exchange rates in the future.

Using the U.S. dollar protects countries from macroeconomic crises such as hyperinflation, which can result from dangerous monetary policy decisions, such as uncontrolled printing of money. Countries afflicted by hyperinflation , such as Venezuela and Zimbabwe, have had to face seemingly insurmountable obstacles to growth as their currencies become worth less by the hour.  In these situations, import prices soar, the price of domestic goods become unpredictable, investors pull out of the country, and the citizens cannot save because their money loses value every day.

Security for foreign and domestic investors

A relatively stable currency makes investors confident that the value of their investment will be preserved over time.

Investors trust in the value of the US dollar, and therefore, currently trust that the value of their investment in Timor-Leste next year will not be significantly different from the value of that investment this year. In fact, Heineken listed the U.S. dollar as one of the main attractions that led them to opening a plant in Timor-Leste. At least in the short-term, a Timorese national currency would discourage investment in Timor-Leste because it would make those investments relatively riskier.

Many commodities are bought and sold in U.S. dollars

Timor-Leste’s two biggest exports are oil and coffee, both of which are sold to the global market in US dollars. Therefore, using the US dollar partially insulates Timor-Leste’s economy from fluctuations in commodity prices.

The impact of the 2014 fall in oil prices on Timor-Leste’s economy was lessened because the country uses the U.S. dollar. During this time, the value of the US dollar appreciated relative to the Rupiah and other currencies, thereby reducing the cost of imported goods. As a result, the rate of inflation in Timor-Leste fell from 12% in 2013 to essentially zero in 2014.  Although the State received less money from its oil exports, prices that people had to pay for goods stopped increasing.

Challenges to using the U.S. dollar

Relinquish control over monetary policy

Monetary policy is a tool used by central banks to respond to different economic situations by adjusting a country’s money supply or interest rates. By using the U.S. dollar, Timor-Leste has given up its power to decide on monetary policy. Otherwise, the Central Bank could use such tools to stabilize the economy and help the country recover from external shocks.

If there are shocks to the economy, the Central Bank can devalue the currency to make exports more competitive, thereby offsetting some of the losses from the shock.

For example: Coffee is Timor-Leste’s largest non-oil export. Coffee production can be negatively impacted by external shocks such as poor weather conditions or widespread crop disease. In this case, the Central Bank could use monetary policy to devalue the currency, thereby making all Timorese goods relatively cheaper to foreign consumers. Therefore, the increased sales of other exports could make up for some of the decrease in the sales of coffee. However it is important to note that currently, Timor-Leste would not benefit much from using these types of monetary policy tools because we don’t yet have diverse exports.

Obstacle to diversification

The value of a Timorese national currency would be weaker than the U.S. dollar, making imported goods more expensive and local products relatively cheaper in comparison. Local products could compete with the relatively more expensive imported goods in the domestic market.  Subsequently, Timorese producers could sell more products, improve productivity and grow their production over time. As production and productivity increase, Timorese products would become more competitive on a global scale, thus expanding non-oil exports. This could be a tool to help Timor-Leste diversify its economy and encourage non-oil sector growth in the future.

The high value of the US dollar is part of the explanation for Timor-Leste’s import dependency because it allows Timor-Leste to import goods at a cheaper price than domestic producers can compete with. Replacing some imported goods with locally produced goods would begin to close the gap between imports and exports of non-oil goods, which will be an important step for economic sustainability as oil production ends and the Petroleum Fund is depleted over the next decade.

Is Timor-Leste ready?

 All of the speakers at the IOB seminar, including La’o Hamutuk, agreed that it is too soon for Timor-Leste to implement a national currency. Timor-Leste will implement a national currency in the future, but first must develop the non-oil sectors of the economy, which includes agriculture, tourism and light manufacturing. This is because implementing a national currency now would lead to an increase in the price of imported goods, thereby worsening people’s purchasing power while domestic production remains low. Additionally, monetary policy is not an effective policy tool without several different export sectors to adjust.

The productive sectors of non-oil GDP are agriculture and manufacturing, which have been stagnant since 2003. Government spending has driven nearly all the growth in non-oil GDP , and it will go down in coming years as oil revenues runs out and the Petroleum Fund balance declines.

After productive, non-oil sectors contribute significantly to the economy, Timor-Leste should consider adopting its own national currency.

Recommendations in the meantime

La’o Hamutuk recommends that policymakers take seriously the need to diversify the economy. There is an urgent need for proactive policies which encourage the sustainable growth of productive non-oil sectors.

One way that countries can boost local production and gradually substitute imports for domestic products is by introducing a combination of import tariffs and government subsidies for targeted sectors. These policies can protect our domestic industry as it develops the capacity to compete with imported products. Over time, as local production grows, Timor-Leste will be able to phase out tariffs and subsidies, as is required by a gradual compliance with the free trade requirements of ASEAN.

Timor-Leste’s people achieved national sovereignty after years of struggle and sacrifice, and it might seem that having a national currency is one of the benefits of that victory. However, we need to be sure that it also materially benefits the people of this country, especially the many who are not yet fully enjoying the economic benefits of independence.

1 comment:

  1. A good article - one that tries to put some of the complex economics of moving to a national currency in to simpler language.
    It is also worth remembering that even if a national currency were adopted, it is very difficult to enforce its use. Take Serbia as an example - they have the Dinar, but for any significant transaction (buying property, renting an apartment, buying a car...) people use Euros - the largest transactions in Dinar are the government paying public sector salaries. Effectively the national currency becomes a tool for operating government, and in times of crisis it is easier to devalue the currency rather than cut public sector wages. I would foresee Timor operating in a similar manner. Implementing a national currency also tends to benefit the better off, who have savings in dollars, and hurts the poor, who have no dollars and who suffer most when the govt starts printing money to cover its budget deficit. Just some extra things to think about...