Since military rule began, Burma has been a shining example of how not to run an economy. The dual exchange rate system that has been in place since 1972 is a major part of the poor economic performance the country has experienced; reforming it will be key to advancing other reforms in the country.
The official rate of the kyat is set at around K6 / $1, while the unofficial rate, as of last summer, stood at nearly K800 / $1 and has grown to around K1,000 since. This hasn’t only hurt private business and agriculture, but has also had a negative impact on some important State Economic Enterprises (SEEs). In addition, as in other cases where the system was in place, we’ve seen widespread corruption whereby those who have access to foreign exchange engage in arbitrage on the black market and can make easy money. Most scholars seem to agree that the best solution would involve unification of the rates as soon as possible.
Burmese businesses have been affected by the dual exchange rates because, in the words of David Dapice, et al.“producers of import substitutes face increased competition from imports with lower kyat prices even as their local costs, especially wages, increase.” Over the past few decades, inflation in Burma has been higher on average than any other Southeast Asian country, even as the kyat has remained at a highly overvalued rate. A similarly disastrous situation has emerged in the agricultural sector, where distortions have affected the import and export of agricultural products and farm inputs. Whereas Burma was once considered the “rice bowl of Asia,” its importance has declined dramatically since military rule began, and since 1985 the sector has seen stagnant paddy production and lower yields.
A more pressing issue is the damage the dual exchange rate system is wreaking on certain SEEs. Although SEEs who mainly import products actually benefit from the system (since they spend less kyat then they otherwise would), exporters are hurt tremendously. Among them are the SEEs responsible for exporting natural gas that produce a large amount of government revenue every year, and are expected to be increasingly important as Burma opens up in the future. The system essentially acts as an implicit tax on exporters and an implicit subsidy for importers, which is the exact opposite approach taken by successful export-oriented countries in the region.
Unfortunately, the current system remains in place because elites in the military and SEEs remain the main beneficiaries of this policy. Although impossible to prove given the opacity of budgeting in Burma, it has been speculated that the junta’s decision to move the capital from Rangoon to Naypyidaw was financed by the “missing billion” in revenue from natural gas exports. Furthermore, numerous avenues for corruption have emerged, which has enriched a great deal of insiders with access to foreign exchange. In addition, there are a significant number of SEEs that benefit from an implicit import subsidy and would likely be much less profitable with a more realistic exchange rate. Those enterprises would then be at risk of having the government favor more profitable ones if a widespread reform of the SEE system was launched in the future.
Reformers will have to find a way to overcome these obstacles and implement exchange rate unification if recent political and economic gains are to have any chance of succeeding. The benefits of such a move are clear: the government will have a more accurate understanding of which SEEs are profitable and which ones are not, any budget deficit that currently exists will possibly be wiped out, and as an added benefit, inflation will be reduced since the government will no longer be forced to print money to pay off its debts.
Of course, how reform is implemented will play a large role in its ultimate success or failure. The IMF has pointed out that certain exchange restrictions, such as easing import licensing requirements, could be lifted immediately.After that, the state could take a number of other moves to smooth the transition, such as buying dollars at the market rate (which will clearly be far greater than before) resulting in increasing the amount of kyat and reducing the amount of dollars in circulation. Another optionwould be to replace the current implicit subsidy/tax system with an explicit system along the same lines, gradually rationalizing as time went on.
One counterargument is that the Chinese path, of a more gradual shift should be followed instead. However, China isn’t a good example for a few reasons.
First, reformers were much more powerful (relatively) within China than they are in Burma, and even then faced a difficult and uncertain path to reform. If Burma attempts to tread a similar path, reformers could find themselves overwhelmed by conservatives and see the changes they implemented rolled back.
Second, Burma doesn’t have a market nearly as appealing as China did when it began reform. Even with setbacks, the desire to invest in China never really went away. Burma simply does not have that luxury. If there are significant setbacks to reform, investors’ concerns will outweigh whatever they see as the potential benefits of investing in Burma. A quick unification of the exchange rate will indicate that reform is truly taking hold and the investment environment in Burma has improved. Setbacks would serve as further proof that investment in Burma is uncertain and risky, and without a positive investment environment reform would likely be doomed.
In the end, though the public face of hope and change in Burma remains Aung San Suu Kyi, whether or not that reform succeeds may depend on the faceless bureaucrats residing in the Ministry of Finance and the Central Bank.
Luke Herman is a member of the Young Leaders program at Pacific Forum CSIS.