(Analysis) – After half a century of having its currency traded on gray and black markets, Burma wants to free up its kyat by the end of next year.
It may be an ambitious target, as the market-friendly move would expose the country's inefficiencies fueled by decades of corrupt military rule and could lead to a shake-up of its banking system and fragile economy.
But the International Monetary Fund (IMF), which is helping Burma steer a delicate set of currency reforms, says the goal is not unrealistic.
Also, few experts are questioning the viability of the plan considering the rapid political reforms introduced in just a year by the nominally civilian government that replaced the military junta in the second-biggest Southeast Asian nation.
It will still be a grueling race for the government of Burmese President Thein Sein determined to achieve a single exchange rate for the kyat by December 2013.
The date is symbolic for the government. Burma will at that time host Southeast Asia's biggest sports event—the SEA Games—for the first time since 1969. The event is regarded as a sort of coming out party for Burma on the cusp of sweeping political and economic changes.
"If they have not unified exchange rates by then, it will simply be a pretty messy situation," Lex Rieffel, a former U.S. Treasury economist, told Radio Free Asia (RFA).
"It will also be pretty messy if they haven't improved the banking system to the point that visitors can easily get local currency in exchange for foreign currency and charge reasonable expenses to credit cards," he said. "These are all reasonable, feasible, and proper objectives."
Rieffel, now an expert at the Washington-based Brookings Institution, said he was optimistic the Burmese government would be able to complete the process of exchange rate unification which was launched last month.
"The actions that have been taken, the actual policies that have been taken and implemented by the government, these are not insignificant and I put the exchange rate move on April 1 way at the top of the list in terms of economic policy measures," said Rieffel, who just returned from a four-month trip to Burma.
On April 1, the Burmese authorities took the first step toward exchange rate reform by adopting a managed floating regime in which exchange rates are allowed to fluctuate from day to day with occasional intervention by the central bank.
Until then, the kyat was formally fixed against the greenback at a rate of around six kyats to a dollar, compared with an unofficial market rate valued as low as 1,450 kyats to the dollar. It was believed to be the largest discrepancy between an official and market exchange rate recorded anywhere.
The complex exchange rate system with many restrictions had given rise to multiple exchange rates, increasing transaction costs, discouraging foreign direct investment and trade, stoking informal activity, and putting appreciation pressure on the kyat.
It gave much uncertainty to investors, local exporters and aid agencies, and fueled corruption under the military junta.
Some suspect that the junta leaders had exploited the official rate – which grossly underestimated state revenue – to keep millions or even billions of dollars off the books and smuggled the money overseas into offshore bank accounts.
"More concrete, and damaging, was that the yawning chasm between Burma's official and market exchange rates enabled Burma's past military rulers to misappropriate the country's growing export revenues, primarily those from the sale of natural gas to neighboring countries," said Sean Turnell, a Burma expert at Macquarie University in Sydney, Australia.
"Floating the kyat, which really means just abandoning the old official rate, closes the door on this particular form of corruption," he said.
After launching the managed float last month, the central bank set a reference rate of 818 kyat to the dollar, bringing the official currency rate in line with its value on the gray market. The local currency was quoted at 827 kyat to the greenback on Friday, according to the central bank website.
The Washington-based IMF said the adoption of the managed float for the kyat is only the first step in the process of unifying all the other exchange rates used by the private sector in informal markets, which will require lifting all exchange restrictions that are in place.
"The authorities do target to achieve this goal by the end of 2013 [and] we are working very closely and supporting them with technical assistance to achieve this," said Meral Karasulu, IMF mission chief for Burma, at a media briefing this week.
The briefing was held in conjunction with the IMF's annual assessment of the Southeast Asian economy, which the Burmese government agreed to make public for the first time.
When asked in a telephone news conference if the 2013 target was sustainable, Karasulu said: "I don't find it is necessarily unrealistic."
The IMF's experience in other countries suggested that eliminating informal markets for currency exchange was a task that would typically take up to two years, she said.
The currency reforms have their potential pitfalls.
The Asian Development Bank cautioned in a recent report that unifying the exchange rate will expose the "inefficiencies and losses" of state enterprises, which dominate parts of the economy.
To cushion against any problems, reforms are required to put state enterprises on a more commercial basis, including privatizing some and possibly closing others, the Manila-based bank suggested.
"Thus, temporary and transparent subsidies will have to be introduced to minimize the impact on the poor as state enterprises raise prices and lay off employees," it said.
Expanded access to formal finance is another key challenge in Burma, one of the poorest countries in the world, with one in four of the country's 50 million people living in poverty and three out of four people having no access to electricity.
Still, Burma's potential is enormous considering its rich natural resources, young labor force, and proximity to some of the most dynamic economies, experts say.
The IMF's Kerasulu forecast that the Burmese economy could expand 5.5 percent to 6 percent over the next two years.
"There is very strong momentum. I have been working with the country since 2009 and I think over the last couple of years the progress is really very, very tangible."
The new currency system can help boost the economy further.
"This is beneficial not for a narrow group of people in power and authority which is the case of the past system, but the principal beneficiaries of this change would be the 50 million people who live in Myanmar (Burma)," economist Rieffel said.
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