Administration and Valuation of the SBD Exchange Rate

There is a need to spell out the definition of what is meant by “stable exchange rate” and what method to use to maintain that stability of the SBD. For instance should “stable exchange rate” mean the same thing as fixing or pegging the value of SBD against its basket of currencies or should “stability” be define as allowing for changes in the daily SBD exchange rate but at a clearly defined upper and lower range limits? The answer lies in the Exchange rate arrangements that the Solomon Island authorities adopt from time. There are four choices depending on the policy objectives taken:
1. Pegging the currency to a single currency or a composite
2. Flexible limited link vis-à-vis a single currency or group of currencies
3. Managed floating
4. Independent floating

Historically, Solomon Island dollar was pegged to a single currency when it became a legal tender currency in 1979, where SBD was at par with the Australian dollar. After October 1979 however, the currency was pegged to a composite of trade-weighted currencies. This continued until 1996 when the exchange rate arrangement was reclassified as managed floating to reflect the policy to allow the currency to depreciate by ½ % each month. However, the exchange rate arrangement reverted to fixed peg against its trade weight composite baskets of currencies in October 1998.

The definition of “stability of Solomon Islands dollar value” actually refers to maintaining the foreign value of the Solomon Islands trade-weighted basket of currencies relative to its Solomon Island dollar exchange rate on a chosen base period as oppose to fixing the value of Solomon Islands dollar. What this means is that the foreign currencies that constitute the basket will remain same each day. Only by the value of Solomon Island dollar against the basket is adjusted. Individually these currencies will change but the total value of the Basket will remain stable. But again this definition of stability is not very helpful, because it means stabilizing foreign value of the basket but not the value of the Solomon Island dollar. Given this argument some other stabilizing rules must be developed. This option is to lessen the impact of volatility in the value of SBD that comes from sudden changes in the value of the currencies in the basket.
To avoid unnecessarily large one-day shock that affect the calculated exchange rate the Central Bank can devise a mechanism to address such large movements. Such a mechanism will put a cap in the maximum accepted daily changes to movement in exchange rate, whether up or down relative to the base rate of [5] percent. Where the calculated exchange rate moves [5] percent above or below the last quoted exchange rate, then adjustments will be made to ensure that the rate stays within the required limit. Also further restriction is imposed on how much the currency can be allowed to depreciate or appreciate in a given year. The problem with this suggestion is that the base rate will change because of the intervention made resets the base rate. The regular changing of base rate relates to comparability of policy from one period to another period. In the event of the absence of market forces to change the SBD rate daily, the Central Bank of Solomon Islands must intervene to ensure the exchange rate is within policy aim.

Basket of Currencies

The number of currencies that are to be included in the basket will be determine from time to time by the Central Bank based on the country’s trading pattern. The currencies constitute the US dollar, pound sterling, Japanese yen and the Australian dollar. But over these years, the trading pattern of Solomon Islands has changed, especially the trading with the USA that is becoming less and lesser each year. At the same time new trading partners have sprung up and gradually increasing their shares of trade with Solomon Islands. Because of this, the number of currencies in the basket will be increased to such numbers that these countries will make up at least 80 percent of the country’s total trade. Therefore in addition to the existing currencies, four other currencies will be introduced into the basket. These currencies are, New Zealand dollar, South Korean won, Singapore dollar and Euro. The increase in the number of currencies in the basket will also help stabilize the volatility of the daily movements in the exchange rate.