Towards the fag end of last year, the Governor of the Bank of Mauritius raised an alert about inflation. While everybody was expecting inflation to have been tamed down to an annual increase of 3% or less, the Governor stated that it was chalked out to be higher than 5% on a year-to-year basis at last December-end and that it would cross the 7% mark by mid-2011. Inflation is actually accelerating. Individuals who are often straight jacketed as “consumers”, are having to empty their pockets a bit more each time the price of a relevant item is going up. On the other hand, they rarely benefit in any substantive manner from significant price reductions. They accordingly see their budgets shrinking due to an accumulation of price increases over time.
Abstracting from the recent escalation of vegetable prices under the weight of which households are reeling already, we have seen increases in the prices of other basic items such as transport, electricity, sugar and edible oil. It looks like a succession of price increases has set in. The prices of pulses are to go up next. This creates expectations that prices will go on increasing helplessly. Mauritius has a track record of generally persistent upward price movements of basic commodities with few, if any, price downturns. In other words, the nature of our internal trade arrangements is such that prices of common consumption goods and services move up rather than down. The general explanation given for persistent upticks of prices is that those prices are increasing in our source markets and that we cannot do anything much.
Most analysts expected inflation to moderate in the wake of the financial crisis which erupted in the west in 2007 and the economic recession which followed it in 2008. This is due to the so-called “output gap”, meaning a situation of excess supply from out of the global installed capacity to produce goods and services against a situation of generalised depressed demand from consumers. So long this “output gap” persisted, it was believed there would be no apprehension about demand pressures causing prices to rise. Many western central banks were contemplating action under this scenario to beef up demand by continuing to pump money into the system to stem the risk of a potential price deflation (a situation of continuously falling prices due to demand failing to pick up). In this context, official interest rates tumbled to historical lows in western countries; our own central bank followed suit by bringing its key repo rate down in several steps, including by a massive 100 basis points in September 2010.
What do we see actually? Prices of nearly everything have been going up. There is no trace of deflation. The ‘All Items’ dollar index of The Economist shows a spurt of 49% during the last year to early February 2011. Food prices have shot up over the same period by 41%; non-food agriculturals have risen by no less than 106%. The barrel of oil which had gone down to $60 with the onset of the recession has been climbing again; it has recently exceeded the $100 level. In the face of all these price increases, there have been two sets of explanations. The first of them – we can call them those who lay the blame – has pointed growing emerging economies like China and India for putting pressure on prices on account of their huge and sustained appetite for goods and import materials. The second type has considered the price rises to be of short duration in view of exceptional climatic factors (large scale floods in some places, forest fires spreading out into agricultural lands in other places) acting to destroy crops on a large scale in the current period which, in its view, will be reversed once things have worked back to normal in a short while.
Consumer prices reflect a different reality actually. Despite high rates of unemployment – which means wage inflation did not act as a pressure on demand – in several countries and despite the slow pace of recuperation from the recession in most of the economies of the world, inflation has been on the upbeat. India was one of the leaders in this respect with an inflation rate of 11.9% in 2010; Turkey: 8.6%; China: 3.2%; Britain: 3.3% (already 4% early this year and set to go higher); Greece: 4.7%; Singapore: 2.9% (now 5.5%); US: 1.6%; and Canada: 1.8%. Had there been an “output gap” acting to keep inflation tame until demand matched up with or started exceeding installed production capacity, we would not have seen this generalised pattern of inflation rising in so many countries. In other words, the inflation we are seeing currently does not appear to be a temporary phenomenon occasioned by some freak peaks of demand in the face of supply shortages.
Elements such as “currency wars”, in which countries have recourse to competitive depreciation of their currencies, are also factored in the global trend towards inflation we referred to earlier. In the case of an open economy like Mauritius, we cannot afford to ignore the fact that countries which see the inflation phenomenon as a structural rather than a conjectural factor, will raise domestic interest rates. Some of them have already proceeded in this direction (e.g., India, China and several South East Asian countries); others (UK, Europe) are preparing public opinion to accept it when it comes up shortly. It makes sense that we consider seriously whether our own current loosened monetary policy will actually pay off in the given international market conditions.
As we see it, lower interest rates in Mauritius have not reduced banks’ excess liquidity (a potential source of excessive demand leading to more inflation) to any meaningful extent which they were supposed to do. They have not accelerated a pickup of demand for credit from banks. They have not stimulated any meaningful diversification of bank credit into new promising sectors of economic growth. They have broadly not served to curtail domestic inflation because local inflation is currently not influenced by prevailing monetary conditions. They have also not induced the expected depreciation of the rupee (and, hence, not accelerated imported inflation) which the export and banking lobbies had hoped for when pressurizing the MPC of the Bank of Mauritius to bring down the interest rate.
It may be said that local monetary and exchange rate factors have not effectively contributed to calm down the observed increasing domestic inflation. What have therefore been the causes of this step-up of inflation? External price rises are one, as seen in the general global price increases notwithstanding the expected dampening effect of the so-called global “output gap”. Some conjectural local factors such as climate affecting the production of fresh vegetables are another factor. Tax policy has helped raise prices too. Seen obversely, had our manufacturing industries, construction sector and even our retail sector not had recourse to imported labour to cut down on costs, inflation would have come in from local labour costs and generalised to other sectors of the economy. This has proved to be a safety valve to contain inflation. But it has not been enough.
In the circumstances, there is a need for policy to address structural deficiencies which hold a threat to keeping inflation high. We need a global plan to keep internally generated inflation to the minimum. The exchange rate should not be allowed to slip to compound the inflationary impact of imported inflation. Our excessive import dependency needs to be addressed by increasing our essential home-based supplies and thus insulate us from exposure to too much of volatile external prices. Besides, it would be extremely ill-inspired for fiscal policy to act as an accelerator of inflation when the external situation is already stressful. Coordination among major stakeholders is a better way to keep down inflationary forces rather than leaving it to “market forces” to bring the necessary discipline on this front.
* Published in print edition on 25 February 2011
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