By Krishna Bhardwaj
A better balance in the economy will help everyone and this is where the private sector should really be concentrating: reduce your pressure on interest and currency positions and go for enlargement of the production base. In other words, take risks
The Monetary Policy Committee (MPC) decided at its meeting of 28 March 2011 to raise the key repo rate of the Bank of Mauritius (BoM) by half a percentage point (50 basis points) from 4.75% to 5.25% per annum (p a). Under normal circumstances, banks and other financial institutions are expected to take the cue and adjust their deposit and lending rates to reflect the central bank’s decision. In other words, if financial institutions give effect to this decision, interest paid by them on financial deposits will go up by half a percentage point and it will be left to the discretion of individual banks whether they will hike up their lending rates by as much. Banks’ have not been able to grow credit to the private sector at an acceptable rate in the recent period as seen from the excess liquidity they have been accumulating. They may therefore not find it appropriate to raise their lending rate in tune with the hike in the key repo rate of the BoM if only to encourage borrowers to come forward. The private sector could itself prevail upon banks to leave their lending rate unchanged so as to favour economic growth. We will have to wait to see how the situation will unfold finally.
The MPC’s decision has come as a result of a majority of members voting in favour of the interest rate hike. It means there were hesitations either about raising the level of the interest rate or about the amount of the increase. There are two aspects to the decision.
The first relates to direction: from July 2007, when the key repo rate was set at 9.25% to tumble finally to 4.75% p a by September 2010, the BoM’s interest rate has been declining unidirectionally, if abstraction is made of the short outlier from July to September 2008, when the rate was allowed to go up by a quarter per cent to 8.25% only to be reversed immediately thereafter by 1.5% to 6.75% by December 2008. All this was played out on the back of the international economic crisis which had affected the West in particular. From there, it was a jolly ride flogged up by the private sector to the 4.75% of September 2010.
The second aspect relates to the quantum of the interest rate adjustment. It was becoming increasingly untenable for the MPC to keep harping on the weakness of the international recovery to justify laying down the interest rate structure. No tangible evidence was produced by the advocates of interest rate reduction in the private sector to show that the lower cost of borrowing by the private sector as a result of the series of reductions of the interest rate had saved jobs by squeezing costs and raising productivity through added investments. Against this backdrop, international price rises seeping through the import window and local price manipulation, have come as a reminder that the MPC had gone too far.
In fact, the communiqué issued after the MPC meeting of the 28th states that, on a no policy change basis, headline inflation, i.e., CPI 12-month average, is expected to go on rising (from below 3% in December 2010) to 5% by June 2011 and to 8% by December 2011 and to double digits in the period ahead. The decision to increase the BoM’s key interest rate by 50 basis points is aligned to this prospect, keeping in view second-round effects, (i.e. exacerbation of price increases on account of the prevailing inflation feeding into further price increases due to internal demand pressures) of existing price inflation. Time will tell whether the MPC could have gone the whole hog to reverse the entire one per cent reduction in the interest rate it effected in September of the last year. It is clear however that at the prevailing interest rate on financial deposits before the latest MPC decision, savers were becoming indifferent towards saving while raising debt for all and sundry was increasingly becoming an option to the public.
The MPC’s latest decision is leveraged against the sustained perception of “uneven and downside risks to global growth”, that is, an economic situation in which growth is not picking up uniformly across all countries with the risk that it may slip if accidents like rising oil prices and excess debts of certain countries, were to hit the momentum of growth adversely. In other words, were the green shoots of economic growth that have pierced through in various regions not to maintain themselves, this would put our own export-dependent rate of economic growth in jeopardy. In the event, the current upward adjustment of the interest rate, after three past years at least when it was being brought down by small and bigger amounts, may have to be reversed to protect economic growth.
We cannot abstract from the fact that we are part of a globalised world and that developments in other places impinge on the degrees of freedom with which we can set down our own policies. In this context, local interest rate decisions which will have the effect of inviting foreign inflows of funds into the country to the point of affecting the exchange rate of the rupee to the detriment of our exports, will need to be closely monitored. Indeed, the mission of Mauritius is to increase as much as possible the scope of such export interaction with the outside economies. To be able to so, we will have to manage our costs very meticulously. One reason why we are having recourse currently to so many foreign workers even in small jobs is because our labour has been pricing itself out of a sustainable range or it is simply becoming too scarce at specific levels. A lot of market distortions such as this one will need to be attended to.
Monetary policy – changing the level of the interest rate to influence the cost of money– is not the sole answer to the international situation confronting us. Managerial efficiency, deeper capacity-increasing investments, market and product diversification, improving the technical content of our labour force for it to start making sense in the driving segments of global markets as well as a higher sense of commitment and discipline across-the-board are ingredients that can work on a par with monetary policy. Going in this direction should minimize concentration of pressure on the interest rate factor as a tool for better economic performance.
Had this platform started setting in gradually over all these years when interest rate reduction and currency depreciation were seen as the mainstay of our economic survival, our prospects would have been brighter today. It is not enough to salvage deteriorating current account balances by putting too much reliance on FDIs in real estate, which is what we have been doing; the macro-economy needed rather to undergo structural changes to create more and varied economic space which would have spared the monetary tools from becoming over-used. In such a case, all economic activities would not have to face downturns simultaneously once we establish a stronger multi-pronged economic base. Time has not run out yet for monetary policy makers to push now for further economic transformation instead of sticking to a macroeconomic framework which condemns them to engage in random walks in interest rate setting, one step forward, two-three steps back. A better balance in the economy will help everyone and this is where the private sector should really be concentrating: reduce your pressure on interest and currency positions and go for enlargement of the production base. In other words, take risks.
* Published in print edition on 1 April 2011