From austerity to lower trend growth: Opportunities missed
In the heat of debate that has followed the Central Bank Governor’s announcement of bold measures to correct the misalignment of the rupee, some of the arguments put forward by the Governor seemed to have been sidelined. He has put the spotlight back on the lingering policy paralysis and structural constraints that are taking the rupee to lower levels. The structural issues among others are the wage increases that are not in line with gains in productivity, skills mismatch, need for diversification of markets and products, addressing supply-chains bottlenecks – efficiency in port, airport, road congestion, cost of energy and telecommunications, reviewing spreads and charges and commissions in the banking system, absence of an enterprising human capital formation programme, food and energy security and the need to develop the “hard” and “soft” aspects of the infrastructure for a sustainable, diversified premier financial centre.
These are the reforms that should have been undertaken by the TINAwallahs (There Is No Alternative) – the Sithanen-Mansoor tandem. We would have been reaping the fruits now for their impact is felt over time. We did not really go through the pains of restructuring — the painful changes involved in improving competitiveness and ensuring cost-effectiveness in education, health care, public sector, social security and pensions. At the first outcry, they backed down. They preferred the easy way out. The few touches to the tax rates and some improvement to the investment climate framework were not reforms that would have generated sustainable growth.
It is because of the absence of substantive reforms and investment in the economic infrastructure during these past six years that the growth rates of the productive sectors are being affected. Their austerity measures boiled down to tax increases unaccompanied by efforts to reduce wasteful expenditures and inefficient transfers. Their fiscal consolidation efforts did result however in budget deficits as low as 1.3% of GDP which was achieved by drastically slashing capital expenditures to an average of only 2.6% of GDP over the period 2006-11.
This drastic fiscal adjustment generated surplus funds which government reappropriated and transferred to a set of Special Funds that were left idle in bank accounts. It was plainly a case of missed opportunities. They have choked off growth by limiting public investments in key sectors at a time that the private sector was finding it more profitable to invest in real estate activities. It is essential investments in economic infrastructure — roads, ports, airports, schools, etc., and human capital formation — that have been sacrificed.
All that the TINAwallahs’ reforms have delivered are billionaires thanks to their real estate schemes. What about the rest? Disparities have widened and poverty still remain a challenge; the common man keeps getting the short end of the stick again and again — the latest being that even the pittance distributed through Corporate Social Responsibility is being denied to him. Where are the jobs? You spend huge amounts to provide education for your kids but without any assured jobs! The money that is spent on educating them doesn’t get them a job. The entire brunt of the resentment among people is borne by their short-termism and stalled reforms. The long-term vision about growth has been lacking.
There are huge events with massive magnitudes that are hitting us. One of them is unemployed youth and graduates. Overall confidence in the economy is waning and a recent survey is showing that some 55% of Mauritians would like to migrate. We cannot continue to do more of the same — the short term palliatives that lead nowhere. Lindsay Rivière in his article titled « Inititiaves » in L’express of this Wednesday draws our attention to the continuing reform and policy inertia: « Le régime improvise souvent, alors qu’il faudrait davantage de ‘creative thinking’ , d’imagination et de cohérence dans l’action d’ensemble, une diplomatie mieux adaptée, une politique sociale plus ciblée. En l’absence de celles-ci, s’installe peu à peu un immobilisme pernicieux, dangereux pour l’avenir. La banque centrale assume, dans ce contexte, une responsabilité encore plus grande. Bheenick vient de donner au pays la preuve que de nombreuses mesures techniques peuvent encore venir soutenir l’économie… ».
The CB Governor is alerting us to the fact that we will be sacrificing an entire generation if we do not think out of the box of IMF/World Bank policy prescriptions and real estate developments and act quickly. There is a need of urgency in policy-making and concerted action to tackle the larger predicaments of weakening growth and plunging business confidence starting with measures to boost both public and private sector investment. We need to bring in a new team that will generate greater collaboration between industry, civil society and government to move ahead boldly on key areas — like accelerating the implementation of large projects in the infrastructure sector — and transforming existing governance and the economic model to find our way back to the path of rapid asset creation and our potential growth level.
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The Monetary Policy Pause!!!
The Central Bank’s (CB) decision to strike a monetary policy pause – i.e. not to cut interest rates amid slowing economic growth — has not gone down well with the business community. The main arguments of the CB are that though both headline inflation and core inflation have moderated, the former is still above acceptable levels at 5.3% higher than the Key Repo Rate (KRR) — meaning a negative real rate of interest — and the mean inflation rate expectations as at May this year were 5.7% for the twelve months ending December 2012. Excessive reliance of the export lobby on the monetary policy tools – the KRR and depreciation of the rupee — to revitalise growth seems to be the problem.
The Governor demands a paradigm shift in our thinking – this is long overdue. We need to tackle inflation and slackening growth by removing the supply-side and other structural constraints. These cannot be tackled by monetary measures only, as the ability of monetary policy is limited. “Monetary policy alone cannot make the underlying structural imbalances disappear as it is made out to appear. There was work to be done in other quarters…”
The export lobby is not convinced; it feels that there is enough room for the CB to bring down the interest rate. An analysis of the inflation data reveals it is being driven up almost entirely by external factors (mainly food articles prices), even as core inflation remains below five per cent. Headline inflation was down to 5.3 per cent in May, as compared to 6.6 per cent in November 2011. All the three underlying measures of inflation eased in May 2012 – CORE1 at 4.6 per cent, CORE2 at 3.8 per cent and TRIM10 at 4.4 per cent. Even in times of crisis, the CB sees its overriding mandate as keeping a lid on inflation. They argue that there is no need to be too rigid about the inflation rate – the present rate of 5% is our historical rate. As P. Krugman puts it, by breaking another of today’s economic taboos, a bit of inflation would be good for us in that it reduces the real value of all that depression-inducing debt. Exporters were thus expecting a monetary stimulus from the CB on the plea that an appreciating rupee, demand slowdown and increasing debt have affected businesses. They believe that there are enough arguments that lead to believe that a 50-point cut was feasible and that the focus now needs to be on growth.
Even if the risks in the euro zone are contained, domestic growth is foreseen to stay below the projections made in March at 3.6 per cent while risks to the inflation outlook appear skewed to the downside in the near term, largely reflecting the risks arising from depressed global demand conditions and the global commodity prices that are now in a solid bear market. But external threats remain and the inflation outlook may change drastically — this may not augur well for our economy as our rupee starts hitting new lows. This may also be the worst time for our imports costs to rise. Greece’s problems combined with the thin possibility of oil prices hitting 140-160 $ a barrel as a result of EU pledge to enforce an embargo on oil imports from Iran starting in July may intensify the pain to Mauritius of imports paid with a falling rupee.
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It seems that some of our local thinkers have not totally outsourced their thinking to the foreign think-tanks especially the panel of experts at the Board of Investment. There have been some valuable suggestions on the question of innovation – the need for a National Innovation Centre. Mauritius future innovation-led growth must rely more on technical efficiency that requires an efficient national environment which will reinforce innovation within the business sector and encourage firms to compete on the basis of unique products or services. In restructuring our existing economic activities and in initiating new ones, innovation will have to be a key driver of this change. We should encourage a new wave of industrial policies that strive to create a R&D culture and foster innovation by new instruments (competitive bidding for earmarked funds and a R&D tax credit). Given the fact that the private sector underinvests in research, government can play a key role to support growth by investing in science and technology, increase its funding for research needs and create the institutional environment that supports technological change.
We need a technology strategy to address specific needs of innovation and technology diffusion. What about a publicly funded Mauritius Industrial Technology Research Institute (MITRI)? MITRI would be patterned along the Taiwan, South Africa and Singapore technology research institutes. MITRI will scour the world for cutting technologies and use its own laboratory facilities to assess their appropriateness to local conditions and build pilot versions to demonstrate them to prospective investors. The experience of existing public research institutes grouped under MITRI will be an asset in tapping the promising research areas like sugar-based technology (for plastics, polymers and for medicinal purposes), renewable energy technologies, seafood and ocean resources.
Paul Romer contributed an approach to growth theory based on innovations in either products or production methods as the key ingredient for development, rather than capital, labour, or other factors of production. Romer argues that importing ideas from abroad, through inward FDI, is an effective alternative to growing them at home. We will have to be selective in our choice of Foreign Direct Investment inflows, encouraging those that are important sources of managerial ability, technical personnel, technological knowledge, administrative organisation and a source of innovations in products and production techniques, all of which are in short supply in Mauritius. These well-screened FDI inflows will impact positively on the economy so far as product upgrading and increased productivity are concerned.
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Capital inflows – a hypothetical catastrophic scenario
European troubles could send shockwaves round the globe with contagion spreading to all emerging markets including Mauritius. This could induce investors to pull out of all emerging markets and rush for the safe haven of the US dollar. Mauritius which needs global financing to bridge its record current account deficit of 12.6% of GDP will be badly hit. If there is a marked diminution in capital inflows, especially in the 70% of our FDI that goes to accommodation, construction and real estate, asset prices would be first to feel the effects and asset saleability would be impaired.
Hot capital, a consequence of capital inflows attracted by the real estate bubbles, will also take flight. Borrowers’ incentives to repay their loans will subside and, all of a sudden, domestic banks will realize that they face a mountain of nonperforming loans and stuck with collaterals whose values are bound to fall. The liquidity crunch will give rise to the drying up of credit causing a severe impact on output and employment.
Such a halt in inflows can lead to higher exchange rate fluctuation (even a significant depreciation of the currency) and a widening current account deficit that reduces the overall balance of payments surplus and thus affect our long term growth prospects. Sudden decline in capital flows not only contribute significantly to drops in economic growth, but their effect is more pronounced in countries with large current account deficits. The appropriate macroeconomic policy mix recommended in such cases that is likely to be associated with the least output loss during a sudden-decline financial crisis is a discretionary fiscal expansion combined with a neutral monetary policy.