“Recovery in economic activity post Covid-19 will be slow, painful and weak”

Interview: Sameer Sharma

* Government cannot borrow to infinity and help everyone under the sun’

* Stimulus Package: ‘It certainly cannot be free give-aways anymore but the structure needs to be independent and guaranteed in law’

Sameer Sharma makes an insightful analysis of the current local and global economic and financial situations and how Mauritius is dependent on the global network. Taking us through the intricacies of the pre-COVID situation of the economy and with an eye on how to face the post crisis, he makes some realistic proposals and suggestions for a viable way forward to salvage the country – but warns that it is not going to be easy and that those who are better off must be prepared to share more in support of the country’s future. Sameer Sharma is a Data Science Consultant currently based in the US. He has more than 12 years of quantitative analytics, predictive modelling and global multi-asset investing experience, and is passionate about all things data and how it can be leveraged to solve real world problems within the financial sector.

Mauritius Times: Mauritius appears at this stage to have the coronavirus under control. Rebooting the economy may prove to be the hardest part of the battle, isn’t it?

Sameer Sharma: Indeed. There is increasing consensus that the recovery in economic activity post Covid-19 will be slow, painful and weak globally and more likely than not in Mauritius too. A lot of damage has been done and will continue to be done to corporate balance sheets and Government finances globally.

Covid-19 may lead to a transition of the world order from peak globalization to accelerated de-globalization which is a permanent negative for potential growth. During the last Great Financial crisis, states barely won the battle but the ensuing gap between markets and the common man meant that policy makers lost the war over time.

Growing wealth inequality in turn led to a rise in populism and nationalism. Europe as a monetary union barely made the past decade out in one piece. Covid-19 will make it all much worse.

* as regards the economic consequences of the pandemic, it surely is going to be painful for all of us – whether it’s the big or the smaller countries? How hard will it be for a small island-state like Mauritius with an open economy highly dependent on the hardest-hit countries of Europe and the USA for its trade and exports?

Given the sheer size of the Global Business Sector when compared to what it was in 2008, given our dependence on tourism receipts and reliance on villa sales to foreigners which we like to call Foreign Direct Investment as if it were some productivity-enhancing investment, Mauritius came into this crisis very exposed to the going-ons in the world, especially in that of Europe. The rise of these sectors over the past two decades brought large foreign exchange flows which, when coupled with an unsustainable wage setting policy, in turn led to an appreciation of the real effective exchange rate of the Rupee.

Too many people focus on the MUR/USD rate, but it is indeed the real effective exchange rate (REER) which matters more as it captures both trade weighted currency movements and growth differentials to those of our main trading partners. These factors when added to our lack of productivity growth had already brought about weak export growth figures for quite some time now.

In the post Covid-19 world, we should not expect a strong recovery in our already weak pre-crisis export and trade figures. The problem this time is that with a weak global growth outlook in the next five to ten years, those foreign exchange flows too (assuming we even get out of the European Union blacklisting on time) will not be coming as easily as before.

* If the going will get tough in the months ahead, how soon will that be?

The recession is already here. What is important to grasp from a policy making angle is that this is not a one-round “game”. Game theorists will understand that the medium term outlook corresponds to a multi-round game. It is in this context that monetary policy must be taken to uncharted territory now, before longer term stagflationary risks, which de-globalization can bring about, come to the fore.

* Besides the cost to the Mauritian economy of the two-month lockdown, further public spending to prevent a deep depression will probably far exceed the current government spending on the Wage Assistance Scheme. How will Mauritius finance all of that? Through financial assistance from the IMF, loans from ‘friendly countries, the reserves of the Bank of Mauritius, a Covid tax?

If this were to be a temporary shock or one-round game, as we say in Game Theory, the right approach would be to increase long-term Government borrowing via traditional means, offer wage support and offer tax breaks to select sectors. Monetary policy would simply respond by keeping rates low for longer. But this will not be a one-round game.

We have to remember that Mauritius was engaging in money printing which is what a special reserve fund transfer is prior to the crisis. The Mauritian Government faces large unfunded liabilities in the form of the Basic Retirement Pension and contingent liabilities with the National Pension Fund assets heading to zero in the coming two decades on top of existing public debt.

On the foreign side, credit rating agencies have already been telling us that our country’s debt metrics are higher than those of similarly rated Baa1 peers although our growth rate and the local bias in debt was higher which kept the rating stable. While we may indeed borrow from the IMF and use up our quota and yes, while we may need to borrow more locally given low interest rates, we just cannot sustain a multi-round regime when our tax revenues will be under pressure as well.

Remember that the two largest local banks are always rated one to two notches below the sovereign rating. A downward revision in the Mauritian credit rating would create quite the volatility in foreign currency deposits held at these banks.

We cannot wait for later when it comes to unconventional monetary policy because there is uncertainty as to what a potential second wave, and over the longer-term what de-globalization could do to the global inflation outlook which is for now quite deflationary. Central banks across the globe are front-loading unconventional monetary policy because of this uncertainty. Mauritius will be doing the same.

* There has been a lot of debate and confusion about ‘helicopter money’, security liquidity, international reserves management and investments in illiquid assets, etc. What do all these mean and how are they working elsewhere?

I do not know where to start given all the confusion.

Helicopter money is basically what happened in December already. The Special Reserve Fund has a Rupee denominated accounting entry but the money does not really exist. The transfer entails the electronic creation of money which is then transferred to Government.

The danger to exchange rate depreciation and to inflation occurs when both money supply and the velocity at which the money churns in the economy increases (velocity of money).

If you keep on printing money and give it to people so they spend it on imported goods, then you will be asking for trouble. However if you print a limited amount of money and gear it towards plugging holes on corporate balance sheets to stave off the worsening credit situation in Mauritius, it will not have the same impact.

I have proposed that Mauritius create an independent private equity type SPV to provide patient capital financing in the form of convertible preferential shares where the equity of the SPV would be financed via helicopter money and the debt of the SPV via the central bank re-directing the large amount of excess liquidity in the system by issuing short-term paper and lending long-term to it. If the leveraged SPV, which would have a 15% to 20% return target to be returned to the state over 10 years, needs to raise more debt, it could issue debt to the market. Should the BoM buy this debt in the secondary bond market, this would quality as Quantitative easing (QE).

Regarding foreign exchange reserves, we first of all do not look at its size in Rupee terms as this defeats the purpose of holding international reserves. The BoM Act section which orders security, liquidity and return is quite outdated and quite contradictory for those who understand a bit about over the counter (OTC) bond trading dynamics.

The law itself should simply say that the Board would determine the asset allocation of the country’s foreign exchange reserves in order to preserve their real purchasing power with a high degree of liquidity over the investment horizon.

Liquidity risk is managed and the diversification of a central bank’s portfolio towards illiquid investments is implicitly linked to whether the level of reserve adequacy is adequate or not. Mauritius has adequate level of reserves when accounting for stresses on GBC deposits. Central banks globally also have access to the repo markets and more liquidity lines via securities lending for example.

If the Board of the BoM wants to repatriate foreign reserves back to Rupees and invest it, then it needs to make sure that it has the skills to manage such portfolios and that it has the right processes and accountabilities in place to make money overall over the investment horizon. Making 0% returns is not preserving the real purchasing power of reserves. Holding cash in a portfolio or long term bonds earning close to zero do not offer grand protection to a risk averse investor.

Asset allocation, risk budgeting and portfolio construction are complicated things which are very often overly simplified in the local media. The reality is that central banks globally have been diversifying into corporate bonds and equities for more than a decade now, and no it is not all about size but the level of comfort with reserve adequacy, investment sophistication and management skills.

* A budget is coming up soon. It is expected that the Government will spell out its strategy and announce measures to help weather the storm and speed up economic recovery. Which measures do you think would sit well with the Mauritian context and facilitate a speedier economic recovery?

There will be no speedy recovery but a gradual recovery. The focus of the budget should be to ensure that the credit situation of the free cash flow poor private sector is contained so that as many jobs as possible are preserved and, secondly, it needs to offer targeted support to the most vulnerable.

For larger corporates, the SPV private equity type approach would be financed mostly by the BoM directly and indirectly. For small and medium sized businesses, the Government should offer loan guaranties on their debts. The Government could, for example, guarantee all securitized loans of small businesses bought by the Bank of Mauritius from banks or guarantee loans via banks directly. We need to strengthen corporate balance sheets as much as possible in this multi- round game.

This may not be possible in this budget, but Mauritius must invest much more in renewable energy and agri so that it can start to reduce its import content. For this to happen, it needs to review its tax policy – which favours the rentier economy – towards one which favours production. This needs to be done gradually of course as sadly we still need to sell villas to plug the current account deficit, assuming we can still find buyers.

The Government must also cut wasteful spending, cut salaries of highest paid bureaucrats and more importantly review all budget programs in terms of cost and benefit. Are we achieving our objectives and can we spend less money and achieve similar objectives? It may not be the right time to raise taxes significantly, but the budget must signal a move towards more taxes on the rich in the form of property taxes and then expand the negative income tax.

The Government must also begin to reform the parastatals which are low hanging fruits when it comes to productivity enhancement of the economy.

* I presume you would also call for more circumspection in the event that Government steps in with a Stimulus Package to bolster ailing companies in the wake of Covid-19 so that taxpayers (present and future) do not have to bail out businesses, which could be restructured in bankruptcy proceedings that should not lead to their shutdown?

Large Mauritian non-financial conglomerates are asset rich but free cash flow poor. Their subsidiaries are undercapitalized and over leveraged and also have weak liquidity metrics. This is the norm. Now with the crisis and post crisis recovery, they will need patient capital. The way you do this is with the SPV which will provide deemed viable firms (after all other resorts have been exhausted) with patient capital in the form of convertible preferential shares.

The SPV would appoint an external fund manager with a clear mandate who would then negotiate haircuts with banks and work on re-engineered capital structures that better match the economic regime. The SPV needs to be independently managed and accountable to parliament and would have an attractive long-term return target to achieve. It would have influence on the Boards and could even push for employee representatives on these Boards. It certainly cannot be free give-aways anymore but the structure needs to be independent and guaranteed in law.

* Besides the ‘sunset industries’, there have also been bad news about Air Mauritius and SBM. The former has been placed in voluntary administration and the latter has seen its profits dip to its lowest level for years. What’s your take on how our Republic’s jewels have been managed?

This has more to do with the political system which has outlived its usefulness. One remedy would be to break down the salaries of politicians and their nominees to a lower base salary and a higher performance-based bonus with clear preset KPIs which would be made public.

If the CEO of SBM had the bulk of his salary paid in vested SBM shares redeemable gradually over five years with claw back provisions, do you think all this would have happened? You need to align the interest of senior management to those of the shareholders.

* However one would have expected the Government to extend more support to Air Mauritius (with the necessary strict and binding conditionalities) given its long-term importance to the country instead of allowing it to go into voluntary administration. What’s your take on that?

Air Mauritius has had an Altman Z score in the bankruptcy zone for close to two decades, and it has had poor return on capital and investment metrics for most of the past two decades bar a couple of years between 2016 and 2018. The state may be largely at fault for where Air Mauritius has come down to but it simply cannot afford to bail it out anymore unless politicians are willing to stay out of the airline.

This bailout will by the way need to come via unconventional means and transfers, a process which entails its own set of risks. It is not as if the Government can borrow to infinity and help everyone under the sun. It is not just about recapitalization but about the planes Air Mauritius has which would correspond to a more profitable strategy. A lot of money will be required and who will negotiate with pensioners to reduce the pension bill?

* BBC reported last week that China is going to face an ‘unprecedented global backlash that could destabilize its reign as the world’s factory of choice’ and India is keen ‘to make inroads into a space it hopes China will vacate sooner rather than later’. Scale no doubt matters, but are there opportunities for Mauritius in the post-Covid world?

If Mauritius is able to get out of this dangerous European Union blacklist and recognize the fact that it has weak demographics and needs to be more open to immigration, then a lot of opportunities will present themselves.

Mauritius should open itself up to young Indian, African and European entrepreneurs who are willing to come to Mauritius and set up their start-ups or midsized companies. We should shift away from attracting just the silver generation. Mauritius has sun, sea, good ‘ease of Doing Business’ metrics and is a safe place to live in. Mauritius needs more people to scale up.

Our demographics are worsening. Mauritius frankly is too small and needs to be more in sync with the happenings of an increasingly competitive world. Some local entrepreneurs still live in their own coconut shells. They are lucky that the country is so small that most large foreign companies are not that interested to come here and compete. 

Banks globally are realizing that they need to diversity the geographies of their operations post Covid-19. Mauritius is blessed with some of the best bilingual accounting talent in the world and we can certainly compete with the Indians and Asians in general when it comes to accounting and being a bank back office. The issue sometimes is that our nominees who are sent out to meet bankers globally do not do us proud. We should introspect on this. 

Local pension funds must also evolve and help develop via seed capital an ecosystem which brings providers and seekers of capital together in order to develop the local private equity and private credit markets. Unless we can deepen our capital markets, we will not attract the right kind of entrepreneurs. 

* Published in print edition on 22 May 2020

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