“The combination of patrimonial capitalism and patronage politics which has existed since independence remains a major challenge”

Interview: Sameer Sharma

* ‘The MIC, as a bailout fund, should have let banks, bond and equity markets work as much as possible and only used public funds as a last resort’

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 Sameer Sharma, who is a Chartered Alternative Investment Analyst and a Certified Financial Risk Manager, comments in today’s interview, on the costly BAI/Bramer failure and delves into our historical shortcomings with a stifling combination of patrimonial and family conglomerates with political patronage. The absence of a thriving market of venture capital funds cripples SMEs and innovative investments between patrimonial conglomerates and State-owned Enterprises, with high barriers to entry in most sectors. He also provides his specialist view on the controversies around MIC’s role and the burden-sharing that should have been the rule between a last resort bail-out and majority shareholders.

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Mauritius Times: The report of the commission of inquiry on the sale of the shares of BAI Ltd in Britam Holdings Ltd (Kenya) has been made public. The commission has concluded that possible offences relating to forgery… and/or breach of the Insolvency Act/giving false evidence would have been committed by a number of persons and an accounting firm. What do your recollections tell you about how the authorities, in particular the Bank of Mauritius, handled the BAI dossier, beginning with the revocation of the banking licence of the Bramer Bank?

Sameer Sharma: I am bound by professional and ethical considerations and cannot give you a personal opinion here, but let me however simply refer you to what the IMF, a neutral source, had said about the now defunct BAI Group on Page 36 of its publicly available Article 4 Report (Annex 1) on Mauritius for information purposes and let your readers decide for themselves:

“The BAI Group collapse has had adverse effects on Mauritius’ real economy, including through the closure or reduction of BAI’s numerous activities and through its contribution to the low domestic credit growth. The event also highlights weak consolidated supervision and regulatory forbearance. The mixed international financial conglomerate had no overall supervisor. The FSC (the non-bank regulator) had concerns about doubtful practices at the BAI insurer, having long required a gradual reduction of related-party investments (among others, into the affiliated Bramer Bank).

“The insurance company, however, was only put into conservatorship in April 2015, and, importantly, only after Bramer Bank’s license had been revoked by the BoM following persistent liquidity and regulatory capital shortages. The bank’s problems had persisted for some time, with persistent signs of weaknesses and elevated risks. Regulatory forbearance allowed the bank to acquire funding through attractive rates, and to quadruple its size.”

* But do you think, on the basis of your experience in central banking, that the Bramer Bank could have been saved, or was it doomed to fail?

For reasons I mentioned earlier, it would not be appropriate for me to provide you with a personal opinion on this matter. I will again refer you to the publicly IMF 2015 Article 4 report (Annex 1) which stated that the

“Bramer Bank’s collapse was eventually caused by severe liquidity problems and failure of shareholders to inject fresh capital. The bank was subsequently transformed into a state-owned entity, as the authorities believed that a disorderly collapse of the bank could spread through the financial system. The authorities’ intervention helped preserve financial stability, but encouraged moral hazard and entailed sizeable fiscal costs. The bulk of BAI’s liabilities have been transformed into debentures with payment distributed over five years for a total of Rs12.8 billion (3 percent of GDP). The short-term fiscal cost is estimated at over 1 percent of GDP. Over time, any recovery of the group’s assets may offset some of the cost of intervention.”

* It could be argued that the revocation of the Bramer Bank’s licence, which speeded up the downfall of the BAI Group, had an impact on the diversity of and dynamism within our private sector. What ensued in following years has been a gradual and sustained concentration of the economy in the hands of a few big corporates, contrary to the earlier objectives of the democratisation of the economic y programme of the Labour Party-led government…

We have to look at it from a historical perspective as well.

Mauritius is a very small country and economic concentration in a few hands is to be expected to a certain degree. If you take a look at the economic history of Mauritius, the relatively concentrated ownership of land which has historical colonial roots and the ability of large land owners to obtain traditional forms of financing via loans backed by these assets as collateral has certainly played a key role in the current state of affairs.

Over time, larger firms which operated in the sugar sector also believed that sector diversification in a small economy was the natural thing to do. Given our size and the barriers to entry, foreign direct investment has largely been constrained to the real estate sector. Even today, the conglomerate model is often lauded in those quarterly listed company account statements as being the best model out here. Despite the fact that more often than not over the past decade, return on capital employed has seldom gone above these conglomerates’ weighted average cost of capital.

From sugar production, energy production, hotels, supermarkets and financial services, majority family-owned holding structures hold a multitude of subsidiaries across the main sectors of the economy. Family control is important in Mauritius, and the reliance on debt financing which may not always be optimal did showcase its limitations during the recent pandemic given the speed at which these companies ran out of liquidity and quickly pushed for loan moratoriums.

There is an argument to be made on the export side of things that economies of scale do matter and such arguments should be restrained beyond this sector. We operate within a largely patrimonial capitalistic system in Mauritius with high barriers to entry in many sectors. This by definition stifles innovation and keeps prices higher than what they would be in a more competitive market. The World Bank, for example, recently analyzed income tax data to find that 70% of our economic sectors had high levels of economic concentration.

The Competition Commission has not given enough emphasis to our more concentrated markets where anti-competitive tendencies tend to manifest themselves. We rarely see any market study on things like whether our licensing regime across various sectors of the economy increase barriers to entry. To be fair to the privately held conglomerates, large state owned enterprises which may account for a large share of turnover in some sectors in such a small market also create natural barriers to entry. It is important for policy makers to enhance the level of independence of the Competition Commission and to broaden its powers, especially when it comes to paying more attention to oligopolistic behaviour in sectors where the level of concentration is high.

Another challenge for newcomers and smaller players is that even when it comes to the sectors of tomorrow, the country lacks a well established venture capital and private credit ecosystem. Local pension and institutional funds have not become conduits to alternative forms of financing and do not tend to allocate assets to such asset classes as is the norm globally. There is enough liquidity in the monetary system, but the pipes have not been developed enough. While new age digital based lending and incubators are gaining some steam, they are still quite limited. Between the private sector conglomerates and the public owned companies, the rest get squeezed in the middle.

The local equity market is also not very dynamic. We still have abridged quarterly accounting in Mauritius in 2021 which does not provide an adequate level of financial information where it matters the most given the aggregations, transaction costs remain quite high and the minority shareholder base tends to be quite passive and powerless. Rights issues and IPOs from domestic companies are a rare event. Merger and acquisition activity is quasi non-existent.

The combination of patrimonial capitalism and patronage politics which has existed since independence remains a major challenge to becoming a more innovative economy.

* It would seem the Mauritius Investment Corporation (MIC) has not been of much help either in this regard. Attention has been conveniently focussed on one building contractor, Avinash Gopee, whose business entities have received assistance from the MIC, but very little is known about what the terms and conditions as well as the sureties provided by the big shots in the tourism, sugar and real estate sectors for MIC’s billions worth of assistance. How do you react to that?

The MIC was meant to be a bailout fund but became a curry of a sovereign wealth fund, a development company, a next generation fund, an infrastructure fund and bailout fund — all on the balance sheet of the Bank of Mauritius itself. It is hard to comprehend the investment objectives of such a diverse portfolio of investments which encompasses drains to hotels when we are told that we had to sell international reserves in order to generate more returns locally and on the other when the MIC is about “love and care” rather than profits.

It should be understood here that the central bank’s balance sheet does matter and that if you adjust for revaluation reserves and the twenty eight billion rupee advance which will not be paid back, the BoM has a negative net worth. The lower the returns, the higher the recapitalization costs shall eventually be. A central bank with a weak balance sheet also faces credibility challenges when it comes to implementing monetary policy. Returns do matter!

When it comes to companies which are in distress, we must clearly discriminate between pre-existing zombie companies and those which genuinely were doing fine before the pandemic. Bailout funds are not meant to replace stock and bond markets but simply aim to provide a backstop that do not seek to replace markets. Central banks, for example, typically aim to provide liquidity to their capital markets in order to create a floor when the going gets tough and this avoids market failure. They do not replace the market itself. They are a last resort and if you look at other bailout deals funded by states globally, the bailout costs are quite high to majority shareholders. This is because policy makers seek to avoid creating moral hazards and risk pricing distortions in markets.

* An interesting comment made to this paper by Kugan Parapen concerns the job-saving mission of the MIC. He says: ‘The MIC did not save jobs, it saved the capital of the shareholders and the profitability of the banks. Is it normal that banks are still reporting billions in profits when the State is resorting to the central bank’s reserves to bail them out?’ What’s your take on that?

Not only are banks still moderately profitable but one bank even managed to reduce provisions and pay a dividend to shareholders recently. On one hand, we are told that the situation was so bad that we had to bail out companies, but then when we look at the quarterly accounts of large and small banks, despite the moratoriums, there is still quite the leg room there in terms of balance sheet strength.

While it is true that credit concentration is high in Mauritius, we should seek the right balance when it comes to burden sharing between banks and majority shareholders, and any bailout should only be a last resort. The trigger point after which a bailout is required should be more clearly defined.

One conglomerate which has a subsidiary which obtained bailout money also paid a small dividend which it could have used to partly offset the bailout costs of the distressed entity. We should protect jobs and not care too much about majority shareholder equity dilutions and, in some cases, internal board room dividend dynamics. Pricing should also be quite different in cases where companies were not doing all that well pre-pandemic and had already high debt to free cash flow levels, low levels of return on capital and liquidity dynamics.

We should not interfere in the natural evolution of markets. We should also let private equity players from abroad come into the market given the low level of domestic savings to GDP.

Lastly, when it comes to this “we had to intervene given the emergency” argument for the MIC, how long after its creation did the MIC start to disburse funds? What kind of emergency was this that we had to wait for months to disburse money? Did these applicants even try to go to the bond market and to the equity markets or did they go to the MIC because the terms were more favourable? Did we study how MIC deals will impact risk pricing in the wider market?

The banks and markets have not and did not collapse in Mauritius in terms of functioning so let them work.

* As regards the highly concentrated exposure of the banking sector to the tourism industry, which prompted the IMF to raise the alarm on numerous occasions, ‘little to nothing was done by the regulatory bodies to address the problem,’ also added Parapen. It’s clearly a failure of the central bank, isn’t it?

The Bank of Mauritius should not be blamed for all the flaws of the economy. We have a small economy and we operate within a patrimonial capitalistic system which when combined with a system of post independence political patronage creates high levels of sector concentration within a few hands. Over time this can lead to a degree of credit concentration as well.

When it comes to tourism, this was a capital intensive pillar of the economy so it is natural that banks in a small country of 1.2 million people would be quite exposed to this sector over time. Banks in Mauritius have always been well capitalized and many larger banks have capital that is well in excess of capital requirements to cater to such risks. This is why the MIC, as a bailout fund, should have let banks, bond and equity markets work as much as possible and only used public funds as a last resort.

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* Published in print edition on 30 July 2021