“The next crisis is unfortunately already here”

Interview: Sameer Sharma, Investment Analyst & Financial Risk Manager

‘The ongoing global negative supply shock creates challenges when it comes to stimulating the local economy with fiscal stimulus’

* ‘The quality of our institutions has been declining for close to a decade with a noted acceleration since 2019.
At the core, Mauritius maintains a system of political patronage’

*’Inefficiently run companies and near-zombie companies will remain a drag on overall growth’

MT readers would have read previous pieces from Sameer Sharma, a Chartered Alternative Investment Analyst & Certified Financial Risk Manager with previous experience in the Reserves Management Divisionof the Bank of Mauritius. In this interview he shares his technical and financial perspective on the current state of our economy, the monetary inflation and depreciation policies pursued, the reliance on property sales and tourist receipts, the IMF and Moody’s ratings and the MIC-BoM imbroglio amongst other issues.

* The situation on the economic front worldwide is still gloomy and getting more uncertain, according to the IMF. Several shocks have hit the world economy already weakened by the pandemic: higher-than-expected inflation worldwide, a worse-than-anticipated slowdown in China, and further negative spill-overs from the war in Ukraine. It seems economic recovery will take a much longer time than thought earlier, but is going back to normal even possible?

The still fragile and unspectacular Mauritian economic recovery, which is largely being driven by continued growth in financial services and the re-opening of borders, will begin to lose momentum as we enter the next two quarters.

Unlike in the Great Financial Crisis of 2008 and during the more recent Covid-19 driven crisis, central banks are belatedly tightening monetary policy at the same time as the global economy continues to slow down. We are entering yet another major slowdown with advanced economies having more than 400% of GDP of combined private and public sector debt made worse by rising costs of funds given the selloff in global bond markets.

Global growth momentum as measured by various high frequency indicators are gaining downward momentum and in many places much faster than anticipated; central bank induced asset bubbles are beginning to come under strain. US consumer balance sheets remain healthy but when one strips out the top 1% of income earners, the picture does not appear to be as rosy. The US however is in a much better shape than Europe, our main market.

In a nutshell, Central banks were overly accommodative with ultra loose monetary policies and are now acting at the tail end of a short and historically unusual business cycle in order to avoid any de-anchoring of inflationary expectations by taming demand. While many market watchers have been talking about a plain vanilla or garden variety, short-lived or relatively shallow recession, all ingredients are currently in place to cause a much worse economic crisis with stagflation likely a base case for Europe. There is now a 60% chance of recession split evenly between a bad one and a shallower one.

Chinese economic indicators along with the potential burst of the less-talked-about Chinese property market is mere icing on the cake. Moody’s wrote about Mauritius lacking both fiscal and monetary buffers to face the next crisis as it did in the past. The next crisis is unfortunately already here. Beyond high levels of public debt and no central bank backstops behind them, the still ongoing global negative supply shock creates challenges when it comes to stimulating the global and local economy with fiscal stimulus.

* It’s said that supply chain disruptions and the dynamics of the global economy will continue to adversely impact the performance of the local economy for many years. In that scenario, what will the economic situation look like for countries like Mauritius in the years ahead, say by 2024/2025?

By 2025, most of the gains to GDP growth driven by the recovery in tourist arrivals, which currently are expected to hover at 2014-2015 levels, will be behind us. On a positive note, I have to say that while the likes of Maldives and Seychelles are ahead of Mauritius given the earlier opening of their borders and aggressive marketing strategy, the current Tourism minister is sending the right signals which is a good sign despite the slowdown in arrivals growth momentum given what is happening globally.

The Mauritian economy over the longer term based on fundamentals can only sustain a real growth rate of between 3% and 3.3% per annum post base effects. This potential growth rate is driven by the low multiplier of the kind of investment we attract, low levels of total factor productivity growth, labour force quality constraints and unfavourable demographics.The state will likely continue to rely heavily on inflation in order to deflate both private and public debt and bloat tax revenues. The distorted tax regime locally will not be fixed and reviewed and inflation which is another way governments can stealthily tax citizens will remain the favoured tool especially when one considers the cost of funding the Basic Retirement Pension scheme. 

The central bank balance sheet will still not have been recapitalized given the significant jump that this would cause to public debt. This along with the MIC still injecting net liquidity into the monetary system will constrain the central bank’s ability to conduct effective monetary policy despite the setup of a flexible inflation target regime. Real interest rates will remain negative while year on year inflation will likely remain high at between 4% to 5%.

* What about the non-financial private sector? How will it fare?

The non-financial private sector will continue with a business as usual approach, focusing on control and their favoured ‘Jack of all trades, master of none’ conglomerate model and frequent asset revaluations that are not always consistent with the free cash flows generated by such assets rather than being more performance driven. Hence, their respective returns on capital employed will remain below their weighted average costs of capital.

The last Covid-19 crisis gave the state a golden opportunity to push the patrimonial non-financial sector to reform, but it missed a golden opportunity to do so by not making bailouts conditional on meaningful restructuring and taking pre-pandemic performance into account when forking out bailout terms. The net result is that inefficiently run companies and near Zombie companies, that is companies that earn just enough money to continue operating and service debt but are unable to pay off their debt, will remain a drag on overall growth.

The favoured policy of the state, egged on by strong behind-the-scenes private sector lobbying, will continue to revolve around bricks and mortar. Mauritius will increasingly rely on foreign retirees, real estate and foreigners in general in order to maintain growth and keep the economy afloat. There will be few or no new pillars of growth beyond the silver economy (a system of production, distribution and consumption of goods and services aimed at using the purchasing potential of older and ageing people and satisfying their consumption, living and health needs) and potentially private health care; the current account will remain in deficit while the balance of payments situation will improve given increased flows that come from villa sales and from the foreign residents.

The extent of the depreciation of the Rupee will depend on the extent of net loose monetary policy offset by the speed of recovery in tourist arrivals and related, the extent of the success of the number of foreign residents who live and spend locally. Inflation and the opening up of the local land bank to foreigners will push domestic asset prices up and wealth inequality will continue to rise and so will social tensions.

* The IMF stated in its last Article IV Consultation that ‘the key macroeconomic challenge for Mauritius is to continue its economic recovery, while controlling inflation in a global environment with high fuel and food prices and slower recovery.’ Annual inflation, it added, is expected to rise to 11.4% in 2022 due to surging commodity prices, past depreciation of the rupee, and recovering domestic demand. How is the Mauritian government doing on those counts?

The Mauritian government is relying too heavily on inflation to bloat budget revenues and on the central bank’s printing press. Most of the monies of the Special Funds and all of the MIC money are net liquidity injections into the system. It is called helicopter money and, by definition, is highly inflationary.

As the rest of the world tightens monetary policy, Mauritian 7-Day and 3-Month Treasury Bill rates remain below 1% which is well below inflation. This will keep the Mauritian Rupee under pressure especially as we enter into a global recession given that the government will likely be spending most of the Special Funds money to stimulate imports at a time when we are still facing a negative global supply shock. Recovery in tourist arrivals from depressed levels (which is what we call a base effect in economics) is buying time for the government to reform the system and economy, but it is choosing not to do so.

* Given the already very high debt level, how sustainable is the current trend of government spending in infrastructure projects, like for example the extension of the metro line to Cote d’Or at costs that look rather exorbitant?

Local public sector debt to GDP metrics and the debt service ratio of government is improving given inflation. The level of foreign debt to GDP however in the high 30% range is more concerning. The problem is that both project return on investment and the net multiplier effect of a more efficient public transportation system is lower than expected.

* There is also the promise to raise old-age pensions to Rs 13 500 before the next elections, and probably even higher to Rs 15 000 should the current governing alliance be voted back to power. What do such populist announcements augur for the country’s economy and the depreciation of the Rupee?

The government is on a spending spree because of the Special Funds which is money that was printed and transferred by the central bank and because the MIC is also helping it out indirectly. Money printing pushes your currency downwards.

On the pension side, the CSG is not a sustainable system and, by 2025-2027, the former National Pension Fund portfolio will be drawn down in a more meaningful manner because increased taxation will be less popular.

Beyond public pensions, low levels of local interest rates for long, lower expected local equity market returns and a more volatile global risk asset environment when coupled with outdated asset allocation strategies employed by private pension funds locally will lead to lower pension payouts for incoming retirees given rising funding gaps. This is a ticking time bomb in Mauritius and is as important as the troubles faced by public pension schemes.

* Does the Supreme Court judgement in the appeal lodged by Suren Dayal open the doors to populist policies and announcements from soap-boxes irrespective of what the consequences might be for the population that will ultimately bear the costs?

This is the most pro-private sector Government since independence and the bar was already set low. It is populism and corporatism all mixed together. Look at the way many MIC deals were structured, how the central bank balance sheet was cannibalized, the lack of success of the Competition Commission and the spree of sops provided to large land owners to sell more high-end villas and you will quickly realize who runs the real show in Mauritius. Follow the money, they say!

* The monetary policy framework of the BOM, its operational independence as well as ownership of the Mauritius Investment Corporation have become a recurrent feature in the IMF’s Consultation reports. The IMF has been constantly saying that the BOM law should be revisited and that it should relinquish ownership of the MIC. But the government seems to have stuck to a different view. Do you think the government would be of the view that the state of the economy is not that bad, so it can afford to snub the IMF/WB?

You can snub the IMF as long as India backstops you with below market rate loans and grants and as long as you can keep tax revenues growing faster than your cost of debt.

As previously stated, the initial proposed idea when it comes to a bailout fund (MIC) was to create an off-balance sheet, independently managed and levered special purpose vehicle which would be funded by government and would then borrow from the market and the central bank. What we got is a bailout fund, which morphed into a biryani of a sovereign wealth fund, and now a venture capital fund that remains on balance sheet with no clarity on its long-term return target.

It is practically impossible for the MIC to be removed from the Bank of Mauritius balance sheet given its sheer size. No local entity would be able to take over and purchase an Rs83 billion investment portfolio or even the current Rs 46 billion already invested portfolio. Any foreign entity like a major private equity fund, for example, would severely mark down any overvalued assets such as those mispriced convertible bonds, given how they were structured and how they benefit the issuer vs investor. This would all leave a big hole in the central bank balance sheet which would no longer be able to rely on its ‘scenario based’ pricing models and on local auditors to validate their outputs.

I suspect that in the coming months and years the MIC, which owns large land banks, will rely more and more on asset revaluations, a favoured strategy of the local private sector. The MIC is in sum too big for anyone to buy out locally and, once you leave paradise, real capitalists will price your assets as they should be.

I am afraid the Bank of Mauritius will be stuck with the MIC which is a big problem when it comes to its ability to conduct credible monetary policy for a long time to come as has been pointed out by the IMF. You do not just relinquish assets like that, someone must buy them from you and those with such deep pockets do not exist locally.

* Is our revised downward rating on Moody’s scale partly a consequence of that deliberate snub to international warnings and suggestions?

It is simply the result of a significant crisis and to the reliance on the central bank to fund the fiscal side rather than engaging in wasteful spending cuts, reviewing the tax system and implementing much needed productivity enhancing structural reforms.

One key reform beyond opening up this country to immigration is what we must focus on is to genuinely open up the country to non real estate foreign direct investment. There are a lot of less talked about hurdles which prevent such investments from coming to Mauritius. Billions of dollars of investments flow through Mauritius towards other countries in Africa and into India but ironically almost nothing is invested locally beyond real estate. The private sector is open to selling you a villa or two, but they’re not very open to be in competition with you.

A capitalistic system can only succeed because of its private sector. The job card is often used by those diversified groups in order to lobby and obtain what they wish for. Just count the number of overlapping private sector lobby groups and look at the number of nominations in key institutions where former private sector lobbyists or current lobbyists find themselves. This is the elephant in the room of structural reforms that no one in Mauritius will never talk to you about given the influence that the private sector has on electoral financing.

In Mauritius we have gone as far as to cannibalize the central bank’s balance sheet in order to bail out the private sector with very favourable terms which is now going to haunt us for many years to come. This is what the former chairman of the Mauritius Investment Corporation called “Love and Care”.

The private sector should be the locomotive of growth, but in Mauritius it is the government that is a locomotive and the private sector through its lobbying acts like a rentier. The alignment of private sector interests with the national interest which existed during the 1980s and 1990s does not necessarily exist today.

The genuine and unconstrained opening up of the economy to foreign investment and know-how will in the short term cause asset price volatility because foreigners will value assets based on free cash flows and appropriate discount rates. The local patrimonial private sector which have benefited from an insulated system with a focus on control will lobby against it aggressively behind the scenes — but this is the right thing to do. We need to let free market dynamics work and the state should focus on job creation and on creating the right environment for free markets to flourish rather than protecting any domestic company and any majority shareholders.

* Moody’s has in diplomatic wordings assessed our public sector structures and governance as weak and failing the country’s aspirations. Is it possible that this failing has become so ingrained that course correction would require major surgery rather than bandages?

The quality of our institutions has been declining for close to a decade with a noted acceleration since 2019. At the core, Mauritius maintains a system of political patronage with significant centralization of power under the office of the Prime Minister. For Mauritius to succeed, it needs stronger and independent institutions and stronger checks and balances.

We need significant institutional reform and major changes in the way the state functions which includes how its majority state owned companies function. There may need to be a review of asset sale opportunities and significant wasteful spending cuts too. To be fair, these are politically delicate reforms, and the appetite for such reforms remains low.

Mauritius Times ePaper Friday 2 September 2022