Fragile Times – The Monetary Policy Stance 

By V. Bhardwaj 

The Monetary Policy Committee (MPC) of the Bank of Mauritius unanimously decided to leave the key Repo Rate unchanged at 5.75% per annum at its meeting of 22 June 10. Caught between rising inflationary expectations and excess liquidity accompanied by the prospect of slackening growth, the MPC thought it preferable to stay on the sideline for the moment quite unsure about inflation and growth outlook. In March 2009 the MPC lowered the Repo rate by 100 basis points to 5.75%, the third cut since July 2008, to support the government’s policy of stimulating the domestic economy in response to the global downturn. In addition, reserve requirements were cut to reduce the cost of financial intermediation, which ensured that the overnight interbank rate was in line with the Repo Rate. And, on 23 March 2010, the MPC had decided to maintain the key Repo Rate at 5.75% per annum but at that time it was believed that the economy was on the upturn and that the outlook for inflation would not worsen in the short term.

But meanwhile, between March and June, we had the sixth Inflation Expectations Survey indicating a gradual build-up of inflationary expectations with some 82.6% of respondents expecting prices to go up over the next 12 months and some 34.8% anticipating inflation to be higher than 4%. The mean inflation rates of respondents worked out to be 3%, 3.8% and 4.5% respectively for the periods ending June 2010, December 2010 and June 2011.

Inflationary pressures have continued to rise in Mauritius. “The annual rate of inflation is now starting to pick up from 2.3% in March to 2.7% in April, and averaged 2.5% in the first four months of 2010, compared to 0.8% in the last four months of 2009. Price pressures are becoming more pervasive, the absolute level of the consumer prices index rose by 0.4% in April, driven largely by rising food and transport costs.”

Indeed the Central Bank (CB) believes that the likely pick-up in inflation — largely a result of external factors, especially higher food and energy prices as the global economy recovers — is the main policy challenge. Inflation, which has remained subdued in 2009, picked up in most economies with the return of commodity market bottlenecks and renewed surge in commodity prices  

Table 1.0: Consumer Prices (%)

Source: EIU

The monetary aggregates (see Table 2, below) show that the excess liquidity in the system is not due to excessive growth in Broad Money Liabilities but rather to the conservative stance of the banking sector that is reflected in the deceleration in credit to the private sector. Banks prefer to invest in the more remunerative and risk-free Treasury Bills. The overall weighted yield fell from 4.37% in January to 3.85% in May. Auctions of Treasury Bills have remained oversubscribed with an average bid-cover ratio of 1.9. The excess liquidity in the system is not an issue given “that the below-trend growth rate is giving rise to a substantial negative output gap which is contributing to keep inflationary pressures emanating from the supply side in check.” 

Table 2.0: Monetary aggregates

But with the slackness in the economy, a deficit in the Balance of Payments for the first Quarter of 2010 and consecutive negative growth in exports of goods since the 1Q of 2007 (with the exception of 1Q 2009), there have been suggestions for a lowering of interest rate resulting in the depreciation of the rupee that will give a boost to the export sector and overall growth.

The Central Bank, however, doubts that such a policy is presently advisable on account of a weakening export demand as the Euro zone consumer and business confidence surveys continue to show signs of optimism waning. Moreover a weaker rupee with its pass-through into prices of consumer goods will fuel higher producer price inflation and eventually consumer price inflation.

The CB prefers “to conduct its exchange rate policy in the national interest of the country and… stands ready to accompany the adjustment of export-oriented sectors through targeted measures.” 

At a more technical level, the IMF Working Paper, “Monetary Policy Transmission in Mauritius Using a VAR Analysis”, February 2010, by Charalambos Tsangarides, supports this policy stance of the CB. The findings show that the transmission mechanism of changes in the repo rate, exchange rates and money supply is stronger for nominal variables (inflation) rather than real variables (output).

The Working Paper notes that “… the lack of a transmission to real variables may reflect bottlenecks and structural problems in financial markets. Traditional analyses of monetary policy assume complete markets which are free of frictions. However, various models in the credit channel and bank lending literature suggest that financial market frictions and rigidities may be manifested in a variety of ways, and are likely to introduce uncertainty into the magnitude and timing of the economy’s response to changes in the monetary policy.”

* Published in print edition on 25 June 2010