“We are in a hole that is fast growing because of downside risks

and we should stop digging to make it a bigger hole”

Interview: Rama Sithanen

* ‘If we add state capture in the decision-making process, economic populism, allegations of fraud and corruption, we have a toxic mix that puts us on the road to Sri Lanka’

* ‘Someone in the future will have to bite the very bitter bullet of painful fiscal and tax adjustment. The longer the policy inaction, the more painful the fiscal shock will be’

* ‘Political demagogy and economic populism will simply trump economic realities and affordability…
Until there is no money to pay future pensioners’

There’s more happening presently than the Baie Jacocet Submarine Cable Survey controversy, which has been hogging the headlines these past two weeks. The recently publishedIMF Article IV staff Report gives a gloomy picture of the present state of the Mauritian economy and the serious predicaments facing it. In this week’s interview, Rama Sithanen comments on its general presentation and the diplomatic wording of key advisory recommendations. More importantly, he shares with us in layman terms the serious predicaments and grave risks facing the Mauritian economy, aggravated both by external factors, poor public finance management and bad policy choices at the Ministry of Finance and the Central Bank.

Mauritius Times: You have been Minister of Finance and have experience in dealing with the IMF and its Article IV reports. What have you “sniffed” and what new data have you captured from the latest report on the current state of and prospects for the economy?

Rama Sithanen: One must be familiar with the IMF’s approach to fully grasp the meaning and significance of their Article IV reports. They do not always explicitly criticize Government policies as they have to be diplomatic. One has to diligently read between the lines, decode some carefully crafted sentences to fully comprehend their analysis, findings and recommendations.

They embrace three to four postures. Often, they use a politically correct language to express their views so as not to irritate the country being reviewed in order to maintain engagement especially if the country does not have an IMF programme but is pursuing inappropriate fiscal and monetary policies. At times, they would even err on the side of political correctness when the actual situation calls for tougher criticisms and observations as they would not want to burn the bridges of continued dialogue.

Many of these institutions also have a soft spot for Mauritius as we have performed well compared to many African countries in human development and they do not want to be seen hitting hard at the poster country of social and economic achievements since independence.

However, they will speak the blunt truth about the economic predicament in one-to-one meetings with the Prime Minister, the Minister of Finance, the Governor of the Central Bank and their senior officers. And if their messages and policy recommendations continue to be disregarded, they will have no choice than to state the facts and figures in their report so as not to lose their credibility and not to be blamed in case the economic predicament worsens. The situation changes altogether when the country is in dire straits and has no choice than to negotiate a programme with the IMF to have access to funds. In these circumstances, tough conditionalities would be imposed to access these critical funds and to reverse the economic decline.

As is the case currently with the likes of Sri Lanka, Pakistan, Argentina, Lebanon, and now Ghana. These countries have often rejected the policy recommendations of the IMF and other independent economists for years with the outcome that we all see. They are either bankrupt or close to bankruptcy and either cannot import or have extreme difficulties to import essentials such as food, energy, fertilisers and medicine. They are now on their knees and pleading for assistance from the same IMF that they rebuffed. And worse, the costs of adjustment will be more painful for the population, especially the most vulnerable segments of society.

* Can you give us examples of this multi-faceted approach of the IMF in its last report?

It is clear that the IMF is very disappointed with the role of the Bank of Mauritius (BOM) in the extreme monetization of the fiscal deficit and in depleting its reserves by transferring significant sums to government. As a result, the BOM does not have enough capital and reserves to conduct proper monetary policies and to defend the rupee. Hence the IMF’s systematic call since some time for the Government to recapitalise the very low equity base of Rs 10bn. Equally the IMF was totally against the setting up of the Mauritius Investment Corporation Ltd (MIC) under the aegis of the BOM as it encourages quasi fiscal operations that are totally outside the scope of the Central Bank. This poses systemic risks to the balance sheet of the BOM and distorts both the allocation of resources and adversely affects its independence. The IMF has recommended that the MIC be transferred to either the Government or the DBM and that unutilized funds be returned to the Central Bank to enhance its equity and reserves.

It further states that there is an absolute necessity to safeguard the independence of the central bank and improve its legal framework and its governance. It underscores that the Monetary Policy Committee (MPC) includes an adviser to the Ministry of Finance and three representatives from the private sector, which may challenge the BOM’s independent decision making. Absolutely no prize for guessing what the IMF thinks of the independence and governance of the BOM and the composition of the MPC.

The IMF argues that Government is lowering its borrowing requirement and its debt through quasi fiscal measures of one-off disposal of public assets instead of credible expenditure and revenue measures. This strategy is not sustainable in the medium-term according to them.

A veiled rebuke is found at paragraph 39 under the heading of ‘Other Issues’. The IMF states that continued efforts are necessary to further strengthen public financial management and fiscal transparency, and safeguard independence of Statistics Mauritius. If one decodes the sentence, it refers to three critical issues besetting the Government. The strengthening of public financial management refers to significant lapses in procurement and deficiencies in the management of government projects and the need to obtain value for money as well as strict observance of procurement rules and proper management of capital projects. There is clearly a lack of fiscal transparency as many public funds and debt sit outside the consolidated funds of Government. Some of these figures are also doctored. 

The IMF calls for the independence of Statistics Mauritius which has lost its credibility as there is too much interference to compel it to produce fairy tale economic forecasts that invariably turn out to be wide off the mark. Its independent Chairperson resigned because of such unacceptable intervention. John Kenneth Galbraith famously said that the only function of economic forecasting is to make astrology look respectable. It seems to apply to the Government. Very good at overpromising and very good at underperforming.

* What more does the July 2022 of the IMF Country Report tell us about the state of the economy that what it had not drawn attention to earlier and which we might already be aware of?

Quite a lot in fact.

The most alarming for consumers is that the rupee will likely further depreciate by 26% to 39% because of the massive deficit in the current account balance at 13% of GDP. In the absence of structural reforms to increase significantly the export of goods and services and/or lower import of goods and services, the USD is on its way to a range of Rs 57 to Rs 63. Inflation will thus remain elevated for a long time.

The BOM is borrowing heavily from abroad and accumulating the foreign exchange deposits of commercial banks to artificially increase the international reserves of the country. If we adjust for these liabilities, reserves have fallen significantly and will continue to decline as the trade and current account deficits remain very high.

Growth at 6.2% in 2022 will be much lower than what the Minister has told us in the budget. The number of tourists will not reach 1 million. Worse there are downside risks if there is a recession and high inflation in Europe and there is a negative income effect impacting the propensity of people to travel.

Inflation will be much higher at 11.9%.

GDP per capita in USD has fallen considerably by 21.5% in three years.

The debt sustainability analysis shows that public debt is still very high and could rise above 100% of GDP in the medium term. Also, debt vulnerabilities remain elevated while the balance sheet of the BOM is very weak due to high contingent liabilities.

Public debt has come down recently not because of credible revenue and expenditure measures but mostly due to quasi fiscal measures as the sale of shares of Airport Holdings Ltd worth Rs 25bn to MIC which helped reduce the overall borrowing requirement. More sales of government assets for an amount of Rs 22bn are expected to lower debt, even if the IMF believes that this target of asset disposal is overambitious in this financial year.

The BOM is in a precarious predicament. Without a recapitalization of its equity and the Government meeting the cost of mopping up excess liquidity, it will be incapable of conducting its monetary policy, fight inflation and defend the rupee. As it costs money for the BOM to raise interest rates and to increase domestic liquidity sterilization.

* Is the IMF report also saying that the economic situation is likely to get worse before it gets better?

Very much so. The economic situation will get worse before it gets better. Because of a combination of external risks and uncertainty and policy paralysis or inappropriate policies domestically and an absence of structural reforms to transform and diversify the economy and to build resilience.

Mauritius had structural weaknesses before the pandemic hit us hard. Covid amplified the economic problems. The war in Ukraine has made the predicament worse with supply chain disruptions, surging inflation, rising freight costs, higher food and energy prices. Now there are high risks of stagflation with structurally high inflation and either low or negative growth in trading partners, less optimistic prospects for tourist flows, and worsening terms of trade.

The FED has been very aggressive with interest rate hikes which has caused the USD to strengthen against all currencies. The USD is at parity with the Euro which is bad for Mauritius as we earn a lot in Euro and spend mostly in USD to import almost everything.

The report mentions that there are significant downside risks to the economy. To highlight the importance of such downside risks, the report contains a Risk Assessment Matrix divided into conjunctural shocks and structural risks. Geopolitical and deglobalisation risks are considered very high as they will provoke both inflation and cause lower economic growth. Rising and volatile food and energy prices carry high risks for Mauritius as they would also lead to much higher inflation and lower demand for our tourism industry. There are also risks if Government does not embrace fiscal consolidation to lower debt and deficit and the Bank of Mauritius does not act fast to control inflation and to raise its equity and reserves to conduct proper monetary policy.

* The IMF notes in the very first paragraph of its introduction that ‘unprecedented high borrowing requirements in FY2019/20, partly driven by a sharp increase in pensions, pushed the public debt to around 85 percent of GDP… The substantial fiscal stimulus to mitigate the health and economic impact of the pandemic, revenue losses, and the contraction in GDP further pushed debt to about 100 percent of GDP in FY2020/21.’ Despite this debt level, Minister Padayachy is still promising to bring up old-aged pension to Rs13,500 by the end of the government’s mandate. How do you react to that?

Let us be very candid. Pension has become a largely politically motivated issue with everybody auctioning higher amounts to win elections. It is an absolute tinder box that will explode as the population ages and there will be fewer people working to support the rising cohort of old people. The IMF and all actuaries have stated that the current pension system is not sustainable. In fact, it is a very simple mathematical problem. Expenditure on pension is projected to reach 8.4% of GDP in two years while pension revenue will stand at 1.5% of GDP. This is a fiscal chasm.

Worse, this massive gap will rise as the country is rapidly ageing. It will worsen the old-age dependency ratio and increase pension spending. Government is simply transferring the burden of adjustment from the current generation to their children and grandchildren. To complicate matters, Government has decided to include contributions from the CSG in the consolidated funds as opposed to creating a special fund as was the NPF. As a result, the money is being used for all purposes including the monthly Rs 1000 granted to employees and self-employed earning up to Rs 50,000 per month. The funding gap will be much larger in 2023/2024. Either the CSG will have to rise exponentially or other taxes will have to increase sharply to finance this massive gap.

To make the pension system sustainable and to protect children and grandchildren from an unbearable fiscal burden, the IMF has made four recommendations. To gradually raise the eligibility age to 65 in line with the CSG benefits, to adopt a targeted approach by giving it to those in need, to keep the current pension nominally unchanged until it reaches 20% of average wage and to convert the CSG into a pension system similar to the NPF with benefits accruing only to those who contribute.

Some of these measures are politically difficult. However, in the absence of fundamental reforms, the funding gap will rise. At the next election, there will be the usual auction of which party will offer more. Political demagogy and economic populism will simply trump economic realities and affordability. Until there is no money to pay future pensioners. Similar to what has happened to many countries and locally to Air Mauritius.

* But he’ll have the Rs 31.7 bn transferred to the Special fund to pay for those increased pensions?

The gap between expenditure on pension at 8.4% of GDP and pension revenue at 1.5% of GDP is 6.9% of GDP. This represents around Rs 36bn at current GDP level. So, the amount in the Special Fund will almost cover the gap for one year only if the entire amount is used for that purpose!

The IMF has recommended that all Special Funds be transferred to the Consolidated Fund for fiscal transparency purposes so that the real size of the deficit and public debt are disclosed. It has also proposed that all unutilized funds that were transferred from the Bank of Mauritius to Government be returned to the Central Bank to beef up its reserves to enable it to conduct monetary policies. Part of the money in the Special funds were either money printed by the Central Bank to give to Government or MIC money obtained in sale of shares by Airport of Mauritius.

Also, the remaining amount in the surplus funds are, on paper, earmarked for the construction of 12,000 social houses and for significant flood management projects.

* Do you get the impression that the government will press on with its objectives no matter what the IMF would propose in terms of corrective measures whether with regard to our pensions system or the incestuous Bank of Mauritius-MIC relationship, etc.?

This is abundantly clear both from the Budget Speech and the IMF report. The Minister is ‘allegedly’ using CSG money from the Consolidated Fund to finance the Rs 1000 monthly allowance to employees and self-employed persons. I say allegedly because money is fungible and as there is no specific fund where CSG contribution is credited, it is impossible to make the difference on the use of that payroll tax. Just like we cannot say that receipts from income tax are used to pay for the health sector.

The challenge will arise where there will not be enough money to pay for the pension commitments of Government. There are only two solutions. Either massive cuts in public expenditure or very high taxes. The additional revenue from higher economic growth will not be enough as the economy will revert to its low secular growth of only 3 to 3.5% in the medium term in the absence of structural reforms to spur growth. It is very clear that someone in the future will have to bite the very bitter bullet of painful fiscal and tax adjustment. And as is often the case, the longer the policy inaction, the more painful the fiscal shock will be.

Both the Minister and the Governor have stated that they will not change the ownership and the scope of activities of the MIC. Even if it weakens considerably the balance sheet of the BOM by exposing it to high contingent risks. Worse the MIC has expanded its scope of intervention. The Central Bank is now involved in land acquisition and it will also invest in venture capital for SMEs, which is highly risky.

As stated by the IMF, the BOM’s ownership of the MIC weighs on the BOM’s independence, blurs the separation of monetary and fiscal policies, and will likely contribute to higher monetary policy costs and/or higher inflation going forward

The key macroeconomic challenge for Mauritius is to continue its economic recovery while keeping inflation under control in a global environment with high fuel and food prices and slow recovery in demand due to the war in Ukraine.

* How can the country achieve this when the BOM do not have the funds to accomplish its statutory obligations?

We have a unique Orwellian predicament in the history of a Central Bank. Because its balance sheet is so weak and Government refuses to recapitalise it and to incur the costs of sterilization,there are no funds for the BOM to effectively carry out its statutory monetary policy obligations. It does not have money to finance its open market operations to pump up excess liquidity; it cannot defend the rupee which is depreciating fast and it cannot combat inflation. Yet the same BOM has diverted Rs 80bn of its precious and scarce reserves to conduct policies that are well outside its statutory scope: land acquisition and speculation, highly risky venture capital funds, financing zombie and insolvent companies. We are already paying a heavy price for this dystopian and delirious Central Banking strategy.

* The tumultuous events in Sri Lanka, the worsening economic situation in other countries, namely Zimbabwe, Pakistan, Lebanon, etc., have raised apprehensions locally that we might ultimately go the Sri Lanka way what with the current management of the economy. Would you say that’s really farfetched?

While the scale and magnitude of the economic decline and decay of Sri Lanka is different from Mauritius, the trend and direction of policies are not dissimilar. Sri Lanka is in a very deep hole for reasons that have been well documented. We are in a hole that is fast growing because of downside risks and we should stop digging to make it a bigger hole.

If we are not careful and do not reverse inappropriate policies and embrace deep seated reforms to cure the structural weaknesses of the economy, transform and diversify the economy, we are heading towards disaster and will face dire consequences.

While history does not always repeat itself, it often rhymes. As Einstein rightly pointed out: ‘Insanity is doing the same thing over and over and expecting different results.’ There are robust lessons to be learned to avert the catastrophic economic situation of the likes of Sri Lanka, Pakistan, Argentina, Lebanon and now Bangla Desh, Suriname, Zambia and now Ghana.

Unfortunately, we share many characteristics with Sri Lanka.

Rising inflation, depreciating currencies, elevated and unsustainable level of debt, lower foreign exchange reserves, limited policy space, a high dependence on tourism, lack of transparency in fiscal and debt policies, poor governance of public sector bodies, reckless investment in ‘white elephant’ infrastructure with low economic and financial returns are some of the undesirable features we share with Sri Lanka. And we add state capture in the decision-making process, economic populism, allegations of fraud and corruption, we have a toxic mix that puts us on the road to Sri Lanka.

Let us hope that reason and economic common sense will prevail to close that road. A good start would be to stop fairy tale economics, fanciful public finance and magical Central Banking.

Mauritius Times ePaper Friday 22 July 2022