Is the Bank of Mauritius serious about tackling the rupee’s persistent depreciation?

The current forex shortage stems from a crisis of confidence in the rupee, reflecting poorly on the BoM’s role as a guarantor of financial stability

By Dr Vinaye Ancharaz

“The rupee has lost about 50% of its value against major currencies since this government took office in November 2014 (on 2nd December 2014, just a few days after the elections, the dollar was at Rs31.20). True, the Covid-19 pandemic dealt a major blow to the economy and sent inflation and exchange rates through the roof. Yet, the major causes of the rupee’s decline are domestic and policy-induced rather than external. That the BoM has become the government’s ATM is a known fact. This is akin to opening the floodgates…”

The Bank of Mauritius (BoM) sold $20 million on Monday 19th August, following sales of an equal amount on 12th and 5th. Cumulatively, the Bank has sold $60 million so far this month. While the previous two interventions were at Rs 46.40 per dollar, the most recent one was at Rs 46.27 per dollar. This means that the central bank wishes for an appreciation of the rupee relative to the US dollar. On 22nd August, the dollar was selling at Rs46.54 (SBM rates), lower from the peak of Rs47.20 at the beginning of the month, and on a slight downward path since the Monday rate of Rs46.72 (see chart). It is too early to tell if the recent interventions have had the desired impact. What is clear is that the dollar has settled at over Rs46.50 and is unlikely to fall below Rs45.00 in the short term.

Figure 1. Selling rate of US dollar (Rs/USD), August 1-22, 2024

Source: State Bank of Mauritius

Growing forex shortages… despite economic recovery

The fact that the Bank has now intervened on every Monday of this month indicates that previous dollar sales have fallen short of meeting the demand for dollars. That is, there seems to be a permanent shortage of foreign exchange (forex) on the market. Yet the economy has picked up, and most sectors are doing rather well. Tourism, exports, and foreign direct investment (FDI) are our biggest forex earners, and they are all showing healthy growth. Tourist arrivals reached 1.3 million last year, edging to the pre-pandemic level of 1.4 million. Exports in June 2024 were 24% higher than the corresponding figure for June 2023. FDI in 2023 amounted to Rs37 billion, 10% higher than in 2022. So, why does the rupee continue to fall?

Why the rupee continues to fall?

First, it seems that forex earnings in the travel and tourism industry are being held in foreign currency (FCY) accounts instead of being released into the market (that is, exchanged into rupees). This practice is called hoarding, and it is intimately linked to speculation. Those holding dollars expect the dollar to appreciate further, in which case they would make a profit (since each dollar yields more rupees). Speculation is a self-fulfilling prophecy. If you expect the rupee to depreciate, you will move out of rupees, thus precipitating the rupee’s decline.

A second reason is that the rupee’s internal value is being eroded by ongoing inflation. As prices rise, you will spend more to buy the same things, which is equivalent to a fall in the real value of money. In fact, inflation discourages saving (why save if the real value of the savings will be reduced by inflation?) and encourages consumption. However, if people find a safe and stable asset, they can save by investing in that asset, rather than just holding their savings in rupees. Foreign currency (FCY) is such an asset, which explains why the phenomenon of hoarding has taken such proportions. It also explains the increased desire among ordinary citizens to hold an FCY account. The number of FCY accounts has doubled in the past two years.

Third, while it is true that the value of merchandise exports has increased, this may be in terms of rupees only. A depreciation of the rupee automatically increases the rupee value of exports. In dollar terms, exports may not have increased. Also, our merchandise imports are increasing faster, with the result that the trade deficit is widening month after month. This reduces our net forex earnings and amplifies forex shortages.

Finally, while foreign investment brings in a substantial amount of forex, much of it may not find its way into the commercial circuit, being held up in FCY accounts. Moreover, the BoM must hold a large proportion of FCY in reserves to meet foreign investors’ demand. Failure to meet such demand could lead to a loss of confidence and a dramatic flight of capital that could trigger a financial crisis, with collateral damage to Mauritius’ global business sector characterized by ‘hot capital’ (that is, investment flows that are hyper-sensitive to economic conditions).

On this note, it is worth pointing out that the sale of IRS/PDS villas to foreigners hardly generate any forex earnings. This is because villa prices are denominated in FCY and payments received are held in FCY accounts, most of it outside of Mauritius. Regulations that require villa prices to be quoted in rupees can help attract larger forex inflows as buyers would need to convert FCY into rupees to pay for their property. However, such regulations could make FDI into the real estate sector much less attractive. As usual, therefore, the challenge is to find the middle ground, with balanced policy incentives.

A crisis of confidence

All these reasons suggest that much of the current forex shortage is due to a crisis of confidence in the rupee. This represents a damning verdict on the BoM’s prime role as a guarantor of financial stability in the country. If only the BoM could issue a firm signal that it wants a stronger rupee, the market will work to bring about an appreciation. Unfortunately, the Bank has depleted its reserves, engaged in colourful accounting practices, and is running a business in parallel (the Mauritius Investment Corporation), which detracts its attention from its core priorities. As such, the market cannot trust the BoM to defend the rupee and achieve its inflation target, and so, the rupee will continue to depreciate.

A weak rupee amid rising international reserves

A careful analysis of the Bank’s official international reserves (of gold and foreign currencies) raises questions as to whether the rupee’s depreciation is deliberate or beyond the Bank’s control. Reserves have increased from $6.6 billion to $8.0 billion between July 2023 and July 2024, that is, by more than 20% over the last financial year. This is a comfortable level of reserves, amounting to 12.3 months of import cover. If the Bank has sufficient foreign exchange in its reserves, why is it selling USD piecemeal and in such tiny amounts? Aren’t the BoM’s actions perpetuating the forex crisis?

A deliberate strategy of depreciation?

Or is it that the BoM does not want the rupee to appreciate, or appreciate too much? For a low rupee is in the interest of both the Bank and the government. It brings revaluation gains to the Bank and imported inflation into the economy. Inflation yields ‘inflation tax’ to the government, allowing it to keep splashing cash on targeted segments of the population (low-income earners, public officers, pensioners) that it sees as its vote bank in the run up to the elections. In fact, a big chunk of these perks is self-financing: part of the cash hand-outs will find its way back into the government’s coffers through taxes on goods and services.

Final word

To be fair, the dollar has been on a declining trend since reaching a peak rate of Rs47.89 on 28th June 2024, so it appears that the Bank’s recent forex interventions have proved quite effective in containing the rupee’s relentless depreciation. However, the rupee has lost about 50% of its value against major currencies since this government took office in November 2014 (on 2nd December 2014, just a few days after the elections, the dollar was at Rs31.20).

True, the Covid-19 pandemic dealt a major blow to the economy and sent inflation and exchange rates through the roof. Yet, the major causes of the rupee’s decline are domestic and policy-induced rather than external. That the BoM has become the government’s ATM is a known fact. This is akin to opening the floodgates.

The depreciation of the rupee will not stop until the central bank is truly independent and focuses solely on its responsibility of maintaining price and financial stability. Research shows that countries with the most independent central banks have low inflation rates and strong currencies. Take New Zealand, for example. The replacement of the Bank’s top management with competent people with a mandate to stabilize the rupee’s external value will go a long way in signalling a shift from the past in exchange rate management. And when the market responds to credible signals, policy targets come within reach.

Mauritius Times ePaper Friday 23 August 2024