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).Read More… Become a Subscriber

Mauritius Times ePaper Friday 23 August 2024