By Eric Ng Ping Cheun
The Mauritian economy is in a dire situation. All the fundamental economic indicators were in the red last year, and they would not improve much in 2021. In a bid to mitigate the dramatic economic impact of Covid-19, the Mauritian government has opted for the easy way out by increasing the budget, raising taxes and printing money. There have been no serious economic reforms to diversify and consolidate the economy beyond the construction and real estate sectors, to create fiscal space for better resource allocation, to generate productivity gains in public enterprises, to curtail the administrative bureaucracy and to rationalise the welfare state. An economy that cannot see the forest for the trees is not out of the woods.
For the first time in 40 years, the Mauritian economy contracted, to the tune of 15.2% in 2020 according to Statistics Mauritius. All the four engines of growth were in reverse gear last year: private sector investment fell by 24.3% in real terms concurrently with gross domestic saving which reached an all-time low of 6.2% of gross domestic product (GDP); both public investment and government consumption edged down by 33.0% and 1.4% respectively; households consumption plunged by 16.8%; and exports of goods and services nose-dived by 36.3%.
From a very low base, real GDP is expected to grow above 6% in 2021, but the economy will barely recoup 2020 losses. Also, this technical rebound cannot mask the underlying weaknesses of the economy such as price distortions, labour market rigidities, lack of skilled workers, waste of public money and poor governance. The Mauritian tourism, in particular, has lost international visibility to the benefit of its regional competitors like Maldives, for the quarantine requirements imposed by Mauritius on visitors are too harsh, the branding of its destination is badly designed, and its promotion strategy is not cost-effective. Overall, rather than providing incentives to businesses to go upmarket, to digitalise their processes and to embrace the Industry 4.0, the government sticks to its expansionary fiscal and monetary policies that are creating a bubble economy. Such policies may help increase the GDP but are not conducive to job creation and price stability.
No employer will hire if it cannot fire
Indeed, positive economic growth this year will be accompanied by a combination of high unemployment and rising inflation, that is stagflation. The number of unemployed has already increased by 50% from 41,300 in the first quarter of 2020 to 62,200 in September, hence an unemployment rate of 10.9% which reflects mass unemployment. The headline (12-month average) inflation rate surged five-fold, from 0.5% in 2019 to 2.5% in 2020.
The Workers’ Rights Regulations 2020 have been extended to 30 June 2021 to forbid companies from laying off workers. Thus unable to cut costs, deeply affected firms will have no other choice than to close down. During a crisis, enterprises must have the flexibility to restructure in order to survive and to save jobs that are necessary. In any case, they will start to shed their workforce once this legal restriction is removed.
No employer will hire if it cannot fire. When the pandemic ends and the economy bounces back, enterprises will not rapidly create new jobs because of escalating business costs. The only large establishment that is recruiting is government, but public finances are deteriorating as a result.
Households will dip into their savings to finance their purchases.
In the coming months, consumer prices will keep going up such that households will dip into their savings to finance their purchases. In the year 2020, the rupee depreciated by 8.2% vis-à-vis the dollar and by 18.9% against the euro. These two currencies accounted for 67% and 22% of merchandise imports transactions respectively in 2019. As the bulk of consumption goods are imported, the sharp depreciation of the rupee, the many-fold increase in freight costs and higher port charges on laden import containers will be passed on to the consumer. Moreover, salary compensation can only prompt businesses to revise their selling prices upward. Last but not least, the 17% annual growth in broad money supply is likely to translate into price inflation.
Twin deficits exacerbated
Yet, the Bank of Mauritius has intervened massively on the domestic foreign exchange market by selling a total of 977 million US dollars from March to December 2020. Gross official international reserves still exceed 7 billion dollars (representing 13.2 months of imports of goods and services) thanks to foreign loans and lines of credit obtained by the Mauritian government. The Central Bank wants to buffer up its foreign exchange reserves to show that it has enough to defend the rupee. But this is not a sign of strength of the economy.
In a country that has a huge offshore sector relative to the size of its economy, one cannot look at reserve adequacy in terms of import cover. Mauritius’ level of reserves is adequate based only on the deposits of global business companies (GBC). However, the island does not really have excess reserves in view of the potential outflows of short term GBC deposits as liabilities. GBC flows are significantly larger than the international reserves held by the Bank of Mauritius. The longer Mauritius stays on the European Union blacklist, the more volatile will be the GBC flows. Foreign exchange reserves will inevitably decline because tourism and air transport services are generating very little revenue, apparel exports are struggling, and foreign real estate purchases are down. The current account deficit has already widened to a staggering 13% of GDP in 2020.
In this context, it is ill-advised to make available up to two billion dollars from the official reserves to the Mauritius Investment Corporation (MIC), a subsidiary of the Bank of Mauritius, with a view to bailing out business groups. No country is using international reserves to save distressed companies. Bailout funds should not be confused with sovereign wealth funds. A bailout fund must be a combination of debt and equity from government and the central bank, with the latter buying bonds issued by a special purpose vehicle set up by the former.
Under-capitalised companies would do better to sell assets and raise more equity capital via private equity or the stock exchange, rather than going into debt to avoid diluting the shareholding. The MIC was meant to have convertible bonds (a hybrid of equity and debt), but those issued by the bailed-out companies (the issuers) have no equity sensitivity and are just subordinated debt. Since the structuring of the bonds is far from optimal, the MIC as investor is most likely to incur losses when it will price them at market value. Helping private enterprises need not be at taxpayers’ expense if market forces are allowed to work.
Under-capitalised companies would do better to sell assets and raise more equity capital.
In addition to transferring some 80 billion rupees to the MIC, the Bank of Mauritius has granted 60 billion rupees to the public Treasury for financing the national budget. Notwithstanding the money printing, which is highly inflationary as it represents one third of GDP, gross public sector debt jumped to 84.5% of GDP as at 31 December 2020. It would have exceeded the 100% mark if government had raised that amount on the debt market. Since central bank financing is not considered as fiscal revenue, the real budget deficit hovers around 14% of GDP. The country’ twin deficits, the combination of large current account and public deficits, have spiralled out of control.
Mauritius runs the risk of suffering the same fate as the Seychelles, a tourism-dependent country that is encountering difficulties in paying the salaries of civil servants. Despite the drastic fall in tax revenue, the Mauritian government continues to recruit hundreds of bureaucrats and to augment social expenses. It requires a lot of political courage to resist to unions’ demands for immediate across-the-board wage increases in the public sector. It is unfair to penalise the outsiders, the unemployed, to please the insiders, the employed, who should be happy enough to keep their job. Mauritius, like Ulysses, has to skilfully navigate between Scylla and Charybdis, or otherwise jump out of the frying pan of economic contraction into the fire of stagflation.
This article first appeared in the newsletter of The Insurance Institute of Mauritius under the title “The Mauritian economy is not out of the woods yet”.