By Sameer Sharma
Mohamed El-Erian, a prominent economist and investor, defines perma crises as persistent and recurring patterns of economic and financial instability that hinder sustainable growth and prosperity. According to him, perma crises are often characterized by a combination of structural problems, policy flaws and institutional weaknesses. These factors create a vicious cycle, where short-term fixes fail to address the underlying issues, leading to a perpetual state of crisis. To tackle perma crises, El-Erian emphasizes the need for comprehensive reforms at both the national and international levels. He stresses the importance of addressing structural imbalances, such as income inequality, excessive debt, and inadequate investment in education and infrastructure.
El-Erian also advocates for better policy coordination among governments and central banks to prevent the “spillover effects” of one country’s crisis on others. He highlights the significance of international cooperation and the establishment of effective global governance mechanisms to promote stability and resilience in the face of perma crises. Moreover, El-Erian suggests that policymakers should prioritize inclusive growth strategies that benefit a broader segment of society. By focusing on job creation, social safety nets, and sustainable development, countries can mitigate the adverse effects of perma crises and foster greater economic and social stability.
Mohamed El-Erian emphasizes the importance of fiscal and monetary policy alignment in managing perma crises. He highlights that the inability of fiscal and monetary policy to work together in both expansionary and contractionary directions is a significant problem in economic management. El-Erian suggests that during periods of economic expansion, fiscal policy should focus on prudent spending, investment in infrastructure, and addressing structural imbalances such as income inequality. At the same time, monetary policy should aim to maintain price stability and prevent excessive inflation.
Conversely, during economic contractions or crises, El-Erian argues that fiscal policy should play a more active role in stimulating demand through measures like increased government spending and tax cuts. Simultaneously, monetary policy should support fiscal efforts by providing liquidity to the financial system, lowering interest rates, and implementing unconventional measures if necessary. He suggests that policymakers should communicate and collaborate effectively to ensure their actions are complementary and mutually reinforcing. This coordination can help prevent conflicts and enhance the effectiveness of policy measures in managing perma crises.
Weak balance sheet and high fiscal dominance
When it comes to Mauritius, policy makers have taken significant risks in relying on outright money printing and have taken the risk of weakening the central bank balance sheet to levels that prevent it from conducting credible monetary policy. In more recent times, fiscal dominance over the central bank has pushed the latter to sell unsustainable amounts of foreign exchange while attempting to constrain demand via a moderate form of foreign exchange rationing. The objective here is to artificially inflate the value of the rupee and fit into the political narrative of “l’année de la stabilité de la roupie”.
The Bank of Mauritius has so far borrowed more than USD 1.5 billion mainly via repos and swaps in a rising global interest rate environment in order to bloat the size of gross international reserves. At the same time, an all too passive approach at managing the international reserves portfolio has led to large unrealized losses pushing the central bank to gradually move more and more money to its Hold-to-Maturity (HM) portfolio so that it can value these securities at cost versus marking them to market. Accounting classifications, which do not correspond to the business model of a reserve manager, do not however change the real value of these securities.
As at the end of September 2023, the Bank of Mauritius had the equivalent of 118 billion rupees in its HTM book that, by definition, it cannot sell given the hold-to-maturity business model. This goes against the logic of liquidity, security and returns. These instruments are likely being pledged as collateral for the Bank of Mauritius’ foreign borrowings. The central bank though completely cuts off 118 billion rupees from being actively managed in dynamic global markets, which is precisely what you do not want to do as a reserve manager.
In its mark-to-market accounting classification, the Bank of Mauritius has lost close to 40 billion rupees since the beginning of last year. It needs to completely revamp the way it manages money and learn that accounting classifications to smooth balance sheets locally can be very costly in global markets. As it sells foreign exchange, it is only reducing its buffers and complicating its balance sheet woes. Key to managing perma crises are buffers. In good times, one must save and keep ammunition on the side.
The question then is, why is the Bank of Mauritius intervening if the times are so good? Firstly, Mauritius continues to run high current account deficits given the reliance on a debt-driven consumption model in a country where we import most of what we consume. Secondly, the market understands that the Bank of Mauritius’ balance sheet is weak and fiscal dominance is high. Despite medium and long term inflation expectations being at above 6%, which is well above its 3% medium term target, pressure from the fiscal side (rising cost of funds) and pressure from the private sector, which relies a lot on debt financing, have pushed the central bank to allow bond yields to drop significantly over the last 3 months.
The credibility of the Bank of Mauritius on the inflation targeting front goes down to zero.
This drop in local bond yield in a country addicted to debt has allowed large corporates to issue corporate bonds at yields well below inflation and what they would get via a traditional loan. The government is also able to borrow at yields below inflation. The under-capitalized central bank is also able to reduce its asset-liability problem slightly. The level of economic capital on the Bank of Mauritius’ balance sheet is negative when adjusting for large unrealized losses in its HTM book, and this is even worse if one properly accounts for the real value of the Mauritius Investment Corporation (MIC) convertible bonds, which is not properly accounted for at both the group and MIC level.
A rupee value that is highly inflated against fundamentals
The problem is that the credibility of the Bank of Mauritius on the inflation targeting front goes down to zero at a time when interest rates globally remain high. It should not be surprising that market players, including foreign exchange earners, are converting the minimum they need and holding on to as much foreign exchange as they can. They can find more attractive investments abroad as well.
The establishment of fiscal and monetary buffers is crucial.
We see this situation of big players not converting to rupees manifesting itself in commercial bank excess foreign exchange liquidity numbers. In October 2022, commercial banks held 35 billion rupees in excess foreign exchange on top of their minimum liquidity requirements. Just a year and more tourists and economic growth later, the excess foreign exchange liquidity position has dropped down to 4.5 billion rupees, roughly 100 million US dollars, or around 2-3 days’ worth of market turnover.
Given where interest rates and fiscal spending are, the rupee is once again overvalued. The Bank of Mauritius is trying to cut off liquidity via rationing in order to have a bigger impact (beyond moral suasion) when it sells foreign exchange at a certain price, but at that price, it is not easy to obtain enough foreign exchange in order to satisfy demand. The foreign exchange situation in Mauritius remaining tight is a symptom of a rupee value that is highly inflated against fundamentals.
In the era of perma crises, it is important for the government to engage in greater fiscal discipline, relying more on taxation than on inflation and loose monetary policy. Such an era requires more savings in order to rebuild depleted buffers including at the Bank of Mauritius, as opposed to using up all the ammunition now and sitting naked by the time the next crisis comes. While some policy makers may be hoping to fix all ills with a Chagos compensation, taking on such risks can lead to incalculable consequences in the era of perma crises.
In the short to medium term, the government should seek to impose windfall profit taxes on foreign exchange gains driven by rupee depreciation (exceptional profits bloating corporate profits), which will push them to convert more money in order to pay the tax. The government should also ensure that all real estate transactions by foreigners are settled in Mauritian Rupees. The central bank should be recapitalized, and the government should raise taxes to fund such measures.
The government and central bank should fix our structural ills, including having an interest rate policy that is aligned with the inflation target in order to bring back credibility. The rupee should be allowed to float without demand rationing sooner than later. You also cannot have fiscal policy focusing on doping the economy with money and encouraging more debt while the central bank tries to fight off inflation.
In conclusion, for a small open economy to effectively tackle perma crises, the establishment of fiscal and monetary buffers is crucial. By building these buffers, countries can enhance their resilience and ability to navigate through economic downturns and external shocks.