By Sameer Sharma
Although monetary policy became the panacea to cure all economic ills and market crises over the past few decades, central banks can no longer use this magic wand to dispel the challenges they face today: runaway inflation and a recession looming on the horizon. The so called disinflationary “goldilocks” narrative – an economy not too hot and not too cold –, that had supported risk assets for so long, has this year morphed into an inflation fighting offensive, belatedly taken on by policy makers, now robbed of their weapon of choice to prevent further financial meltdown.
This past week’s Jerome Powell Jackson Hole speech once again confirmed that the Fed would continue to tighten monetary policy and be more tolerant of tighter financial conditions which is likely to stall the economic restart. Indeed, as Chart 1 and Chart 2 highlight, monetary tightening globally, when coupled with geopolitical tensions and a more pronounced Chinese property bust fuelled slowdown, are leading to deteriorating economic sentiment and momentum. As recently highlighted by JP Morgan chief Jaime Dimon, there is now a 60% chance of a recession evenly split between a mild one and a more pronounced one.
This uncertainty stems from the unusual nature of the current business cycle which remains characterized by unusually still tight labour markets, still healthy consumer balance sheets in the United States, declining consumer confidence and property and risk asset prices. The expectation now is that corporate earnings may weaken more as consumer spending shifts and profit margins contract. While high frequency inflation indicators appear to be peaking out globally as the global economy slows, there are secular trends at play, given the balkanization of supply chains which comes with de-globalization which will keep inflation high enough for longer. The risk of stagflation is hence increasing and remains the current base case for Europe in particular.
Chart 1: Global Growth NowCaster
(Source: Bloomberg, Author Calculations)
Chart 2: Google Search Trends on Recession & Inflation as a Measure of Sentiment
Distorted capital structures and poor free cash flow
With more than 180% private and public sector debt to GDP and with a very weak central bank balance sheet to boot, Mauritius lacks fiscal and monetary buffers in order to withstand slowing growth momentum globally. The supply of US dollars in the domestic foreign exchange market has remained tight while an unofficial policy of selective foreign exchange control has allowed the central bank to achieve significant, albeit temporary, results with small foreign exchange interventions.
The Bank of Mauritius (BoM) sells USD 10 million in the market, which is a small amount of sales, and is able to obtain 44.15 rupees (MUR) when the market was trading at above 46 to the dollar. This, as was the case multiple times before, can only create short term gains for those who buy the dollars, but cannot be sustained given the secular trends inclusive of the BoM’s own money printing policy. In fact, a few days after such interventions, the MUR/USD is once again approaching 45.
Mauritius lacks fiscal and monetary buffers in order to withstand slowing growth momentum globally.
Large conglomerates in the Mauritian private sector have largely benefited from the bailouts of the Mauritius Investment Corporation (MIC) to their subsidiaries, but have unfortunately not made structural changes to their business models which had led to distorted capital structures and poor free cash flow generation pre-pandemic. The local stock market has seen no rights issues given the allergies which come from equity dilutions while persistent excess rupee liquidity in the system has allowed credit spreads to remain distorted. The government continues to encourage bad behaviours which lead to return on capital employed (ROCE) levels well below their respective weighted average cost of capital (WACC). If free markets are not allowed to work, then Zombie and near Zombie-like companies will continue to remain a drag on economic growth.
The Mauritian consumer remains under pressure given higher cost of living expenses, the corporates are not reforming and the state itself has high levels of public debt and continues to rely heavily on monetary financing, given the size of off-budget Special Funds (mostly financed by BoM, which is helicopter money) and given the remaining size of MIC funds yet to be spent. The latest balance sheet release for July 2022 for the Bank of Mauritius now points to MIC commitments of MUR 83 billion compared to MUR 81 billion (1 billion in equity commitment in MIC by BoM included) in June 2022, an increase of MUR 2 billion. Beyond the interesting accounting of MIC assets, any money once disbursed is similar to helicopter money. It is plain and simple liquidity injection into the economy. The increase, ironically, also allows the BoM to massage its asset levels which impact its level of economic capital.
At the same time, under liabilities of the BoM balance sheet, back in January 2022, BoM’s MIC liabilities (which are assets to the MIC) stood at MUR 39.4 billion, meaning that the MIC had invested almost half of the initial MUR 80 billion commitment. By July 2022, this amount fell to MUR 35.2 billion in terms of cash remaining to be spent, and some MUR 48 billion in investments. No wonder some commercial banks are getting credit outlook upgrades with this kind of backstop to borrowers.
Persistent excess rupee liquidity has allowed credit spreads to remain distorted.
The Mauritian government continues to rely heavily on printed money which will not only put more pressure on the currency, which small interventions will not be able to offset, but will also keep inflation uncomfortably high even if it falls from current levels. In many ways, this government is relying heavily on tourism to help soften the impact from the global slowdown, which is complicated to do given the cyclical nature of this sector, and on other countries and central banks to get the job done on its behalf. The Mauritian economy may be expected to grow at 5% this year, but this is base effect driven. Actual quarter-on-quarter growth momentum will begin to show signs of weakness sometime during the current quarter, and more likely into the next two quarters.
Mauritian politicians these days seem to be busy campaigning and engaging in the “who has the bigger crowd” contest, but right now what is needed is serious policy action in the form of a significant central bank recapitalization which includes a combination of returning special funds and public borrowing, meaningful public sector spending cuts coupled with serious structural and institutional reforms in both the public and private sectors. It also involves a genuine opening of the economy to foreign investors beyond real estate, despite the private sector lobbying and middlemen problem.
One of the key messages of the last Moody’s credit report was that Mauritius would struggle to face the next crisis, given its depleted fiscal and monetary policy buffers. The next crisis is unfortunately already here.