Monetary policy in Mauritius has been loose

As a recently well respected economist named Samuelson wrote in the Washington Post, “far from being an unavoidable accident, the relentless wage- price spiral that ravaged the 1970s was the direct consequence of a well-meaning attempt to keep the economy permanently near full employment.’’

 

That the government must increase fiscal spending in order to have a soft landing is beyond debate but the question of how much and on what is where the abuse tends to come from. When governments try to do too much, that is precisely when they make things worse. Before I get to the fiscal side, let me entertain the monetary side.

 

Have you ever noticed how articles about doom and gloom tend to mysteriously appear a few weeks before there is a major policy move in Mauritius? What is funny is that the articles tend to talk about the same things over and over again every day. Such campaigns get policy makers to hold emergency meetings. Does anyone remember how the current Governor of the Bank of Mauritius (BoM) was characterized as being an autocratic king in the weekend edition of a local newspaper one day before the Monetary Policy Committee (MPC) met in September? In a country where many newspapers are so easily influenced by powerful lobby groups and the economic think tanks that work for them, I do not find that surprising at all. A sense of panic was created in October, not that the fundamentals were strong either, which forced policy makers to negotiate and react.

 

First, the good news. The change in the way the Automatic Pricing Mechanism works is the right thing to do, not only for the short term but for the long term as these one time quarterly shocks did more to increase inflation variability than diminish it. Assuming that crude prices remain around the 50-75 dollar range and that the rupee remains relatively stable (an uncertain proposition), inflation in Mauritius is now forecast to hover around 9.7% in December 2008, at around 9% by March 2009, between 7.5% and 8.6% in June and between 5.5% and 7% by next December. Convergence towards pre-June 2008 Core2 inflation levels is hence expected to occur much more quickly. While forecasts are error prone, I can make one that is more likely than not to be in the money: the Finance Ministry will ask for a further cut in the Repo rate as it continues to try to prop up an oversold and overheated growth “miracle.”

 

If you have been listening to the lobby groups and economists who work for them lately, being bombarded with their propaganda, your reasoning is more likely than not to resemble the following: Because India, China, the US, Europe, Japan, Korea and a host of other countries have cut interest rates, why should we not be doing it too? After all it is a crisis and we must lower the cost of capital! Why should we be increasing our rates or keeping our rates so high when the global economy is slowing down? Even if I am telling you that headline inflation is going to fall starting January 2009, heck year on year inflation will begin to fall in November 2008 itself and will probably stand at around the mid 5% range throughout 2009 unless the rupee plays the spoil sport, a not to be dismissed scenario!

 

Since the beginning of this year, what I have been trying to warn against and explain is that monetary policy in Mauritius has been loose, not restrictive. It is not the nominal but the real that matters and in real terms we have had an expansionary monetary policy since 2007. Remember how the same people who are telling you that rates need to be cut now because of what the Indians and the Chinese are doing were telling you that Mauritius was a different country and could not be compared to those countries when these countries’ central banks were raising rates a few months ago?

 

The Mauritius Bankers’ Association has recently compared Mauritius to India. The next time they make such loose comparisons, they should check the following facts: Interbank lending rates in India had tripled to over 20% and the credit market was nearing collapse and may still do. The Reserve Bank of India had also sold some USD 32 billion in the foreign exchange market thereby sucking in an equivalent rupee amount out of the money markets. High loan to value lending habits have begun to hurt “conservative” Indian banks as real estate prices in various Indian metros have collapsed. This is also due to highly levered positions by speculators on bare land outside major metropolitan areas. India was not cutting rates and the cash reserve ratio (CRR) because the US was cutting rates, but because India was facing a major domestic problem. Anyone who convinced you that the Indian real estate market was in the early stages of its growth cycle is probably bankrupt right now if he invested in Mumbai or Delhi.

 

Before other policy makers compare Mauritius to China, perhaps they should look at both headline and core inflation in China first. Do they know that inflation in China currently stands at 4% and is forecast to fall to 2% next year? All central banks in any half decent country cut interest rates when inflation is expected to fall to or below their inflation targets especially when the economy is slowing down or is nearing recession. There is nothing wrong in that and that is why the US, Europe and South Korea have done so. In fact this whole crisis started because the former Fed president Alan Greenspan kept rates in the negative territory for too long thereby encouraging excess leveraging and risk which has cost us far more than it ever earned. Of course our policy makers will not mention that point since they have been ignoring negative real interest rates domestically and our journalists will not ask the tough questions and the lobbies will do the rest because let us face it, they are the ones in control.

 

By Sameer Sharma

Canada-based financial analyst.