During the second Competitiveness Foresight exercise that it has recently organised, the National Productivity and Competitiveness Council was reflecting upon the current competitiveness status of Mauritius. This came at an opportune time after private sector lobbies had managed to convince government to take steps to boost exports by currency manipulation. Not only does the ministry of finance subsidise exchange rate losses made by exporters of goods, but the Bank of Mauritius has also loosened further its interest rate policy and keeps on buying dollars to artificially weaken the rupee. Alas, tampering with exchange rate can only make things worse as it brings about misallocation of resources and distorts the production structure. And it goes against “inclusive competitiveness.”
Participants to this workshop were invited to read “The Competitive Advantage of Nations” of Michael Porter. Although it was published 27 years back, this seminal article is still relevant today for a very small and open economy like Mauritius. At the outset, the author emphasises that national prosperity does not grow out of a country’s currency’s value. It actually “depends on the productivity with which a nation’s labor and capital are employed.” Thus, “the only meaningful concept of competitiveness at the national level is productivity.”
A competitive nation, says the Harvard professor, is not one whose exchange rate makes its goods price competitive in international markets. He advises governments to “avoid intervening in currency markets” because such policies “work against the upgrading of industry and the search for more sustainable competitive advantage.” International exchange rates are symptoms, not causes, of economic deterioration. Firms should respond to currency appreciation by improving productivity and quality control through plant and equipment investment and innovations in factory management. They must seek efficiency gains by adopting new technologies to make high-value-added products suitable for export. They can hedge their foreign exchange risk with swaps and financial futures.
Porter refutes two sophistries on the concept of competitiveness. First, contrary to the belief of the Mauritius Chamber of Commerce and Industry, “defining national competitiveness as achieving a trade surplus or balanced trade per se is inappropriate.” Expansion of exports due to a weak currency may bring trade into balance but lowers the country’s standard of living. Now, “the principal goal of a nation is to produce a high and rising standard of living for its citizens.”
Second, contrary to claims made by the Mauritius Export Association, “competitiveness does not mean jobs. It’s the type of jobs, not just the ability to employ citizens at low wages, that is decisive for economic prosperity.” The Mexa pretends that exchange rate intervention would create, or at least save, jobs. Empirical evidence, however, clearly shows that our decades-long export friendly monetary policy has not caused Mauritius to gain manufacturing jobs. Export-oriented enterprises shed more than 40,000 jobs over the last 16 years, with employment down from 93,218 in March 2001 to 51,954 in March 2017.
In 2015, the rupee’s value slid by almost 20 per cent against the dollar, falling to a buying rate of around Rs 36. In November of the same year, the monetary policy committee slashed the key interest rate by 25 basis points, and it cut it by a further 40 basis points in July 2016. In response to this aggressive monetary easing, exporters were supposed to invest, to borrow and to expand their production of goods. Instead, their output contracted by 5.1% in 2016 while the manufacturing sector’s gross fixed capital formation declined by 0.6% in real terms. As regards bank credit to export enterprise certificate holders, it barely increased from July 2016 to July 2017.
Worse, there was no improved competitiveness on account of rupee depreciation. True, the ratio of export price index to import price index rose by 18.5% from the first quarter of 2015 to that of 2016, indicating that the terms of trade moved in favour of Mauritius. However, the terms of trade decreased by 14.0% in the first quarter of 2017 compared to the corresponding quarter of 2016, despite the fact that the US dollar stayed high between these two periods.
The lacklustre performance of the export sector can be attributed to a confluence of factors, notably restrained demand in key external markets, competitive pressures, growing business costs and currency dynamics. It is not a foregone conclusion that a sustained decline in the external value of the rupee can sharpen export competitiveness. Firstly, in spite of better export prices, demand can remain stymied by subdued economic conditions overseas. Secondly, the net effect of rupee depreciation on the demand for Mauritian exports can be insignificant in view of the evolution of the competitors’ currencies.
Thirdly, the import content of exports is substantial for a trading nation. As rupee depreciation triggers higher import prices, they feed directly into higher production costs. As time goes by, the effects of loose monetary policy also filter through a broad spectrum of prices of goods and services and ultimately eat into exporters’ profits. Thus evaporates the gain of cheaper exports.
The British Chambers of Commerce is right to point out that the collapse of the pound in the wake of the Brexit vote has done “more harm than good” to the UK economy. Currency depreciation inflates and redistributes, transferring wealth from the poor middle class to the wealthy owners of export industries. In Mauritius, workers do not have bargaining power to negotiate a nominal wage increase to bring their real wage back up to before the devaluation.
The central bank acts as a reverse Robin Hood, taking from the have-nots to give to the haves. Currency depreciation is unhealthy as it undermines confidence and demoralises. Other economic actors are also hurt, namely consumers who bear the brunt of more expensive foreign products, and firms which import their inputs and sell on the local market. The country gets poor in terms of real wealth, in terms of the goods and services required for maintaining people’s wellbeing. An economy does not gain in competitiveness by excluding the many for the benefit of a few.
As an international organisation funded by its state members, the International Monetary Fund (IMF) is always indulgent towards, well, governments. Appointing itself central planner for the world, it happens to be the fire chief of economic crises, providing loans to countries subjected to financial hardships. Its complacency prevents it from foreseeing flare-ups, and once they occur, IMF firefighters tend to put out fires with gasoil.
Prior to the Asian crisis of 1997, the IMF had praised the conditions in Thailand, Indonesia and South Korea, downplaying the problem of global capital flows combined with high domestic savings. Under the IMF’s thumb, Russia was compelled in 1998 to create a new 5% sales tax and a 3% surcharge on tariffs, which provoked a massive capital exodus that pushed the country into default. One year before the 2008 banking crisis in Iceland, three IMF economists (Robert Tchaidze, Anthony Annett and Li Lian Ong) noted that “foreign currency borrowing has been growing strongly… and this could potentially become an important indirect credit risk for banks,” but the true risks involved in currency mismatching were actually more direct than they thought.
Fortunately not all IMF policy options are taken on board, and better still governments sometimes implement bold measures that are home-grown. In 1999, Malaysia suspended income tax altogether. In 2001, Russia adopted a 13% flat tax on individual income, down from 30%. In the same vein, Mauritius introduced ten years ago a 15% flat tax on both personal and corporate income despite calls from the IMF, in the context of the 2007 Article IV consultation, for “more decisive fiscal consolidation.” Those tax policy actions lifted the three countries out of crises.
Rarely have we seen here government and opposition parties alike, including the far-left Rezistans ek Alternativ, comment favourably on an IMF statement, namely that made in regard to the 2017 Article IV consultation with Mauritius. Yet, no sensible economist can be in total agreement with the views of the IMF mission led by Amadou Sy. They contain many inconsistencies, contradictions and confusions.
Mr Sy states that “the Mauritian economy continues to be robust”, which implies that economic growth has remained strong for the past years. Its annual rate has stayed below 4.0% since 2011. In March 2016 though, the IMF concluded the Article IV consultation by saying that “Mauritius has continued to grow at a moderate rate”. Between moderate and robust, there is a significant difference in substance. And if the Mauritian economy were really robust, how would the IMF qualify its own staff estimates, over the period 2011-2017, of the growth rates of Côte d’Ivoire (6.9% to 10.1%), of Ethiopia (7.5% to 11.4%), of Tanzania (5.1% to 7.9%) and of Togo (4.8% to 6.1%)?
The choice of words is not unimportant. Mr Sy is satisfied that “total public debt remained constant at 65% of GDP.” It may be constant from June 2016 to June 2017, but this is not an achievement when compared to 61.6% of GDP in December 2014. Likewise, nothing has been achieved to warrant his “optimism that the country will successfully manage the reform process.” What reforms? The high level committee set up to look into the pension issue is stalled while sugar planters are still waiting for labour market reforms in their sector.
The IMF mission points out that “real GDP growth in 2017 is projected at 3.9%.” To be precise, it refers to gross domestic product at market prices, the terminology used for international Governments should not give the IMF an excuse to intrude in their affairs whenever they do fire fighting. In Mauritius, however, the related indicator is gross value added (GVA) at basic prices, and the official growth rate for this year is estimated at 3.7%.
Another blurring of distinction is between headline inflation and year-on-year inflation. The IMF mission is alarmed to see that “headline inflation outcomes in the first half of the year surprised on the upside, and more than doubled to 5.3% year-on-year in July.” While that is true, the IMF must know that Statistics Mauritius calculates the headline inflation rate by using the annual average method, i.e. by comparing the average level of prices during a twelve-month period with the average level during the corresponding previous twelve-month period. The year-on-year inflation rate is instead defined as the percentage change in the consumer price index for a given month with respect to that for the corresponding month of the previous year. The former is used for adjusting wages and pensions to compensate for loss of purchasing power, whereas the latter is monitored by central banks for monetary policy decisions.
Thus, Mr Sy recommends “tightening monetary policy”. The problem is that the Bank of Mauritius staff considers rather headline inflation, which stood at 2.7% in July. The inflation surge largely reflects budgetary measures. A more useful guide for the conduct of monetary policy is the yearon- year core 2 inflation which is a proxy measure of demand-pull inflation as it excludes volatile price components that are beyond the control of the monetary authority such as food, beverages, tobacco, mortgage interest, energy prices and administered prices. It fell from 3.0% in May 2017 to 2.2% in July.
The IMF position on interest rate does not square with its suggestion for “more flexibility of the exchange rate.” This is an understatement that the Central Bank must devalue the local currency, even if Mr Sy has not expressed any concern about a supposed overvaluation of the rupee. But prices would go through the roof without narrowing the current account deficit, and this would further reduce our cost competitiveness. An abrupt monetary tightening together with a sharp rupee depreciation would amount to the policy of a pyromaniac fireman.
Ironically, the IMF’s original mission, established in 1944, was to promote fixed exchange rates, a mission that should have ended in 1971 when exchange rates were floated. Since there is now no need to coordinate cross-border monetary policies, the IMF is suffering a loss of relevance with its 2,600 overpaid workers. Governments should not give it an excuse to intrude in their affairs whenever they do fire fighting.
By Eric Ng Ping Cheun
The author has just published a new book, Economic Sense, on sale at Bookcourt, Editions Le Printemps, Librairie Petrusmok, Librairie Le Cygne, Le Bookstore, Carrefour Bookshop and Jumbo.
Courtesy: Conjoncture, Bilingual Journal of PluriConseil.