Looking beyond the 2019/2020 Budget (1st part)

Much has been said about the 2019/2020 Budget of Mauritius. While a rosy picture of the economy was painted by the government, the reality is somewhat more nuanced. Growth over the past decade has gradually been slowing because both labour input growth and capital input growth have been consistently decelerating. Back in the 1980s, a major jump in female labour participation, a low base from which productivity growth could accelerate from and capital accumulation allowed gross domestic product (GDP) growth to shoot up. In the 1990s, the fruits of a higher quality education system (back then) coming from a lower base allowed labour input growth to continue to increase along with capital accumulation and total factor productivity growth. Mauritian policy makers embraced capitalism and openness to trade, and understood at least that a prudent wage growth and exchange rate policy would be key to maintaining growth momentum. The gradual increase in hand-outs and political largesse could be offset by preferential trade deals with the West. In the 2000s, the fruits of vision from local policy makers and a favourable tax treaty with India helped to offset the erosion in preferential trade with the West.

On the capital input growth side, domestic private investment has been declining...

The International Monetary Fund, in its Selected Issues 2019 paper (“Unlocking Structural Transformation in Mauritius, Challenges and Opportunities”), reports that between 1980 and 2000, labour input growth’s weighted contribution to GDP was 3% while capital input growth’s contribution stood at 2.3% during the same period. From the 2000s till date, labour input contribution slowed to average 1.2% annually while capital input contribution to GDP growth fell down to 1.4%. The small residual between GDP growth and growth in the factors of production was led by productivity growth as the economy transitioned towards a services economy. While the purpose of this article is not to dwell into the well known reasons as to why Mauritian input growth slowed, it aims to tackle the future. The reality is that since 2010 at least, policy makers have failed to address the structural challenges which torment the economy.

For example, with an ageing population, stagnating women labour force participation, the lingering impact of the brain drain of the 1990s and 2000s and an education system which is simply not working anymore, labour input growth will not be accelerating anytime soon and admittedly, unless we are more open to immigration, it will not happen easily. On the capital input growth side, domestic private investment has been declining (it gets worse if you exclude real estate related activities) and this will not change unless the structure and the business ecosystem of the corporate sector change.

Mauritian companies, especially the larger non financial ones, tend to be asset rich and free cash flow poor (which should make any CFA student ponder about asset valuation standards). Just have a look at the Return on Capital Employed (ROCE) of non bank related listed companies, and it will not be hard to see that large non financial corporations cannot sustain ROCE levels above their cost of debt for a sustainable period. Just exclude the listed banks over the past two years, and you will find that there has

been little profit growth when comparing similar quarters to each other. Over the past eight years, this chart would not look stellar either. In fact the last five years have seen a slew of corporate debt restructurings with many taking advantage of the mispricing of credit risk in the corporate bond market with a focus on optimising balance sheets and unlocking liquidity.

The theme has been more about getting one’s house in order and improving cash flows and return on capital versus actually investing on aggregate. The reality is that the investment capacity of the corporate sector is limited, and this situation is further complicated by an outlook wherein most business opportunities would not see returns on capital above the weighted average cost of capital, let alone the cost of debt. With the tourism sector facing obvious headwinds and with troubles within the sugar and manufacturing sectors, a meaningful break from the zigzag pattern of corporate profits looks unlikely in 2019. While the government has done all it can via middle class tax breaks and higher wages for those at the bottom of the wage scale, if the falling trend in core inflation is to be believed, there has been little left when it comes to accelerating consumer spending growth from current levels.

Now if we go down to smaller non listed companies, almost 60% of small and medium enterprises are subsistence corporations with limited growth capacity. The bulk of the rest are not doing that well or are unable to scale up to the next level given the market size, oligopolistic tendencies of some larger peers, the lack of fair opportunities from the public sector, sub-optimal capital structures, corporate governance issues and capacity constraints. What sustains Mauritius’ private investment to GDP ratio is actually not real investment but increasingly luxury villa purchases by foreigners.

*Sameer Sharma is a chartered alternative investment analyst and a certified financial risk manager.
Source : Conjoncture July/August 2019.