Monetary nonsense

By lowering further the Key Repo Rate, the Bank of Mauritius makes a nonsense of monetary policy as the private sector will not engage in new projects with elections close. By caving in to pressure from the Treasury Building, Governor Googoolye has not assuaged firms’ concerns over the Workers’ Rights Bill, but has rather done a disservice to the government which will have to face up to angry voters. By enhancing the monetary stimulus, the authorities are set to increase excess liquidity. By choosing a 0.15% decrease, the Monetary Policy Committee makes a fool of itself in front of international opinion as changes in global benchmark interest rates are always a multiple of 25 basis points.

If we go by official data, Mauritius does not need a rate cut. The MPC is not expecting an abrupt worsening of the domestic economy as it believes that “the underlying growth momentum remains broadly positive”. With a real GDP growth rate of 3.9%, with an overall unemployment rate down to 7.9%, with an underlying core2 inflation rate (which excludes food, energy and administered prices) remaining at 1.9% in the first semester of 2019, with domestic credit expanding briskly by 7.4% in the year ending 30 June 2019, and with rising wages (from the first quarter of 2018 to that of 2019, the nominal wage rate index jumped by 4.9% in the private sector, notably 7.4% in the manufacturing sector), nothing justifies bringing down interest rates that are already artificially low. If the economy needs monetary easing under these conditions, it is hard to imagine a situation in which the MPC will be willing to raise the repo rate!

To conclude that another rate cut is now warranted is to signal that the Mauritian economy is not performing as the government and the central bank have long pretended it to be. For many economic operators, this has been obvious for years, of course. Policymakers are therefore lying to the population when they hammer home the message that the economy is getting better. Has the Prime Minister and finance minister not just assured us, in his budget speech, that economic growth would be higher in 2020?

One of two things must be true: either the economy is weaker than the headline data suggest, or the method of measuring inflation is wrong. Incidentally, the discussions within the MPC no more revolve around the so-called trade-off between growth and inflation – the gospel of Keynesian thinking. The likes of Oliver Blanchard must have some difficulty in explaining why sustained growth and decreasing unemployment have not led to a resurgence in inflation.

It is possible that both conclusions are plausible. If inflation is truly more sizeable than the official estimate, real wage growth is insufficient to drive up prices. The consumer price index happens to be a measure based on a lot of arbitrary judgement calls, such as the claim that price increases are overestimated because products have improved in quality. Such an assumption, which is used to push down inflation rates, is a pretty tone-deaf way of calculating the change in the level of prices.

It is evident that the rate cut is not motivated primarily by economic data, but by politics. The Bank of Mauritius under the current top management, for all its protestations of independence, is simply doing what the government wants it to do. The fiscal authority has kept on applying pressure behind closed doors with complicity inside the central bank.

There are two reasons why the ministry of finance keeps a heavy hand on monetary policy. The first is the importance of low interest rates in a situation of runaway government spending. As the public sector debt continues to rise, and the budget deficit to mount – in a period of “growth”, mind you! –, it becomes crucial to maintain debt service low by pushing down interest rates. If debt payments increased substantially, welfare programmes could be trimmed, which would be politically unpopular.

The second reason is the necessity of a weak rupee to replenish the Special Reserve Fund of the Bank of Mauritius. The problem is that the country has witnessed significant net outflows in portfolio investments (a total of USD 2.3 billion in 2017 and 2018). The Stock Exchange of Mauritius alone suffered a net foreign divestment of Rs 3.2 billion over 14 consecutive months. As our survey respondents explain, “foreign investors are pulling out because the rupee is sliding, the fundamentals of listed companies are not strong, and the future does not look good”. Thus, “as long as the rupee remains weak with respect to the US dollar, it is difficult to see foreign investors coming back massively.”

Government interference in monetary policy carries a heavy political price to pay with ordinary savers. The effect of a decade of low rates has already been devastating for them. The interest rate policy has worsened income inequality, being designed for the rich who can chase high yield through investment products. Families living on fixed income, who can only afford to have lower-yield savings accounts, will continually lose purchasing power.

The majority of MPC members assume that their decision will help Mauritius “to further enhance its resilience”. It is a joke because interest rate policy is meant for cyclical stabilisation. Even so, says an analyst, “the impact will be limited given the weak monetary transmission mechanism. What is needed are structural reforms aimed at nurturing a more competitive economy.” But that is too much for the government to stomach.