Managing the Trilemma: The MPC

Titbits

The ” impossibility trinity or trilemma” holds that policy authorities cannot simultaneously and continuously follow the three objectives of free capital mobility, fixed exchange rates, and an independent monetary policy. And even if the exchange rate is allowed to float, monetary policy cannot be entirely independent of what is happening to the value of the rupee. The trilemma implies that an economy can enjoy capital inflows and an independent monetary policy so long as it gives up worrying about the appreciating exchange rate. It is impossible to have all three goals at a time.

The Mauritian economy is facing an increasing trilemma – attempting to pursue an independent monetary policy and limiting exchange rate flexibility. Capital inflows put upward pressure on the rupee – a real appreciation. If the BOM does not intervene, this results in a nominal appreciation of the rupee. If the central bank intervenes and buys foreign exchange, the monetary base or reserve money goes up and over time the inflation rate goes up. Thus to contain these inflationary pressures, the monetary authorities sell government securities or treasury bills to mop up the increased money supply. This is called sterilized intervention.

Table 1: Extent of Sterilization of inflows

Year	∆ RM	∆ NFA	∆ NDA	∆ NDA/RM
2007-08	2,651	5,145	-2,494	-8.9
2008-09	5,272	9,048	-3,776	-12.3
2009-10	9,002	8,826	176	0.5
2010-11	3,345	6,202	-2,856	-6.4
2011-12	4,342	11,459	-7,117	-14.7
2012-13	9,727	11,938	-2,211	-4.2

∆ = change, RM = Reserve Money, NFA = Net Foreign Assets, NDA = Net Domestic Assets

Table 1 shows that the extent of sterilization was relatively limited as the monetary impact of reserve inflows (i.e. positive levels of ΔNFA) was partially sterilized. These inflows were not fully compensated by negative changes in domestic asset holdings by the central bank (negative levels of ΔNDA). The capital inflows thus led to large increases in the monetary base. Last year, it was growing by over 18 percent, showing that the authorities have found it increasingly difficult to limit the liquidity effects of the foreign exchange asset accumulation.

The sizeable capital inflows would have caused noticeable nominal and real appreciation, and the BOM has thwarted this to some extent by intervening in the foreign-exchange market and buying foreign exchange. It has not succeeded in fully sterilizing the inflows which resulted in excess liquidity in the market. It had to raise bank reserve requirements and imposed macro-prudential measures or lending restrictions in an attempt to decouple reserve money growth from broad money growth. The slack in economic activity and the resulting low aggregate demand explains to some extent why the vast flow of liquidity into the banking system was not translated into equally high money supply growth.

Table 2: Growth of Money Aggregates

% Change	2009	2010	2011	2012	2013
Net Foreign Assets	16.2	13.6	8.4	14.3	13.0
Monetary Base	17.2	25.1	7.4	9.0	18.5
Money Supply	8.0	1.3	6.4	8.2	5.8
Domestic Credit	1.8	11.3	10.5	14.6	14.6

The capital inflows also led to a significant increase in domestic asset prices, such as real estate prices, and pushed down long-term interest rates. This in turn has been associated with a sharp increase in the credit to the private sector (see Table 2 Below). Over the past few years, we have also seen the share of non-performing loans rise in the balance sheets of many banks.

Lowering the Key Repo Rate (KRR) would not have been a very sensible policy option as this would have provided an even stronger domestic stimulus, thus exacerbating the bubble in financial markets and the risk of an overheating, and worsening growing financial imbalances.

What about raising the KRR? It would have encouraged more inflows and reinforced market expectations of further appreciations. Moreover, given that the BOM allowed the build-up of a large excess liquidity in the money market, it has resulted in a disconnect between the Repo Rate and money market interest rates. The rates in the interbank market have fallen sharply and have remained much below the KRR, which has undermined the monetary policy transmission mechanism and rendered it ineffective. The sharp decline in economic activity has given us a breather but once demand picks up, the trilemma becomes binding and the excess liquidity will lead to potentially higher inflation rates.

Thus it would be futile presently to be discussing about U or V turns or other flip- flops. Keeping the Key Repo Rate unchanged at 4.65 per cent per annum was the only wise and pragmatic thing to do as long as the Ministry of Finance and the BOM do not work jointly to absorb the excess liquidity and align the KRR to the interbank rate. Only then, with an effective transmission mechanism, through the tighter links between interest rates and better signaling, would it be worth discussing the decisions of MPC and its likely impact on the economy!!!

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SOE reform: Need for a new dynamism

The 2007 Budget announced an ambitious reform programme, an important component of which was a Public Enterprise Reforms Programme. The main objectives of the State-Owned Enterprises (SOEs) reforms were the setting and monitoring of key performance indicators of operational and financial performance, restructuring, rationalizations and mergers to improve resource utilization and reduction of the explicit and implicit burden of SOEs on public finances. A special unit was even set up to realize these grandiloquent goals – the Public Enterprise Reform Unit (PERU) under the World Bank financed ‘Mauritius Economic Transition Technical Assistance Project’. Unfortunately, like the other schemes (Jin Fei, LBOI, Tourist villages,…) of the TINAs (the There-Is-No-Alternative tribe), our PERU unit did not deliver much in terms of results and the 18-million dollar loan from the World Bank for the project had to be cancelled.

A more gradual approach was then adopted aiming at efficiency improvement leaving the major reforms for a subsequent stage. It was based on the belief that at the outset small incremental changes can deliver some quick meaningful results. It was demand/crisis driven. The whole programme of reform was entrusted to an advisory body with the mandate of merely providing support to public sector enterprises in implementing performance enhancing reforms approved by government and in recommending corrective measures, where appropriate.

And where are we now with SOE reform? Are we still stuck at the level of “satisfactory underperformance”? We still have a huge unfinished reform agenda. Many SOEs are operating in areas where they do not address any identified market failure or provide any public goods. There has been a proliferation of state-owned enterprises (SOEs) in recent years spanning almost all economic sub-sectors including the utilities, commercial, economic, educational, welfare, social, and cultural sectors which employ around 20,000 people or 1.6% of the population. Six out of 15 large SOEs had an operational deficit in 2010, the highest number since 2006. Government transfers to SOEs are amounted to 3% of GDP in 2010; total SOE debt was 7% of GDP or 12.5% of total public debt in 2010 with half of it being guaranteed by the government.

The performance of SOEs in terms of service delivery is undermining overall economic competitiveness. They are not held fully accountable for their performance, There is no clear demarcation of the ownership and oversight roles, and a lack of transparency and accountability. They do not publish annual reports without being penalised for non-compliance. Many do not have either strategic plans, or any targets or performance indicators agreed between the respective parent ministries and their boards. Indeed, we still have a long way to go.

But now we have a different setting, and time is not on our side. We need to beef up growth, create jobs, raise revenues, reduce expenditures and bring down the budget deficit, the current account deficit and debt. We stand the risk of being stuck in the middle-income trap with declining investment ratios, slow manufacturing growth, limited industrial and export diversification and poor labour market conditions.

To meet these challenges, we have to create fiscal space, for example, boost investment in human capital formation and address the quality and relevance of education. And there is an urgency for fiscal rectitude. The Consolidated budget deficit (including Special Funds) works out to around a high of 4.6% of GDP for both 2013 and 2014. Fiscal consolidation will be difficult given the low growth in tax receipts, the high growth in the government wage bill and the continuing upward trend on welfare benefits, and the failing SOEs which are like albatrosses around the neck of government as they drain public finances.

It’s time now to revisit many things that we do and the ways that we do them. There is an urgent need for a bold overhaul of the system itself. We have to move fast on the reform of SOEs – a more ambitious SOE reform programme. The proposal of the chief editor of Business Magazine in one of his latest editorial pieces titled “Le temps du grand toilettage” goes in this direction – the need to have a centralised autonomous ownership agency, with a wider and more powerful mandate than the present OPSG, which reports to a new Ministry of the Economy like France’s APE, or China’s SASAC, Peru’s FONAFFE, Malaysia’s Khazanah, Hungary’s State Holding Company and Mozambique’s IGIPE.

Such a body will have more of an implementation focus and will be actively involved in exercising the state’s ownership rights. It will have a clear and focused mandate of setting the SOE objectives, managing board appointments and providing oversight/monitoring of SOEs while giving autonomy to SOE boards and management in operational decision making. It will set out the roles and responsibilities of SOEs and protect them from political interference. It should be given the resources to recruit skilled staff with more of a business culture. It will put in place clear reporting arrangements and facilitate the design and implementation of effective performance monitoring systems and develop policies, tools and guidelines for governance.

Though many Finance ministries do take a shareholder perspective of SOEs, they typically focus on budgetary and financial issues and they do not have the broad outlook to act as a strong advocate for restructuring and governance reforms. We concur with the proposal that a Department of Public Enterprises (DPE) under the aegis of a new Ministry of the Economy will definitely define the boundaries of state intervention and address the problems of vague or conflicting objectives, politicization of decision-making and excessive or unwarranted state intervention in day-to-day operations.

We believe that such an institution as the DPE will indeed help to strengthen corporate governance by ensuring clear separation of the ownership and management of SOEs, enhance the performance of SOEs by making them responsible and accountable for their performance, raise funds for investment, maximize return on investments, advise on shareholder issues and promote the growth of a dynamic public sector.

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Indiscipline and violence in schools

There is no point in producing report upon report on the issue of indiscipline and violence in schools if these are not accompanied by proper actions on the field. As we continue our research examining the new generation’s food habits, their activities before going to sleep, the impact of loud music and video games and the causes of their greater stress and lower concentration levels and their propensity to boredom, we should involve more NGOs in tackling this problem of indiscipline in schools.

Especially those NGOs that have a proven experience in child empowerment and in training the child to reinforce his values, in strengthening the sense of self and the sense of sharing, enhancing his creativity, improving his focus and concentration in studies, helping him to be independent and responsible, to communicate better and to respond to stress in an emotionally healthy way. The NGOs will also help parents to handle their child’s transition to teen, getting them involved in their teen’s life physically and emotionally, understand their need to appear trendy and be accepted among peers, and be a friend and guide in choosing their career – what they want to be in life!

Some of these NGOS know how to bring about the development of every child in all the three aspects body, mind and spirit. They lay great emphasis on sports, performing and visual arts. The varied interests of the child are nurtured through activities like creative writing, quizzing, debating, computer programming, out-of-the-box arts, martial arts. The focus is always on encouraging children to excel without compromising on human values. Children will excel when they are in a stress-free environment. Their curriculum includes daily yoga, asana and breathing exercises, which enable them to develop a calm and focused mind. This helps discover the inner potential of every child.

It is time that we open up our schools and colleges to these NGOs and give the opportunity to those who want to enjoy the benefits of music, arts, yoga and meditation. We believe that such collaboration between the Ministry of Education and the specialised NGOs will go a long way towards attenuating the level of indiscipline and violence in schools while equipping our kids with the knowledge to blossom to their full potential.

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Reform of the Welfare State

It is not uncommon in our societies for people to be defensive when we talk of the reform of the Welfare State and they tend too easily to brand the proponents of these reforms as lackeys of the Washington institutions.

Many of the reformists will be cautioning us that there is a sense of urgency and if we are to avoid the impending crisis, we have to get rid of our excess baggage, scrap off our excess fat, streamline or dismantle the exiting social system for reasons of international competitiveness and fiscal exigency. Our demographic situation is imposing its own logic and is a major reason for the urgency of the reform: society is getting older and older. The shrinking population has very adverse effects on our social security systems. While fewer people pay into the Welfare System, more people take money out of it. If nothing is done to correct this trend, our system will collapse.

The more radical among the reformists may even argue that our Welfare State has resulted in passivity and a culture of dependence; that it has undermined the country’s moral fabric; that it has stripped us of our natural capacity for enterprising self-reliance; that the collective sentiment among the people is that Mauritius is falling back in the global competition while other countries are more dynamic, there is a sense of stagnation in the country; that we are only redistributing wealth — from the productive to the non-productive.

These are not our arguments; we’ll leave these for the neo-liberals. We believe, without having to quote the neo-liberals or the leftists, that our “structured” welfare benefits belong to another age. It has served the country well thus far but has started to fall short of today’s needs. It has been slow to adjust to the dual demands of economic growth and social exclusiveness. More importantly, the existing system has been providing benefits to an “undeserving lot” for which the hardworking folks are being made to pay.

Indeed most of the redistributive social policies have been captured by the better-off from the higher middle and rich classes. Do the social programmes really help the poor? Subsidies for items of middle class consumption, for example on LPG, rice and wheat, contribute to the fiscal deficit, and thereby to inflation which is a crushing burden on the poor. This amounts to a betrayal of the very downtrodden sections of people that the redistributive social policies claim to cater for.

Social insurance payments exceed 4% of GDP, including over 1.3% of GDP for the basic retirement pension scheme. However, almost 40% of the basic retirement pension benefits go to the richest 20% of the population. Only about 24% of direct and indirect beneficiaries of social protection programs are for the poor. The poor receive only about 13% of total social protection payments. Estimates from the latest household survey indicate that the two richest quintiles of the population (top 40%) receive close to 58% of all social protection benefits and the richest 20% receive about 37% of all benefits.

Household Budget Surveys have confirmed that the unfocussed and non-targeted social safety nets and universal provision of some services have not contributed significantly in getting the core out of poverty. Pensions and social aid, they point out, are lifting a bare 6% of all households out of poverty. The lowest income group benefits the least from government expenditure on education. “Over 90% of government expenditure on primary and secondary education goes to the middle and higher income groups, while the low income group gets a share of only 7% on outlays for the secondary education sector:”

We find it so aberrant that we continue to cling to an archaic and perverse system which is “subsidizing the rich at the expense of the poor and the more deserving segments of society”.

Reforms tend to hurt the vested interests of at least some people and the political parties fear that they would be punished by the voters. Politically, this explains why we had – and continue to have – difficulties in pushing ahead with drastic political, economic and social reforms in education and the Welfare State. How can we expect the very people who are benefiting from the system to be proposing alternatives to the status quo? Inevitably, within reduced welfare budgets, the prioritising and re-prioritising of the demands of different groups of claimants will be decided by political calculations.

 

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* Published in print edition on 25 July 2014

Tags:BoM, Growth of Money Aggregates, Jin Fei, LBOI, Lowering the Key Repo Rate, NGO, R. Chand, Reform of the Welfare State, SOE Reform, State-Owned Enterprises, TINAs, Tourist villages, Trilemma