“There is a lot to do to fix the mess and the cost will be steep”

Interview: Sameer Sharma, Investment Analyst & Financial Risk Manager

‘We either do this, get British compensation money for Chagos or/and we just devalue the currency’

* ‘Without meaningful reforms, we will continue to stagnate and hence rely on the inflation demon to bloat budget revenues’

* ‘The MIC has allowed the private sector to privatize gains while socializing losses via Rupee depreciation’

Sameer Sharma, an Investment Analyst & Financial Risk Manager with a deep understanding of Mauritius’s economic dynamics, provides invaluable insights into the country’s financial strategies, challenges, and future prospects. With a keen eye for detail and a wealth of experience, Sharma sheds light on the complexities of Mauritius’s economic policies, offering critical analysis and thought-provoking perspectives on key issues such as fiscal sustainability, social equity, and the implications of global economic trends.

Mauritius Times: Minister Padayachy’s budget seems to have prioritized feel-good measures in the run-up to the next elections. The immediate beneficiaries will probably support the governing alliance for such “generosity,” but what are the medium- and long-term risks or unintended consequences associated with this emphasis on feel-good measures and freebies without clear funding sources?

Sameer Sharma: On the international front, the geopolitical landscape, as the world becomes increasingly multipolar, is becoming quite volatile. Decades of rising wealth inequality are leading to a gradual balkanization of global supply chains which will lead to lower productivity growth over time.

Major technological disruptions are beginning to impact lower value-added jobs with repeatable processes. Climate change is also becoming more costly. Mauritius also no longer has a one-sided and highly favourable double tax treaty with India, and we are losing market share in this space.

Domestically, our education system is not producing the quality of human capital we need to move to the next level. Our private and public sector firms are not dynamic enough, and we have many firms with oligopolistic positions. We are not open enough to free and fair competition, which stifles innovation. Brain drain is accelerating while the population is ageing.

The population is becoming increasingly dependent on debt and inflation-funded public handouts as a percentage of total revenues which are self-defeating. Economic policies are inflating asset values such as land locally making the asset-rich richer and the asset poor, poorer. We have not seen the emergence of any new sectors of the economy for a while, and existing sectors are seeing more moderate growth.

Labour costs are rising faster than productivity growth. Additionally, our debt profile presents a complex landscape, encompassing not only public debt but also various other liabilities stemming from special purpose vehicles and contingent obligations related to governmental engagements with the Mauritius Investment Corporation (MIC). Moreover, there’s a pressing need for substantial recapitalization of the Bank of Mauritius, coupled with the substantial deficit in our public defined benefit plans. Total private and public debt is well above a trillion Rupees when added to contingent liabilities of government. All political parties seem to be competing for a populist race to the bottom.

Our international reserves portfolio now has a reserve adequacy metric known as the ARA metric of less than the recommended minimum of 100%. We essentially lack meaningful fiscal and external buffers to face the next external or internal shock to come. We rely a lot on inflation to deflate the real value of debt, and when the next economic shock happens – whether it comes from endogenous or exogenous sources -, we will need to quickly allow the currency to depreciate to smooth the impact of such shocks.

* But nobody, not even the IMF, is suggesting that the government has gone too far with its five budgets focused on feel-good measures, and that we have now reached dangerous waters. It has somehow managed to stay afloat, isn’t that correct?

We may be reading different IMF reports, but the latter has essentially said that our sovereign debt risk is “elevated” and that we needed to engage in meaningful structural reforms, raise taxes and cut spending.

We are instead using the inflation trick to increase revenues and reduce the real value of debt. The problem is that inflation hurts the asset poor and the lower middle class the most.

* What implications, if any, does the budget have for key economic indicators such as inflation, unemployment, and GDP growth?

Inflation as measured by both the Consumer Price Index and the GDP deflator will remain high, with the former remaining well above the 3.5% medium-term inflation target of the Bank of Mauritius, a level that is key to maintaining price stability and economic competitiveness vs. the rest of the world. This is because a debt-fuelled consumption model, which stimulates domestic demand via consumption in a country where we import most of what we consume, only leads to a vicious cycle of structurally high trade deficits along with an ever-weaker Rupee which then requires the consumer to borrow more money to continue to consume.

The pace of economic recovery in 2023, with real GDP merely 3% higher than its 2019 levels, places Mauritius among the slowest recovering small island economies and offshore centres within our peer group. Delving into the nuances of real GDP growth reveals an intriguing anomaly that warrants closer examination. While much discussion has centred around the inclusion of a portion of Global Business net income in GDP calculations, a less understood factor lies in the relationship between nominal GDP, the GDP deflator—a comprehensive measure of inflation—and real growth.

Importantly, nominal GDP comprises both the deflator and real growth components. Underestimating the deflator can artificially inflate the real growth figure, giving a misleading impression of economic performance. Given that a significant portion of domestic inputs in Mauritius relies heavily on imports, the rising prices of these inputs, including essential commodities like oil, due to the depreciation of the Rupee, have fuelled cost pressures. Factors such as increases in the minimum wage and rising labour costs further compound this challenge.

Analyzing the situation through the lens of an import-weighted nominal effective exchange rate reveals a depreciation rate of the Rupee substantial enough to suggest that the GDP deflator may be understated, thus inflating the reported real growth figures. To assess this, establishing a base index starting at 100 for 2019 and incrementing it annually by the deflator rate up to 2023 provides a clear picture. Comparing the resulting 2023 index with the initial 2019 index yields a percentage increase over the four-year period, which should intuitively mirror the extent of Rupee depreciation against the US dollar, the currency in which most of our imports are denominated.

Despite facing significant cost pressures both internally and externally, the indices for the deflator between 2019 and 2023 appear disproportionately lower than the observed depreciation of the Rupee against the US dollar. This discrepancy raises concerns about the accuracy of reported real growth figures and underscores the importance of scrutinizing GDP calculations to ensure they accurately reflect economic realities.

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Despite the severe price shocks, the GDP deflator looks understated. If the GDP deflator is a representative index of a far larger number of goods in the economy, why has it often been lower than the index for the CPI basket, which has, by definition, a downward bias? Explore this area and you will have difficulties in resolving what appears to be contradictory.

Put that question to Statistics Mauritius for the last 15 years. You will never get a satisfying response. So I do not completely buy those real GDP numbers given that I believe that the deflator is being underreported. Unemployment numbers depend on how Statistics Mauritius conducts its surveys and on how many people are what we term as discouraged workers who are not counted or when it comes to the underemployed.

* To come back to the IMF, what do you make of its Article IV Consultation report released last May and its comments on the BOM and the MIC?

This is perhaps the nastiest comment in the report no one is talking about. The IMF is essentially telling us that there are “potentially significant contingent liability risks to the central government from BOM’s operations via MIC remain, and an independent audit of MIC’s asset quality should be considered.”

I have been saying the same for years. The MIC is some pretend sovereign wealth fund funded via money printing that has inflated convertible bond and land values. It has allowed the private sector to privatize gains while socializing losses via Rupee depreciation. This notion that this is a Sovereign Wealth Fund a la GIC when the BoM essentially prints money to fund it is quite the sad joke.

One of the key priorities of the next Governor of the central bank would be to order an independent audit of MIC asset values which sit on the central bank balance sheet. International experts with no conflicts of interest and with expertise in valuing illiquid assets should be brought in and heads would need to roll. Those who got involved in make-believe debt structuring with no prior experience in the field will not be able to hide behind Board decisions and “the land valuer or auditor said so” excuses.

The Bank of Mauritius has a major asset liability problem which is why it has little credibility when it comes to the conduct of monetary policy and in defending the Rupee which has incidentally depreciated since the Budget was announced. An off-balance-sheet bankruptcy remote special purpose vehicle would need to be created, and it would purchase MIC assets at fair market value. The Government would need to fund this SPV along with banks. No more privatizing gains! The hole that will be left on the BoM balance sheet once assets are marked to market and sold will need to be plugged by Government debt too and/or depreciation over time.

This is the hard truth no one wants to hear and after we do this, we won’t have that much money left for all those populist promises. A new and modern strategic asset allocation framework will need to be designed for the international reserves portfolio which has been poorly managed. New competent people with actual experience and track record in global markets should be brought in.

Fix the balance sheet, revamp the lousy way in which we have been managing international reserves, get more independence, get banks which benefited from the bailouts to also participate in fixing the central bank balance sheet problem. Impose steep levies on those who got 3.5% fixed coupon ultra-cheap convertibles until they pay back their debts as soon as possible. There is a lot to do to fix the mess and the cost will be steep. We either do this, get British compensation money for Chagos or/and we just devalue the currency. Your choice.

* It’s crucial to assess how the economy will fare in the coming years due to the policies implemented in recent times. Would you say there are compelling reasons for optimism regarding both the immediate future and the medium term?

The Mauritian economy cannot sustain levels of growth well beyond 3.3% to 3.5% per year based on our economic fundamentals. We will reconverge to this long-term potential rate of growth as from 2025, and then all those populist promises will either need to be rationalized or funded via more inflation. Unless Mauritius engages in meaningful tax and structural reforms with a supply-side bias, we will continue to stagnate and hence rely on the inflation demon to bloat budget revenues.

One of the objectives of the budget may be to promote social equity and inclusive growth. How effective are the proposed measures in addressing income inequality, poverty alleviation, and access to essential services for vulnerable groups?

When you run an economic model that relies so heavily on consumption, selling villas to foreigners and on inflation, the asset-rich benefit while the poor and middle class spend their time funding their own dependence via taxes on goods and services.

Yes, real income of those who are above 60 already receiving retirement pensions in addition to the successive rounds of hefty increases in old age pensions must have gone up. If both husband and wife have retired, they should be happy with their real income after adjustment with those understated inflation rates.

Of course, you can make real income go up by pumping and spending money. For how long? Government transfers for social security payments have shot up. Where did the money come from? Even the recently introduced pension fund, the CSG has been emptied. Of course, real incomes for the retired citizens may have gone up. What next? What will cause nominal income to go up and where will the money come from? BoM money printing again?

In my view GDP in real terms has not been growing at the official rate. At best, growth, if any, is marginal. That being said, asset values in an inflationary and pro-foreign villa sales environment have been going up making the asset rich richer and the asset poor poorer. That’s why when you drive around towns in Mauritius, you see so much poverty and so many dilapidated buildings but notice luxury villas in gated communities elsewhere.

Remember, the private sector got the mother of all bailouts and wage assistance write-offs in a year of record profits. We really perfected the art of privatizing gains while socializing losses. Saying that this is a pro-poor macroeconomic policy stance is being economical with the truth.

 

* How does our approach compare to Singapore’s?

Mauritius is no Singapore. Singapore privileges free market principles, good governance, meritocracy rather than nepotism and favouritism, and its leaders have big ambitions when it comes to the country’s place in the world. Singapore is open to the world and does not function in its own bubble. It engages in responsible fiscal and monetary policies and has a right-sized tax regime that is well balanced. The country’s private sector is dynamic and innovative rather than being one that is sometimes too rent-seeking.

It invests its savings via a real Sovereign Wealth Fund (SWF), not a pretend SWF funded by money printing, to not only gain strategic clout internationally when the fund invests billions abroad but in order to grow wealth for future generations by generating high levels of risk-adjusted returns.

Singapore may have a high debt-to-GDP ratio of 174%, but its free cash flow-generating net asset position is highly positive, leading to an AAA rating from all three credit rating agencies. Singapore essentially borrows to invest and generates higher returns compared to its cost of debt.

Mauritius follows a debt-fuelled consumption model that invariably stimulates import demand, making foreign exporters richer and also leads to continuous depreciation.

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Mauritius Times ePaper Friday 14 June 2024