“The Monetary Policy Committee seems skewed and suffers from structural weaknesses”

Interview: Dr Ashok Aubeeluck, Former Budget Director

“Growth forecast will most likely be revised upwards, not downwards, closer to 4%, if not higher. Even so this is below potential”

“Our sugar price is under threat. We will again be swept by the tide to crash against the rock”

 

Dr Ashok Kumar Aubeeluck, who has served as Budget Director at the Ministry of Finance for a number of years in a recent past, gives his views on some thorny issues confronting the financial sector and provides some answers to some major challenges that are looming: pension reform, job creation for the young unemployed – graduates in particular, as well as throws some insights into the approaches adopted by international banks and financial institutions.

Mauritius Times: There might not be any political undertones to or proxy battle being waged in the on-going tussle between the Minister of Finance and the Governor of the Bank of Mauritius as many would like to believe, but the deafening silence of the one who appointed both in their respective jobs may be allowing things to drift. What do you think?

Dr Ashok Aubeeluck: On the surface of it the interest rate controversy appears to be diverging diagnoses and policy remedies to current and foreseeable problems in relation to priority goals.

At the same time it is vital to understand that each institution is governed by its mission and vision statements. The Bank of Mauritius is governed by the Bank of Mauritius Act. Inspired by the Bank of England and conceived along the Radcliffe Report, it operates as a separate independent organisation with specific responsibility for price stability. It is good to note that faced with excess liquidity and threats of inflation other central banks (Turkey, South Africa, India) chose to raise interest rates.

 

Sorting out disagreements behind closed doors is usually a wiser and more effective approach for resolving major decisions under whatever circumstances. An institution is like a temple and should be shielded from unwarranted attack. Deviations from such principles might send the wrong signals to investors abroad and the business community in the domestic market. Warren Buffett, once the wealthiest person on the planet, stated: ‘It takes 20 years to build a reputation and only 5 minutes to destroy it.’

* Though it might also be considered improper for the Prime Minister to intervene and put a decisive stop to this public spat in view of conventions and the operative context in which independent central banking is carried out, he did mention however in his end-of-year message that his government would endeavour to keep a tab on inflation. What does that suggest: is he being guided by propriety or has he taken sides with the BoM?

No rational person would seek to jeopardise his or her future. High inflation rates are regarded as harmful to an economy. Adding inefficiencies in the market renders it difficult for firms to budget or plan long-term. Inflation can act as a drag on productivity forcing firms to shift resources away from products and services in order to focus on profit and losses from currency inflation. Uncertainty about inflation discourages investment and saving. Inflation can impose hidden tax increases. Inflated earnings push taxpayers into higher income tax rates.

The Prime Minister has had sufficient exposure to be aware of the critical impact of an inflationary spiral on international competitiveness, economic growth, prospects for manufactured exports, tourism expansion, productivity and wage policy. Job creations and growth are priority goals. These issues are intertwined and cannot be treated in isolation. They need to be addressed in a holistic manner. The question of taking sides does not arise. As in health any medicine may have side effects; some are major ones with high risks while others are minor ones with greater tolerance for the consequential pain. When it was the central bank of Germany the Deutsche Bank had adopted a policy favouring low inflation. This created the propitious climate for long years of sustained growth. Against all odds Greenspan ran the FED with emphasis on low inflation which ensured growth and high employment.

* What about the Minister of Finance? What’s guiding his actions? He has come out publicly with a press communiqué which puts in doubt the forecasting procedures of the Bank of Mauritius in relation to its estimates of the rate of inflation – “the Bank of Mauritius has continuously overstated expected inflation, and should review its forecasting procedures,” it stated. Does this strike a chord with you? Of some colourable devices or manipulation? Could this be possible?

Given the global acceptance that central banks operate in total independence to ensure greater effectiveness of monetary policy, it would appear that the MOFED’s action may have been ill-inspired or an accidental slip. Forecasting, while grafted on sound scientific foundation, is no easy task. MOFED’s criticism may be misleading. The BOM forecast warned that inflation could attain the undesirable rate of 5% in 2014. In the very first month of 2014 the year on year inflation as announced by StatsMauritius is already 5.1%. Passing such sweeping statements perforates the credibility of an institution and is fraught with the danger of a boomerang effect. The IMF too failed to anticipate the 2007 financial crisis. The World Bank equally went wrong with its diagnosis on Thailand’s problems in the early 1960s and created unemployment when such problem did not exist prior to their COBA exercise. More recently, the European Union came with a completely wrong solution in Azerbaijan which decimated the sheep population of over 11 million to a little over 2 million when the objective was to raise the sheep population! Similarly various projections in the Budget went off the mark. Knowing well that economics is not a precise science, we should perhaps coordinate efforts and attempt a reverse forecast with actual figures to identify which factors produced which effect with a view to improving forecasts in the future.

* Monetary policy was at one time vested with the Governor of the Bank of Mauritius; he alone would decide on the direction the Key Repo Rate should take. That responsibility has been taken over by the Monetary Policy Committee whose several past decisions show an identical voting pattern of either maintaining the Repo Rate at its present level or of bringing it further down. Isn’t that defeating the government’s avowed policy of taming down inflation and inflationary expectations?

In the name of transparency and participation the setting up of the MPC is a big progressive stride. Unfortunately it seems skewed and suffers from structural weaknesses. It is like the US trying to use all its efforts to topple a dictator for greater democracy and elimination of brutality but ends up causing a civil war! The principle is good and it will settle down. Meanwhile we have a cost to bear. Perhaps one alternative is to further share the power to nominate MPC members with the President after consultation with the Leader of Opposition in order to provide for more effective checks and balances. This will reduce biases, real or perceived, and will add to the credibility of the MPC.

Inflation becomes a scourge if it gets out of hand. Low stable inflation is prerequisite for maintaining our international competitive edge, therefore preserving jobs and sustained growth. It protects the poor and fixed-income earners, creditors.

* It is a recurrent feature here for the private sector spokespersons to lobby in favour of bringing down the Key Repo Rate or for maintaining it at its present level in the name of “economy easing” to help promote growth and create unemployment. What are the risks involved in that policy and has it delivered on its promise?

Some players are too selfish, even if this is a rational behaviour. Unfortunately they still believe that their sector is the leading growth engine that is pulling all the bandwagons. It is no longer the days when export-oriented industrialization and manufacturing accounted for 24.5% of the economy. Today the economy is well diversified with a fairly well developed financial sector and policies should cut across all sectors. The last three MPC decisions have been woefully ineffective. It is more likely that we are in the grip of a liquidity trap.

I was surprised at the sweeping analysis and value judgment of the JEC which claims that ‘une hausse du taux directeur aboutit inévitablement à une montée du taux d’inflation.’ While some accountants have brought this argument, there is not much empirical evidence in its support. It equally shows poor understanding of the transmission mechanism. That’s why I have given a diagram from Riksbank to explain the transmission mechanism. It shows the way in which changes in the Repo rate affect inflation and the rest of the Swedish economy and involves the interactions of several different mechanisms. What is more surprising in the JEC argument is the view that interest rate should not be raised as it would attract foreign capital inflows. Is not the goal of most economies to attract foreign capital especially if there is wide resource gap between investment and saving or if the country is faced with high current account deficits? When your savings are low, how do you finance development without resorting to foreign capital?

* The Bank of Mauritius asserts excess liquidity is the doing of the Ministry of Finance. The Central Bank is of the view that if this is not addressed “as early as possible, this would eventually not only distort the interest rate structure… but also heighten the risks to financial stability”. Do you share that view?

We are on slippery grounds. Worse it will fall on the BOM to come to the rescue of commercial banks as a weapon of last resort.

* Would you say that this issue of excess liquidity in the banking system has also to do with the model of development which we have adopted?

Our model of development has a proven track record and is well cited as a success story in all international circles. We are among the top on several reputed indexes. The excess liquidity could have been mopped through the convergence of a number of factors.

Banks could be suppler. They satisfy the Basel agreements and are excellent students. The CAR is almost twice that recommended. Our banks are ultra-cautious and take good care of shareholders’ money. They could have taken the risk of offering flexible terms to borrowers or reduce their margin. However, they are equally faced with constraints. The BOM has already sounded the alarm bell with some real estate projects in the red. One school feels that an over-investment in real estate as occurred in the hotel construction a few years ago could lead to a bubble.

By borrowing from external sources MOFED made an inappropriate move in the conjecture. To the extent that it is a very big player, this has caused a glut. To borrow its own analogy: if all Mauritians decide to order tomatoes from South Africa instead of buying from the Bazaars of Port Louis, Quatre Bornes, Goodlands, Flacq or Mahebourg, there will be a glut of tomatoes in the market, whatever the price.

Finally sentiment analysis did show that the business community had very weak expectations in light of the contraction in our traditional markets.

* As for the economic performance of the country, our potential growth rate – like that of many other countries — has been revised downwards. Why is that so? Has it to do with structural constraints?

This year the forecast will most likely be revised upwards, not downwards, closer to 4%, if not higher. Even so this is below potential. I believe we have a potential between 5% and 7%. Our resources are lying involuntarily idle. The government may think in terms of a high-level think tank reporting to the Prime Minister to chart our destiny through the troubled waters. Our workers in textile are ageing, and without foreign workers our industry cannot survive. Indeed, foreign workers are helping Mauritians preserve their jobs. We need to come forward with more attractive plans to induce them to stay longer and offer them better treatment with possibility to stay.

The construction sector went through a stage of reverse accelerator-multiplier as it contracted 9.4% and 3% in 2012 and 2013. We have been riding a tiger! We need to find new projects. With tourism stagnating, and the private sector having burnt their fingers through over-investment as revealed by the ICOR, poor management and incestuous diversion of resources, investment in this sector is likely to slow down.

The domestic public transport remains archaic. May be this situation is a blessing in disguise which would ensure the effectiveness and viability of the light railway transit system.

With the LRT coming in place and its dozen of stations, it is imperative that the planning authorities give some thoughts to reserve lands close to the stations to prevent speculation, and create a cluster of activities for the convenience of commuters.

Our sugar price is under threat. We would again be swept by the tide to crash against the rock. In the 1990s the writing was on the wall. The specialised refereed Journal of Brussels which is carefully kept in the University of Queensland library contains an article on sugar in every issue. The Australians did their intelligence homework. We Mauritians behaved more like the grasshopper in La Fontaine’s fable of the Ant and the Grasshopper until quite late. The private sector is more rational, and soon like the Illovo Group, sugar in Mauritius would be of little value to them as they divert their resources to Tanzania. ENL is diversifying. We must decide whether to turn our sugar fields into real estate development sites, or shall we continue producing sugar in a more integrated manner that it becomes an input in a pharmaceutical industry, in an energy sector or in other processing activities? Time is of the essence and this time placing the begging bowl at the door of Brussels will not work.

We need to produce skills for the incoming Ocean Economy, consolidate the tourist industry by also opening our windows through an air route to Brazil through Mozambique and oil-rich Angola, while universities have not only to market their programmes in these countries but equally to offer Portuguese language as an option.

We need to diversify into pharmaceuticals. This is an industry that will take a minimum of 10 years to grow at the cruising rate. We need to create a Pharmaceutical Village, provide basic infrastructure, come with a generous incentive structure (since currently the opportunity cost is zero), and unfold the red carpet at the feet of Indian pharmaceutical magnates just like the Danes to exploit this avenue.

* Private sector investment in productive sectors has also been going down despite the so-called “economic easing” policy and the numerous incentives that have been dished out in successive budgets. Why is that so?

In the absence of reliable detailed surveys and empirical studies, it is difficult to state with certainty the causes. Demand for investment capital seems strangely insensitive to low interest rate. With repo rate at 4.65%, investment has not only stagnated but actually declined. Savings rate too have been hovering in the range of 13-14% as a share of GDP/GNI while the resource gap keeps widening.

I start to wonder whether we are not in the web of a liquidity trap. Cash-holdings in commercial banks are rising. Even at such low interest banks do not find sufficient borrowers to buy goods or invest in projects or in replacement equipment. This stems from dim prospects including low expected returns. In principle the business community is more likely to take decisions on the basis of expected returns, demand for the goods they produce and the associated profits rather than sheer cost of capital. We are more like the situation in Japan. If low interest is not effective and not bringing the expected results while it is causing adverse impact on other variables such as savings or foreign direct investment and is fraught with danger of an inflation spiral, then why should we back a losing horse, to parody a cherished image of Sir Gaëtan Duval.

MOFED should be more concerned with the real sectors. More precisely, the figures show that performance of the real sectors like tourism, manufactured exports, construction or agriculture has been disappointing. More efforts are needed to create a more enabling environment as our competitors improve and catch up with us. Demand in our external markets has been gloomy because the economy of our traditional trade partners was still struggling with the recession. This is neither the fault of the Ministry of Finance nor of Bank of Mauritius.

* We are also not making much headway on the employment front despite the IMF-inspired labour laws reform. Some economists argue that the Youth Employment Programme can only provide temporary relief. What’s the remedy then?

The YEP is a good start and is meant to be temporary. A different version had been introduced in the late 1990s and proved effective. We need to give it time. However, it has to be supplemented by more innovative measures. The market is like a patient and can react with different speed to any prescription.

Pending the ripple effect of the existing policies and the Youth Employment Programme, the MOFED could have borrowed through the issue of long-term bonds from the domestic market rather than borrowing from international market as in both cases debt would increase. The risk of crowding out is presently negligible. This money could finance a dual community programme using a synchronised Keynesian demand management and a supply-side approach to absorb some 5000 unemployed from the labour market. Pre-determined goal-oriented productive programme will be offered on an auction basis to potential entrepreneurs. Government officers will design, monitor, define the criteria and make disbursements.

Suppose we decide to create a green belt along the slopes of the mountains around Port Louis. The government unit will call for proposals; decide on the type of trees, the area, the distance and the period as well as the survival rate of the plants. The nursery will be entrusted to another set of entrepreneurs. Similarly many riverbanks may be cleaned, afforested, de-polluted, replenished with fish and crayfish and protected by a proper permanent squad so that they become in a decade a coveted place of leisure, tranquillity, nature tourism and fishing as a hobby. A group of experts from Reunion carried out an inventory report on some of the rivers and brooks on which much more remains to be explored and learnt. It is here that unemployed graduates under the directives of scientists can make a valuable contribution to the nation.

The case for a compulsory or optional service of all young persons at whatever level below 30 similar to the controversial conscription may be explored. Under this scheme the young will be paid to do sports, learn a few useful trades, protect the environment, clean the beach, learn to produce a crop, familiarise with first aid, etc. Two thousand jobs may be created per year if there are sufficient incentives.

These 7,000 jobs will create a ripple effect and assuming a multiplier of 1.2, this means some 8,400 jobs can be created and a major dent can be made in unemployment. Once the unemployment rate drops to 6%, the project should be downsized and not repeat previous blunders. Whatever funds are spent, the government will recoup at least 15% in the form of tax. Some institutions may even be closed and its budget re-directed to finance such projects.

* It would appear that the IMF has fixed ideas about pension reform. Do you consder its prescription for targeted pension to be the right one for Mauritius?

Saying the IMF has fixed ideas about pension reforms is unfair. Reforms are an on-going process. Universal trends suggest that a dynamic modern country in quest of efficiency and fairer wealth distribution should move with the times. A number of distortions need to be corrected to achieve efficiency. Unfortunately some trade unionists often indulge in potted thinking. Why do we need reforms? With present policy in place schooling is compulsory till the age of 16. An increasing proportion of students will study till Masters and doctorates with government funding. This means a huge proportion in the age group of 28-30. Those beyond 62-65 will claim retirement pension; those beyond 60 will claim basic pension. That makes the dependency ratio extremely high, especially with higher life expectancy and an ageing population to be funded by those taxpayers (30-62/65 age group). While some of the pension fund has been financed by the retired pensions, it may not be sufficient. At this rate the pension will not be sustainable. The NEF may run out of funds if nothing is done. There are various formulas to reform the system and make it sustainable. It is a choice the nation has to make.

The government through the budget can introduce new incentives in the insurance sector so that people can buy pension insurance. Workers may decide to act as entrepreneurs and vote to use part of NEF money to invest in more remunerative schemes. It is unlikely workers would dare look for high risks-high return projects given recent Ponzi schemes, global financial crisis and ethical transgressions. Another alternative is to raise contribution. With the extension of retirement age one reform is already underway. For public servants the PRB report already provides for contributory pension for new recruits and a higher salary for civil servants already in service. The portable pension is also a reform which appeared in the budget some years earlier.

The basic pension is currently distorted. It is irrational that some recipients who are still active in the labour market at the age of 60 and earn a salary should also be paid basic pension. Basic pension should be paid effective from the date of retirement in the name of equity, fairness and efficiency.

As regards targeting, the IMF may be making a mountain out of a mole hill. The last time we carried out an evaluation, the administrative costs of targeting amounted close to Rs 4 million; expected savings were estimated at just Rs 4 million. Does it make any sense to re-introduce targeting? It is equally political suicide! Targeting is a sterile exercise.

Olivier Blanchard, top World Bank Officer and a respected academician in a top US university, reports in his book that studies show a Wealth Effect with pensions. The wealthier old people are the more grandchildren are attracted. In Asian society grandparents take pride to offer gifts like gold earrings or a watch to grandchildren. Deny them the pension and the family system weakens and old parents are abandoned with risks of these old persons developing Parkinson’s disease, Alzheimer or senile dementia to be cared through taxpayers’ contribution! Many retiring suddenly experience a drop in income at a time they need to finance studies for their children/grandchildren, social events (weddings), re-adjustment in lifestyle or a surgical operation. Others develop a philanthropy hobby of helping others, again a behaviour supported by empirical studies. The Leclezio sisters, the former owners of Eureka, offering their pensions to less fortunate residents in the Moka region is a case in point. Old people need a role to play. We have one of the best pension systems but like a tree we need to water it and prune it from time to time.

 

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* Published in print edition on 14 February 2014

Tags:COBA, Illovo Group, Interview Dr Ashok Aubeeluck, Key Repo Rate, Leader of Opposition, LRT, Monetary Policy Committee, Pharmaceutical Village, Riksbank, Sir Gaetan Duval, Youth Employment Programme