MACRO-ECONOMIC ISSUES AND MONETARY POLICY

OF THE BANK OF MAURITIUS

Statement by Mr. R. Basant Roi, Governor, Bank of Mauritius

at the MEPZA Interactive Session on Managing Exchange

Rate Risks in a Competitive Environment

(6 April 2000)

Ladies and Gentlemen

Good afternoon

I am delighted to be here with you this afternoon. May I first of all express my appreciation for the invitation extended to me by my good friend Danielle Wong of MEPZA to give a brief expose on current macro-economic issues and monetary policy of the Bank of Mauritius. Thank you Danielle.

Developing countries across the world have embraced open markets and international trade as a means of speeding their economic progress. Against the background of a drastically changed economic paradigm, characterized by deregulation, privatization and a startling pace of technological innovations in production processes as well as in financial markets, both developing and industrial countries have, since long, made a strategic choice. It’s not a choice that confines them to traditional methods of running business enterprises, be it manufacturing or banking. Nor is it a choice that keeps them off from the mainstream of economic and financial innovations. The choice is one that focuses on structural adjustment regularly and pro-actively effected to improve economic performance. All nations have been constantly adjusting to the new reality of heightened international competition.

Let us ask ourselves some honest questions. Do we put in more man-hours of work in our daily activities at the national level than our competitor countries? Do we make sincere attempts to implement tight cost control in both the public and private sectors? Human capital is the most versatile capital. Do we provide for adequate quality investment in human capital? If such capital is available, albeit in limited amount, do we make full use of it? Or do we chase them out of the country? Should we continue ad infinitum with a policy of systematic depreciation of the rupee for many more years to come and expect foreign direct and portfolio investments at the same time? Should we continue with ‘quick fix’ solutions to the problem of competitiveness? If so, for how long? In a world where capital is highly mobile, is it politically correct to advocate systematic depreciation of the rupee and clamour for low rates of interest? Why do we have large trade deficits for many years? Is it not because we are all the time consuming more than we do actually produce? Why are we having fiscal deficits for very many years? There are many more questions that we should ask ourselves. I am sure all of them are answerable. I am also sure that you have the right answers. We cannot shy away from the stark realities of the world we live in today. It appears that it was much easier for the Germans to bring down the Berlin Wall than for us to bring down the wall of rigidities so much deep-rooted in our economic system.

Adjustments of the magnitude that these questions call for are never easy. They have been stressful, painful and disruptive in other countries and they will be so in Mauritius also. But we do have to adjust, failing which the adjustment process will end up being more wide-ranging and more intense when we shall receive the ‘wake-up’ call. Restructuring of enterprises in the private sector as well as in the public sector will mean rationalization and, therefore, greater macro-economic efficiency. More people will move between jobs. Re-training, re-tooling and upgrading of skills of the work force will certainly be a demanding task. What we should not overlook is that restructuring will ultimately have significant payoffs for the economy in terms of productivity gains and competitiveness.

I have often been asked why, unlike in the past, the Bank of Mauritius now emphasizes so much on monetary stability, financial stability and price stability. We did not stress so much on stability and yet we did well in the 1980’s. Let me once again clarify the position of the Bank. Prior to July 1994, we had exchange control, credit ceilings and interest rate control. The Bank of Mauritius used to fix the exchange rate of the rupee on a daily basis. Prices of a wide range of goods and services were controlled. That is why the high rates of monetary expansion in the pre-1994 years did not much affect domestic prices, interest rates, exchange rates and the external payments position of the country. All these administrative controls were gradually scrapped by July 1994. In the summer of 1998 the Bank of Mauritius altered its policy approach, bearing well in mind that the direct administrative controls were no longer in force.

Financial liberalization necessitates monetary and fiscal discipline. Monetary and fiscal discipline would, in turn, help bring about micro-and macro-economic efficiency. We have initiated monetary discipline with the precise objective of bringing about price stability in the medium-term. A low-inflation policy is not an end in itself but rather the means through which monetary policy contributes to sustained good economic performance. If our economy is to function well, we need to have confidence that the rupee retains its value over time. The rupee will hold its value only if it is not eroded by inflation, that is, if the general price level in the economy remains stable. I need not expatiate on the fact that high inflation is very costly. It is not a lubricant of progress, as some may claim; it is the enemy of sustained growth. It creates uncertainty, renders economic decision-making more complex and diverts valuable resources away from productive to speculative activities as people seek protection by hedging against inflation. You will certainly appreciate that not everyone is sucessful in hedging against inflation. Those who are less fortunate in society suffer the greatest losses. In order to avoid these costs to society, the Bank of Mauritius is conducting monetary policy in a manner that should build confidence in the value of the rupee. In a highly open economy like ours, a low-inflation policy also implies a stable exchange rate for the rupee.

With a view to making the policy commitment of the Bank more credible, thus helping to reduce expectations of ongoing inflation, the Bank of Mauritius sets specific targets for inflation control. For the current fiscal year, we are likely to perform better than expected and hence the recent reduction in the Lombard rate from 14 per cent to 13 per cent. I am totally convinced that the low-inflation policy of the Bank of Mauritius should provide the foundation of a more stable and productive economy over time.

In the recent past the Bank of Mauritius has been accused of being overly obsessed by a low-inflation policy. If at all it is an obsession, may I say it is a magnificent obsession. Assume for a moment that the Bank of Mauritius followed the same policy path it did before 1999. In other words, what would have been the outcome had the Bank of Mauritius pursued an inflationary monetary policy instead of pursuing a policy aiming at building confidence in the rupee. Obviously, the rate of inflation would have been higher. More importantly, the dynamics of inflation would have been much stronger - a phenomenon much more difficult to fight back in subsequent periods. Costs and prices would have contined to chase each other as business and workers sought to stay ahead of inflation. The external value of the rupee would have dropped at a more accelerated rate. Costs of production would have risen more dramatically than one would ordinarily expect. Uncertainty would have triggered further disturbances on the exchange market. Interest rates would rise inexorably. Increasing concerns about how far the exchange value of the rupee would drop would have caused interest rates to move to higher levels. I am sure no one of us would ever wish to be trapped in a similar situation.

Are we not better off with a monetary policy stance that aims at stability despite some short-term stresses?

Global foreign exchange rate developments, particularly in the Euro, have caused problems for all exporters into the Euro zone. This problem is not unique to Mauritius. The weakness of the Euro has no doubt impinged on the profitability of our EPZ firms. Having recognized this problem, the Bank of Mauritius introduced the Rediscount facility in favour of EPZ exports invoiced in Euro. Exporters elsewhere have adjusted to the Euro problem through restructuring and also through better means of exchange rate risk management. I was happy to respond to MEPZA’s request for assistance in this area and wish to express my appreciation to the commercial banks, which are members of the recently established Financial Markets Committee, for their active participation in the Interactive Session on Managing Exchange Rate Risk in a Competitive Environment. It is my hope that all participants will learn from the presentations today and that commercial banks will make a special effort to familiarise their customers with the range of hedging techniques best suitable for Mauritius.

I wish this Interactive Session the very best of success.