Ramesh Basant Roi: “The key issue is structural transformation of our economy”

Business Magazine met with the central bank governor Ramesh Basant Roi following the recent rate cut. Several issues were discussed during the interview, among others the savings rate and the possible impact on our economy of a policy reversal in the US as the Federal Reserve starts to hike.

BUSINESSMAG. The MPC, which you chair, surprisingly decided to cut the repo rate by 25 basis points at its last meeting. Why?

The Key Policy Rate (KRR), which signals the monetary policy stance of the Bank of Mauritius, has remained unchanged at 4.65 percent since June 2013. The unanimous decision of the MPC to reduce the policy rate by 25 basis points to 4.40 percent at its November 2015 meeting was reached after a careful review of external and domestic considerations.

The global economic recovery remains subdued and uncertain. In October 2015, the IMF as well as other international organizations once again downgraded their global growth projections for both 2015 and 2016. Overall, monetary policy in major economies remains very accommodative, with many central banks lowering their policy rates amidst low inflation to boost growth. Global commodity prices remain low.

Weak external demand has contributed to sub-par domestic growth in recent years. Investment has not picked up yet. The Bank’s staff has forecast domestic growth at 3.4 percent for 2015, which is well below potential growth. Although growth is projected to pick up to above 4.0 percent in 2016, job-creating growth remains a policy concern.

The inflation outlook is soft in the context of low commodity prices and low inflation in major trading partner countries. Inflationary pressures in the economy are subdued. In September 2015, headline inflation subsided to as low as 1.2 percent while year-on-year inflation was only 2.0 percent. Against the backdrop of a moderate inflation outlook and persistent downside risks to the domestic growth outlook, the MPC decided to cut the KRR.

BUSINESSMAG. Is the economic outlook that worrying? What are your expectations now that the cost of money has been brought down?

The economy is not growing below the trend rate of the past several years. The economic outlook is not worrying; it’s just a concern that is being addressed.

Growth in our major export sectors has been on the low side, despite diversification efforts, given the rather subdued outlook in our main trading partner countries. The domestic growth outlook remains subject to downside risks, due largely to the under-performance of our exports. The construction sector remains weak. Moreover, weaker business sentiment could further weigh on capital investment. While we foresee a pick-up in growth in 2016, it could nonetheless still be below potential. The reduction in the policy rate signals investors, businesses and households that monetary policy remains accommodative and supportive of the real sector of the economy. The interest rate cut is expected to alleviate the debt-service burden of leveraged economic operators and to provide the necessary impetus toaccompany investment decisions.

BUSINESSMAG. Any concern for the savings rate, which is quite low?

The Bank is concerned with the low savings rate in Mauritius. Gross Domestic Savings (GDS) as a percentage of GDP at market prices has been falling over the years and is forecast to reach 11.9 percent in 2015.

However, we have to be careful in associating low saving rates to low interest rates. There is no conclusive empirical evidence that interest rate is a major determinant of saving. The most important factor that determines the level of savings is the level of income. Income remains the principal determinant of savings in an economy. The fall in the savings rate is mainly on account of a fall in private sector savings. To boost the national savings rate, we must strive to increase the gross national income. The economy must grow close to its potential frontier and income has to be fairly distributed. Increasing the production frontier will ensure higher income levels which, in turn, should help boost our savings rate. Let me reiterate the point that income is by far a stronger determinant of national savings than interest rate is. Our policy emphasis needs to be on growth and employment.

BUSINESSMAG. In the past we have seen important rate cuts of 100 basis points but without any major impact on investment. What make you feel it would be different this time?

Let’s set the question the other way: would our growth performance have been what it is today if rates of interest were kept high? A high level of interest rates would, in my view, have dampened growth prospects more seriously and jeopardized financial stability. The KRR was cut by 100 basis points in December 2008, March 2009 and in September 2010. A cut in the KRR normally transmits into lower borrowing costs that encourages demand for credit, resulting in higher investment and consumption. With the knock-on effects of the international financial crisis on economy, a cumulative 200 basis points cut between December 2008 and March 2009 helped to turn around the declining path of credit expansion. Credit extended by banks to the private sector bottomed to a growth rate of 3.2 percent in December 2009, while credit extended to the corporate sector reached quasi-stagnation before picking up. In September 2010, credit facilities availed from banks maintained an average growth of above 10 percent. This uptrend in bank credit expansion necessarily reflects a sustained level of economic activity.

BUSINESSMAG. Both local and international analysts from the IMF have been saying that the monetary transmission mechanism is not working well. Where are you with the repair work?

As you rightly say it, it’s a ‘repair work’, implying that the transmission mechanism has been damaged. It’s certainly not something that resemble the repair work of a mechanic; it’s a repair work related to market behaviour. A market that is wired with so many faulty lines takes time to repair.

Let me point out that, by virtue of our strong linkages with the global economy and given the level of development of our financial markets, the overall transmission mechanism in Mauritius is rather weak. The exchange rate channel is stronger than the interest rate channel and this is of no surprise given the openness of our relatively small economy.

The transmission mechanism of monetary policy impulses to the real economy has been further dented by the excess liquidity overhang over a protracted period, which caused a persistent disconnect between the policy rate and market interest rates in the past several years. Banks have been adjusting their interest rate structure independently of the policy rate, which hindered the transmission of monetary policy impulses to the real economy.

As soon as I assumed duty in January 2015, one of my top priorities was to repair the transmission mechanism of monetary policy by addressing the huge excess liquidity. As from January 2015, the Bank undertook sterilized foreign exchange interventions and as from May 2015, we pursued active liquidity management, mainly through the issue of Government and Bank of Mauritius securities. Excess liquidity of around Rs31 billion has already been sterilized since the beginning of the year, which have contributed to bring about more orderly market conditions and a smoother yield curve.

The Bank is in the process of reviewing its operational framework for the conduct of monetary policy. We are proceeding in a phased manner. We have addressed the excess liquidity situation and ensured that the yields at auctions reflected market conditions. We are now finalizing the new operational framework which should be implemented sometime in the early months of 2016.

BUSINESSMAG. The US Federal Reserve has been quite successful in using the monetary policy tool to support the economic recovery. Do you think such a recipe could be applied in our case?

The characteristics of the Mauritian economy and the US economy are worlds apart. It is true that the US Fed has quite successfully managed to ride out of the Great Recession, thanks to its Quantitative Easing/asset purchase program. The US have a much deeper financial system, with more developed money and debt markets. All the principal agents in the US economy are very sensitive to policy signals. As a result, one can expect more robust channels of monetary policy transmission to the real economy.

Printing money massively and pumping it in the Mauritian economy, as it has been done in the US, would instead set forth highly disruptive forces. Our currency is not a reserve currency, to begin with. Excess creation of money would be reflected in serious external imbalances. And external imbalances and the resulting losses in the forex reserves of the Bank of Mauritius are certainly not a desirable option. For Mauritius, what we need is clear: a business-inspiring strategy, a responsive private sector combined with an appropriate mix of policies. By appropriate mix of policies I essentially mean to say accommodative policies that do not imply having recourse to the printing press.

BUSINESSMAG. We are expecting in coming days a policy reversal in the US as the central bank starts to hike. With our recent monetary policy easing, should we fear a capital flight?

On paper, one should expect it to be so. In fact, with higher rates in the US and lower rates in Mauritius, you would ordinarily expect ‘hot’ money to flow out of a highly-open economy such as Mauritius, with no restrictions on capital flows, into dollar-denominated assets. The risks of capital outflows cannot be ruled out. However, even if there are outflows, I have no reason to believe that the outflows would be destabilizing. We should not however forget that despite the US contemplating a lift-off, in nominal terms interest rates in Mauritius are still higher than in the US.

However, I have two words of caution here. First, in addition to interest rate differential, investors’ decision will also depend on exchange rate expectations, and more broadly on the macroeconomic outlook of the country. If we expect the Mauritian economy to be stalwart and to recover going forward, then one should expect these stronger fundamentals to mirror in our exchange rate in the future.

Second, I believe that the foundations that have buttressed our past growth performances traced their roots to the presence of long-term Foreign Direct Investment (FDI), which tends to be less sensitive to interest rate differential arguments. Going forward, I expect the economy to continue to attract FDI to strengthen our future growth performances. A greater share of FDI in total capital inflows means that our economy can become more impervious to interest rate differential arguments.

BUSINESSMAG. Mauritius is still fighting to come out of the middle income trap. What would you advise to put the economy back on track?

Countries that have reached the middle-income status gene-rally experience lots of difficulties in making headway to still higher income levels. Mauritius has, in fact, been striving to make a giant leap forward in the past several years. This is a challenge that is very demanding in terms of sacrifices that society as a whole needs to make. We have made very little progress.

For far too many years since the dismantling of the Multi-Fiber Arrangement and the end of the Sugar Protocol, we have not seen the emergence of any new solid economic sector. In the absence of a re-engineering strategy up to late 2014, the existing sectors have not been able to absorb the new influx of fresh graduates on the job market. The resulting unemployment – a crude measure of loss output opportunity – was also characterized by mismatch between skills and vacancy. Furthermore, those factors that lay the very foundation for future sustainable growth were not diligently looked into. In particular, investment as a percentage of GDP was far below the level needed to enable the economy escape the straightjacket of the ‘middle-income’ country trap.

The key issue is structural transformation of our economy. Going side by side is the required improvement in productivity. At the same time, one should not overlook the strong winds of ‘vertical specialization’ across the world. High-value chains are rapidly mushrooming around the world and I believe that Mauritius can step into the bandwagon and position itself firmly as a key hub of these high value-chains. Measures such as the acceleration of investment projects implementation, the transformation of the island into air and maritime hubs, and the creation of new sectors, all blend in the right direction to help the economy climb out of the middle-income trap.

BUSINESSMAG. At your last news conference, you said that the economy will expand by a rate of above 4 percent next year. What makes you so optimistic?

My optimism is rooted in the belief that our exports sector is doing relatively better. Our tourism industry, too, is doing better. Investment in the economy is expected to pick up. Barring any setback, we expect our growth performance to be much better in 2016.

BUSINESSMAG. The BoM has reviewed its calculations of tourism earnings. What is new with the methodology?

The Bank has not reviewed its calculations, but rather it has extended its data coverage to capturing tourism earnings. We have been tracking the activities of money changers and foreign exchange dealers for some time. The Bank’s staff has identified that these institutions have been interacting more and more with tourists over time.

Tourism earnings were so far being estimated from ban-king records. However, we have concluded that this source alone cannot explain all tourism earnings of the country. In fact, the purchases of foreign currencies from tourists and operators in the tourism sector by money changers and foreign exchange dealers also represent to what tourists generally spend in our economy.

BUSINESSMAG. How would it impact on the balance of payments?

The impact of tourism receipts associated with the activities of money changers and foreign exchange dealers will be reflected in the services account of the balance of payments. These transactions have both debit and credit entries (as per balance of payments convention). We expect a higher surplus of the services account. This will reduce the current account deficit estimated for 2015 and going forward as well. At this juncture, we estimate that the inclusion of the transactions of money changers and foreign exchange dealers will result in an improvement of the current account deficit by about 0.7 percent of GDP.

BUSINESSMAG. Does it also mean that the growth rate will have to be adjusted?

Higher tourism earnings certainly imply a higher value added for that sector in the GDP. One should a priori expect a higher GDP growth, other things being equal. But the overall growth rate of the economy will also depend on how the other sectors are faring. If the other sectors grow as expected, then with a higher contribution from the tourism sector, one should expect a slightly higher estimated growth rate for 2015.

BUSINESSMAG. Several months elapsed since the revocation of the banking licence of Bramer Bank. Do you still believe that it was the best way to do it?

On 2^nd April 2015, the Bank of Mauritius (the Bank) revoked the banking licence of Bramer Banking Corporation Ltd (BBCL) in the public interest under section 17 of the Banking Act 2004. BBCL had been issued a banking licence on 27^th August 2008.

BBCL had a serious liquidity problem. Its own Board Director withdrew deposits from the bank. Its pension fund, too, did the same thing. How do you expect the public to have confidence in the bank when insiders themselves were losing faith in the ability of the bank to survive? A bank can survive without capital for some time, but without liquidity the bank is bound to collapse within hours. When a regulatory authority discovers that when what looks like a run on a bank is gathering momentum at a rapid pace, more so in a small gossip-ridden place, there is no other alternative than to take the most drastic action. The regulator is guided by one and only one consideration. In other words, depositors’ protection overrides all other consideration.

Public trust in a bank is like virginity. Once lost, it’s gone for good.

BUSINESSMAG. Where do matters stand with regard to the nTan enquiry?

In view of the nature and complexity of the investigation in the BBCL/BAI case, the Bank deemed it necessary to solicit the expertise of an independent forensic accountant having the relevant experience. The Bank enlisted the services of Mr Nicky Tan Ng Kuang of nTan Corporate Advisory Pte Ltd of Singapore to establish the facts behind the complex financial transactions carried out by the BAI Co (Mtius) Ltd and its related parties, affiliates, shareholders and directors, within BBCL (In Receivership) and other financial institutions. We expect nTan to submit its report soon.

BUSINESSMAG. How much time do you think it will take for our financial centre to stop feeling the pinch of the BAI saga?

As far as the defunct Bramer bank is concerned, the Bank of Mauritius resolved the issues quite speedily. The BAI Group is a harder nut to crack. I suppose the FSC is giving its best shot in resolving the issues. But what you refer to as the BAI saga is already taking a back seat and seems to be a vanishing episode.