The monetary mix up

The US dollar/Rupee rate nearly broke the psychological level of Rs 25 in the early weeks of this month rising from a peak rate of Rs 33 per dollar in the last quarter of 2006.  Against the Euro, it strengthened nominally by around 7% over the same period whereas vis à vis the pound, the hike in the rate was around 25%. In case of the Repo rate it has not been a straightforward one way upward trend; it picked up from 8.50 to 9.25 in June   2007 and then after a first reduction by 25 basis points in Feb of this year and it was further lowered by 50 basis points to 8.50 per cent in March.  The monetary policy of the Bank of Mauritius (BOM) appears somewhat to be more like the traditional riddle, wrapped in a mystery, inside an enigma. Neither is it  be able to provide stable conditions in financial markets, nor is it able to manage the exchange rate of the rupee for  the orderly and balanced economic development of Mauritius or able to control inflation . It is caught up in the impossible trinity of reining in inflation, curbing the rupee appreciation and at the same time sustaining growth.

The main source of the rupee’s ascent nominally comes from sustained foreign direct investment inflows (mainly to IRS Schemes) , portfolio investment inflows due to the relatively high interest rates and the plunging dollar. Since July 2007, the collapse of the sub-prime bubble has forced the US to cut rates to save its collapsing banking system, which has sent the US dollar plunging. The widening interest rate differential in favour of the Mauritian rupee as interest rates on key currencies are brought down has also been driving the Mauritian rupee to higher levels. The BOM has allowed the exchange rate to appreciate to take pressure off imported inflation and also to manage capital inflows. But increasing interest rates at a time when the world as a whole is tending to a more benign interest rate regime attract the flow of funds from abroad which contribute to worsening the problem the authorities intend to solve. Up to December 2007, with both headline and core inflation on the decline, the authorities felt quite confident they have at least been able to anchor inflationary expectations and controlled the secondary effects of the imported inflation . The monetary tightening, as reflected by the increase in the Repo rate, has allowed a rather high interest rate differential to build up and this has increased the flow of liquidity from abroad .The bigger the interest rate differential, the bigger is the pressure of capital inflows . The BOM was finding itself in a dilemma that their measures at hiking the interest rates has further increased capital inflows that may turn out to be inflationary. Broad monetary liabilities in 2007  were growing by 15.3 %, aggregate monetary resources by 15.7% though total domestic credit were growing by only 9% ,of which private sector credit at a moderate rate of 12% . There was thus an urgent need to stem this flow of liquidity by calibrating its interest rate measures appropriately. This explains the reduction in the Repo rate. This is a difficult task at all times. Those who erroneously claim that « il vaudrait mieux intervener sur la quantité et non sur le prix »  have not understood this simple logic.               

So what’s the issue then ?  The issue is that the Central bank is facing one of  its toughest challenges as it finds itself caught up between  exporters lobby who find themselves priced out of markets  because of the strong rupee and the exchange rate fundamentalists  who believe that the way out of the inflation problem is for the currency to appreciate

The proponents for a weaker rupee believe that the present policy is mere short term stupidity bearing enormous long run consequences. It will affect key areas of the economy such as Export Oriented Enterprises / Manufacturing,/ tourism/ICT which are labour intensive and destroy the employment growth being witnessed presently. This will hurt the poor more than all this nonsense about controlling inflation. When the poor have no jobs and no money – it is not  a question of the loss of purchasing power, but the  loss of his livelihood. They argue that the stronger exchange rate is already taking a toll on exports. The growth forecasts of Export Oriented Enterprises (EOE) and tourism sectors have been revised downwards and during the first semester of 2008, the tourism sector has grown by only 5% whereas in the last quarter of 2007 , 13 EPZ enterprises closed down and EOE exports grew by only 2.8%. EOE exports growth have been declining over successive quarters from 23% to 17%, to 10% to 2.8% in the last quarter..

It is true that an appreciation in the rupee can slow down our exports and one argument for a weaker rupee is that that Mauritius needs to promote exports. This argument overlooks the fact that export competitiveness is not determined by the nominal exchange rate, but by the real exchange rate, which also takes into account the differences in the rates of inflation of other countries. If our trading partners or competitors have low inflation, their costs of production remain low. We lose export competitiveness when our inflation rate is higher than theirs. So what we are gaining by keeping the rupee from getting stronger, we may be losing through inflation.

 

But they counter attack that prices are climbing in response to global factors and that monetary or exchange rate measures cannot, by itself, bring down imported inflation in the economy. Some of their experts have worked out the simple inflation reducing effects of exchange rate appreciation casting some doubts on the exchange rate fundamentalists, perhaps too simplistic, notions of exchange rate pass-through.

 

 

 “The most successful country — the US. With an exchange rate depreciation of 25 per cent, it achieved a 7 percentage point lower inflation rate. China is the third worst country — excess inflation of 11.4 per cent. The country with the most monetarist concern about inflation, Germany (via the Bundesbank before and now the ECB), has the worst inflation fighting record among developed economies (excepting Sweden). Given the large 27 per cent appreciation in the euro, inflation in Germany should have been -6.5 per cent instead of 2.8 per cent! The comparison between the US and Germany is stark and as follows. Germany has a currency appreciation of 27 per cent and an inflation rate acceleration from 1.8 to 2.8 per cent. The US has a 25 per cent depreciation and an inflation rate acceleration of only 0.4 percentage points.” Courtesy Surjit Bhalla..

 

 

 

 

 

 

 

 

 

 

Country	CPI Inflation  (%)		Change in Inflation (% points)	Currency Change	Predicted Inflation	Excess Infaltion
	2006	2008	2008/06	2008/06(%)	2008(%)	2008(%)
Czech Republic	2.8	7.2	4.5	-38.9	-8.9	16.1
Poland	0.7	4.1	3.4	-38.4	-10.8	14.9
China	0.9	8.3	7.4	-13.3	-3.1	11.4
Sweden	0.6	3.1	2.5	-27.3	-7.6	10.7
Singapore	1.2	6.3	5.1	-16	-3.6	9.9
Israel	3.1	3.5	0.5	-29.8	-5.9	9.4
Chile	4	7.8	3.8	-18.4	-1.5	9.3
Germany	1.8	2.8	1	-27.6	-6.5	9.2
Switzerland	1.4	2.4	1	-27	-6.7	9.1
Italy	2.1	2.9	0.8	-27.6	-6.2	9.1
Spain	3.9	4.3	0.4	-27.6	-4.3	8.7
Australia	2.8	3	0.2	-26.4	-5.2	8.1
Brazil	5.4	4.5	-0.9	-24.8	-2.1	6.6
Russia	10.5	12	1.4	-16.8	5.5	6.5
Thailand	5.4	5.3	-0.2	-21.7	-1.1	6.3
Japan	-0.1	0.7	0.8	-17.5	-5.3	6
Taiwan	1	3.8	2.8	-8.3	-1.5	5.3
Britain	2	2.5	0.5	-14.8	-2.5	4.9
Hong Kong	1.2	6.1	4.9	0.3	1.3	4.8
India	4.6	5.4	0.8	-10.6	1.4	3.9
Mexico	3.6	3.6	0	-2.8	2.8	0.8
South Africa	3.8	9.3	5.5	23.8	11	-1.6
United States	3.5	3.9	0.4	25	11	-7.1

 

 

 

In Mauritius, the appreciating rupee has not succeeded in denting inflationary pressures, they claim. The 8.7 % rate of inflation for FY07/08 is explained by the prevalence of administered prices, the increased use of subsidies and the delay in adjustment to imported inflation and the changes in the new HBS basket for calculating CPI.  We have thus been subjected to some very doubtful and questionable claims about the instantaneous benefits of rupee appreciation . The scourge of high inflation has not been vanquished by the appreciating rupee. These very economists who in the not too distant past were arguing that we have little policy leeway against imported inflation have now become the apostle of the  "strong rupee is good for inflation" crowd.   La rupee forte  « a permis de maintenir le prix de l’essence pendant trois mois consecutifs malgre la hausse vertigineux du brut ». Such arguments ne fait pas honneur to the economist class,. While other economies are responding and adjusting to the international price signals (that’s what the APM was meant for), we are subsidising petrol and gas, and users of cars and middle class users of LPG, at a price that is nowhere reflecting the global prices and at the cost of creating big gaps in the trade account; is that sustainable.? 

 

One should also be careful about copycat references to Singapore which deliberately allowed its exchange rate to appreciate in the mid 1980s . From a low manufacturing base, Singapore reinvented itself and went into high-end manufacturing and financial services. We willingly missed the boat for massive human capital formation in the late 1980s and opted instead for the prodigal “no tax budgets” ,  while Singapore coming out of its successful job creation programme in the late 70s prepared the economy to move to its next phase of development. Prior to the appreciation of the rupee, much before the economy, de maniere deliberee,  the Government started a program of economic restructuring. This was achieved by modifying education policies, expanding technology and computer education, offering financial incentives to industrial enterprises and launching a productivity campaign

 Some glimpses of the preparedness of Singapore and the strategies that contributed to facilitate its transition to an increasingly private sector-led knowledge-based economy.  I hope, these will help to discard those simplistic comparisons for a more meaningful investigation into the  key ingredients of their success --particularly human resource development, efficient resource allocation, and openness to modern technology. These are: a) Singapore productivity growth was indeed very low until the 1980s but improved significantly to level comparable to OECDs in the 1990s; b) their Human resource Development strategy was to improve the training of Singaporean workers through government training institutes. A typical training program would meet twice a week for three-hour sessions over a two year period. The training was voluntary and free and it was geared to the needs of the companies operating in Singapore at that time. But the newly trained, highly motivated Singaporean workers not only replicated the old production process but began to make improvements that further lowered costs and enabled the economy to absorb the appreciating exchange rate. There developed in Singapore a culture of innovation. The government training program proved to be so beneficial to employers that they acquiesced to a special tax to help pay for it. c) Singapore branched out into the creation of a Science Park to share research between government and industry a national computer board to encourage the computerization of Singapore’s schools, offices and homes  a tripling of the size of the two engineering universities the creation of a $50 million venture capital fund to encourage Singaporean start-up companies but which would also fund start-ups outside of Singapore. And d) established in October 1979, the Skills Development Fund provides financial incentives to encourage employers to continuously upgrade their skills of their workers through structured training. And So on

 

Most of our East Asian economies have current account surpluses, while Mauritius  has a huge current account deficit of above 5 per cent of GDP in 2007 and 8 % in 206/07.  So, based on fundamentals, while it is understood that these economies should let their currencies appreciate, why should the Mauritian rupee, given the fundamentals, not depreciate?  What if the Mauritian Rupee is over--valued as a result of the “ dutch disease”.  Can we say that we have a strong high –value manufacturing base, with growing trade in all segments and excellent export growth that are powering this strong rupee ?

The sustained capital flows to the IRS and real estate sector have been the main cause of the appreciation of the rupee.  These flows do not enhance our productivity and flexibility. They are temporary and they do not in any way boost our export potential. There is no transfer of technology or know-how or any multiplier effects on the economy.  . We can only stem the rupee appreciation by imposing limits on these types of unproductive capital inflows and reprioritise our development projects and reconsider our development strategy.   Given the limited absorptive capacity of the economy, greater priority should be given to those programmes and projects that rapidly enhance our productivity and boost our export potential.

Only then can we afford to leave it to the market to determine the exchange rate and the BOM can then focus on a single objective — low and stable inflation. Whatever monetary measures we take for inflation control, they will be mainly aimed at preventing expectations to become entrenched and the spills over into second-round effects if supplies are constrained.