( Published in Business Magazine No. 1316 -13-19 December 2017)
Some years back we were one of those few “ fake” economists” who had alerted the authorities on the futility of the Central bank to be supportive of growth in its exchange rate and monetary policies because of the " impossible trinity or trilemma” and the presence of excess liquidity.
Some years back we were one of those few “ fake” economists” who had alerted the authorities on the futility of the Central bank to be supportive of growth in its exchange rate and monetary policies because of the " impossible trinity or trilemma” and the presence of excess liquidity.
Despite a change of guards at the
level of the Monetary Policy Committee and the direction of the Central Bank,
there has been little progress. They continue to fool themselves in believing
that they can influence growth by varying the Key Repo Rate (KRR). They “ persiste
et signe “ and monetary policy has become a farce. And it is no surprise
that some “fake” economists are questioning the independence of the Central
Bank. Allow me to explain.
The " impossibility trinity or
trilemma” refers to the trade-offs among the following three goals: a fixed
exchange rate, an independent monetary policy and free capital inflows (absence
of capital controls). An economy can choose at most two of these
three. The Mauritian economy is facing an increasing
trilemma—attempting to pursue an independent monetary policy and limiting
exchange rate flexibility. Capital inflows put upward pressure on the rupee- a
real appreciation. If the Bank Of Mauritius( BOM) does not intervene
, this results in a nominal appreciation of the rupee. If the
central bank intervenes and buys foreign exchange, the monetary base or reserve
money goes up and over time the inflation rate goes up. Thus to contain these
inflationary pressures, the monetary authorities sell government securities or
treasury bills to mop up the increased money supply. This is called sterilized
intervention
Table 1: Extent of Sterilization of inflows
∆ RM
|
∆ NFA
|
∆ NDA
|
∆ NDA/RM
|
|
Year
|
||||
2012-13
|
2,651
|
5,145
|
-2,494
|
-8.9
|
2013-14
|
5,272
|
9,048
|
-3,776
|
-12.3
|
2015-15
|
9,002
|
8,826
|
176
|
0.5
|
2015-16
|
3,345
|
6,202
|
-2,856
|
-6.4
|
2016-17(Sept)
|
4,342
|
11,459
|
-7,117
|
-14.7
|
∆ = change, RM= Reserve Money, NFA=
Net Foreign Assets, NDA=Net Domestic Assets
Table
1 shows that the extent of sterilization was relatively limited as the monetary
impact of reserve inflows (i.e. positive levels of ΔNFA) was partially
sterilized. These inflows were not fully compensated by negative changes in
domestic asset holdings by the central bank (negative levels of ΔNDA). The
capital inflows thus led to large increases in the monetary base In recent
years, growing over 18 percent , showing that the authorities have found it
increasingly difficult to limit the
liquidity effects of the foreign exchange asset accumulation.
The
sizeable capital inflows have caused noticeable nominal and real appreciation,
and the BOM has thwarted this to some extent by intervening in the
foreign-exchange market and buying foreign exchange. It has not succeeded in
fully sterilizing the inflows which resulted
in excess liquidity in the market; It had to raise bank reserve
requirements and imposed macro prudential measures or lending restrictions in
an attempt to decouple reserve money growth from broad money growth. The slack
in economic activity and the resulting low aggregate demand explains to some
extent why the vast flow of liquidity into the banking system was not
translated into equally high money supply growth.
The
capital inflows also led to a
significant increase in domestic asset prices, such as real estate prices, and
pushed down long-term interest rates. This however has not been translated into significant credit growth given the overvalued exchange rate and a situation of
feeble growth and demand in world markets. (see Table 2 Below). Moreover, in the
past few years, we have also seen the share of nonperforming loans rise in the
balance sheets of many banks.
Table 2: Growth of Money Aggregates
|
|||||||
%
Change
|
2013
|
2014
|
2015
|
2016
|
2017(Sept)
|
||
Net Foreign Assets
|
-1.3
|
15.5
|
15.6
|
3.8
|
4.1
|
||
Monetary Base
|
18.5
|
9.0
|
8.3
|
11.5
|
17.5
|
||
Money Supply
|
5.8
|
8.7
|
10.2
|
9.1
|
11.4
|
||
Domestic Credit
|
14.6
|
-0.3
|
6.7
|
3.5
|
15.2
|
||
The
buildup of large excess liquidity in the money market has resulted in a disconnect between the KRR and
money market interest rates. The rates in the interbank market have fallen
sharply and have remained much below the KRR, which has thus undermined the
monetary policy transmission mechanism and rendered it ineffective. Thus For
the moment it is inconsequential whether we have a low or a high KRR as the
money market or interbank rates have been consistently below the KRR.
The
lower KRR has undoubtedly benefited the leveraged corporate sector at the cost
of private savings and impacted negatively on the current account of the
Balance of Payments. But we have more problems ahead. The lacklustre
performance of the economy has given us a breather but once demand picks up the trilemma becomes binding
and excess liquidity will be leading to higher inflationary pressures. Thus, can we blame some “fake” economists for having doubts on the independence of the Central Bank ?
