Rapid Inflation : Supply constraints or Policy ?
Firstly, in simple terms, there seems to be a disagreement as to what caused our inflation. The argument that our inflation is mostly the result of supply shocks such as the war in Ukraine or of global supply chain problems seems to be gaining ground as opposed to the view that the inflation that we are experiencing today is largely a demand-side problem.
In our case, I do not think that the supply constraints, as the main cause of our inflation, can explain the persistence of our high inflation rate or its scale compared to the inflation in other countries.
In its press statement, following the last Monetary Policy Committee (MPC) meeting, our BoM Governor, named only those countries that have inflation as high as ours and omitted to mention countries like Seychelles (2.9%), Maldives(3.1%) , Singapore(6.7%), and Sub-Saharan African countries (3.7 %). If we go by the pure logic of the supply shocks as the main cause of our inflation, why are our prices rising so fast as compared to other countries- especially the tourism-dependent economies- undergoing the same supply shocks ?
The typical answers to explain our rapid inflation have been :
• The soaring cost of energy :Oil and gas prices increased because energy was in greater demand as life got back to normal after Covid. At the same time, the war in Ukraine meant less was available from Russia, putting further pressure on prices.
• The war in Ukraine also led to food prices going up, by reducing the amount of grain available. Annual food inflation hit 16.5% in November, the highest rate for 45 years, and up from 16.4% in October.
But what they had omitted to mention as the main cause of our higher rate of inflation , besides global supply bottlenecks, higher fuel and food prices and freight costs, was the exaggerated depreciation of the rupee.
What led to such depreciation of the rupee (around 26% against the dollar on the average since 2015) ?
The higher inflation, as compared to some other countries, that we are experiencing is the result mostly of our expansive monetary and fiscal policy, rather than the result of global supply chain problems or other supply shocks.
About half of the support that was provided during Covid and after was off-budget, mainly through quasi-fiscal support under the Bank of Mauritius (BoM) umbrella special purpose vehicle (SPV)-MIC- to finance systemically important firms in tourism and related sectors( around 14.2 % of 2020 GDP).
These policies contributed to a sharp increase in the monetary base, 58 percent at end-2020 compared to end-2019. The 2021 IMF Art IV report had warned that “ If left unattended, these measures threaten to further spur excess liquidity limiting the BoM’s ability to steer the interest rate and aggregate demand and to achieve low and stable inflation.”
And in the very countries( UK, Euro areas, Nigeria, Argentina , Ghana..) mentioned by our Governor, Quantitative Easing (QE) or loose fiscal and monetary policies have led to substantial depreciation of their currencies over the past years and their current inflation is more of devaluation baring its teeth. In the case of UK for e.g their present high inflation rate has long been warned by some dissenters at the BoE - “the beast of inflation stalking the land once more, with booming demand, labour shortages and supply-chain disruption risking a “wage-price spiral familiar from the 1970s and 1980s.…..which warrants action to reduce the scale of the Bank’s £895bn quantitative easing bond-buying programme, and take some heat out of a red-hot economy.”
Secondly, as to the question of the effectiveness of the increase in interest rate to control inflation, perhaps J.Stiglitz comments on the real debate on the key dimensions of today’s inflation, may help to better apprehend the whole situation . “ Yet, for all the din and roar over inflation and the monetary-policy response, there is less disagreement than one might think. Most commentators on both the left and the right believe that interest rates should be increased. The controversy stems from questions such as when we should worry that rates are increasing too much and too fast, and how pre-emptive we should be …..those more concerned with the real economy and ordinary workers argue for a gradualist approach, whereby significant tightening would be withheld until there is evidence of a significant acceleration of inflation. “
Thus, in our particular context, we can say that the pace of tightening must be fine-tuned to changes in inflation expectations, the credibility of our monetary policy frameworks, and the extent of exchange rate pressures together with fiscal consolidation which should also be a crucial part of the disinflation strategy.
Please note that Unsal, Papageorgiou, and Garbers in their 2022 Working Paper ,“Monetary Policy Frameworks: An Index and New Evidence” had observed that “Many countries have strengthened central bank independence, reduced fiscal dominance, and improved monetary policy transmission channels. But policy frameworks are still relatively weak in some countries, and high debt levels can raise the prospect of future monetary financing of the fiscal deficit. These factors tend to undermine the inflation-fighting credibility of the central bank, making second-round effects from external shocks more likely, and lowering the effectiveness of monetary policy.”
Thus we should not be surprised if the hike in the repo rates are not being that effective given that our structural liquidity surplus was being fuelled by the large fiscal deficit monetization and quasi-fiscal expenditures financed by the BoM, and not fully sterilized. As a result, BoM’s interest rate management was not effective with the money market interest rate systematically and substantially below the announced policy rate or the rate that the BOM attached to its main OMOs.
Moreover, without fiscal consolidation, the government’s interest costs on the debt will rise. Unless fiscal policy tightens to pay those interest costs, raising interest rates just makes deficit-induced inflation worse. As economist Eric Leeper states, “fiscal responses are fundamental, even indispensable to monetary policy impacts on inflation.”
Now , with a more modernized monetary policy framework and inflation targeting , ( as recommended and enforced by the IMF) and the right fiscal responses, we may hope for a more effective management of the interest rate as an effective policy signal to tackle our runaway inflation. Moreover, "one of the lessons of the cost-push inflation of the 1970s after the first oil price rise was that supply-side shocks can also, in central banker jargon, de-anchor inflation expectations and produce second-round effects in labour markets."
Thus , as you see, the government and their dwindling band of apologists were giving their standard response to any negative news: "The blame lies elsewhere. It is beyond our control."
We are witnessing the same kind of response about the proposed increase in the electricity rate by February next. Because of the external factors- we are being told- the CEB is now losing Rs 600 million per month and an increase in the electricity tariff from 19% to 29% is unavoidable.
What has happened to the billions of rupees of CEB reserves?
What we know is that ,as reported in the 22-23 Estimates, , under the section “Other Revenue” sub-section “Other Revenue - Withdrawals from Income of Quasi Corporations”, the revised estimate of income withdrawn from the Central Electricity Board in 2021/22 amounted to Rs 3.5 bn. This withdrawal of Rs3.5 bn was simply a means of financing the Govt deficit by drawing on the CEB’s accumulated capital reserves. The CEB’s reserves represented profits accumulated over several previous years.
In the past, such income withdrawals included funds from the Bank of Mauritius, the Financial Services Commission, the State Trading Commission and the Mauritius Ports Authority, not the CEB. The reserves of the Bank of Mauritius have been largely depleted by transfers to Govt, and the BoM now holds negative equity. To finance excessive, uncontrolled and unproductive spending, Govt has bankrupted all the country’s public institutions.
When it's for the corporates or for their populist policies and unproductive prestige projects, hundreds of billions can be found on the magic money tree. But for inflation (caused by govt policy)......, you're on your own. We can't do anything about that pain, sorry . Oh, and you can't have wage rises or full compensation either, you see as that will fuel inflation. The elite & wealthy along with big corporations/banks have this all stitched up . “ It is beyond their control !”
And Pada who was claiming that they were "taking back control ! Taking back control of what?
They have lost all control…our poor Governor boy , his only hope is that perhaps changing the Key Repo rate to Key rate may help….more interest pains ahead for our Governor boy !
