Monetary impotence

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Not respecting the schedules of rate-setting meetings is a deviation from international best practices. After two unexplained postponements, the Monetary Policy Committee (MPC) is due to meet today to decide on the Key Repo Rate (KRR). Had the Bank of Mauritius (BoM) postponed the meeting again, this would have changed nothing in the conduct, or rather the lack thereof, of its monetary policy. Today, the balance sheet of the BoM is in a mess, which severely impacts its ability to transmit its policy via the interest rate channel. 

People are unaware that monetary policy is closely intertwined with the central bank’s balance sheet. Suppose the MPC jacks up the KRR because it wants to see the market interest rates increase. Then the yields of 3-month Treasury bills must be brought closer to the KRR, and for that to happen, the BoM needs to issue more monetary policy instruments to mop up excess liquidity. Otherwise, the theoretical rise in the policy rate will remain without effect and depend solely on moral suasion. 

The problem is that the BoM does not have enough capital to issue lots of bills, notes, and bonds as this will augment its domestic liabilities. The BoM will have no credibility if its balance sheet shows negative net worth. Right now, it must recapitalise itself following the transfer of Rs60 billion to government which exceeds its level of capital, and given the extra capital buffers needed to cover for the very risky multi-billion-rupee loans given to the Mauritius Investment Corporation which sit on its balance sheet. 

On May 29, 2020, Governor Seegolam announced that “up to two billion US dollars from the foreign exchange reserves of the Bank will be made available to the MIC”. Till now, however, the sales of US dollars have been slow and limited. The reason is that the BoM cannot allow the rupee to appreciate too much as any appreciation will worsen its financial position. 

People wrongly think that official international reserves are money that the country has as savings. In fact, these reserves are assets that are set against liabilities, be they banks’ excess liquidity held at the central bank or monetary policy instruments used by the latter to sterilise the liquidity created by purchases of foreign currencies on the domestic market. 

International reserves are meant to service external liabilities. It so happens that the reserve adequacy of the country is not improving: according to the International Monetary Fund, the Assessing Reserve Adequacy (ARA) metric of Mauritius, which considers imports, external debts and deposits of Global Business Companies, is only at 103 %, closer to the lower bound of the 100-150% advisable range. 

The BoM must review its asset-liability framework. It is accumulating external liabilities as government has taken foreign loans that go to international reserves in exchange for rupees. Also, out of these reserves, around a billion dollars belong to commercial banks which park their excess foreign currencies at the central bank. The BoM must maintain this money in highly liquid assets.

The best way for the BoM to rebuild capital from its own assets is by generating abundant income from international reserve management and from a profitmaking MIC. 

But this is unlikely to happen because the BoM has no professional knowledge in managing reserves across global markets, while the CEO of its subsidiary is not interested in what profits the MIC. The safer option is for government to inject fresh capital into the BoM, but public sector debt will then shoot up. It will therefore require arduous negotiation between the fiscal and monetary authorities. Rupee devaluation seems to be the preferred solution, but it fuels inflation which warrants monetary tightening. 

So, further monetary easing is not in the cards either. With all the money that the BoM has printed and continues to print, and with the increased spending by the government, Mauritius is poised to suffer higher inflation and weakening purchasing power in the coming years. Driving down interest rates does not create economic growth, but market distortions. 

Interest rates are prices that clear the markets between suppliers and seekers of loans. Normally, when the government borrows a lot, it pushes interest rates up. However, the BoM has boosted the money supply, putting more money into loan markets and funding a big portion of the budget deficit, thus bringing interest rates back to their historically low levels. 

The economy cannot tolerate a jump in yields on government securities. Yet, low yields are evidence of a debt trap. The ultra-loose monetary policy will not stop soon, being a tool to avoid structural economic reforms. 

The impotent Bank of Mauritius lacks not only an official inflation target that can anchor inflation expectations, but also the balance sheet to craft a policy framework. The MPC can stay put, let alone kaput, until and unless the BoM strengthens its balance sheet.

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