No scope for normalization

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Why had the Monetary Policy Committee (MPC) fixed a meeting for today, just two months after the last one, if it was not to justify the fees paid to its members? The meeting has been postponed to 20 October, but an increase in the policy rate is unlikely because the government, the private sector and the central bank are all stuck in a debt trap, and the economic recovery has yet to pick up any steam.

This is what the Governor of the Bank of Mauritius (BoM) has implied in its e-mailed responses to questions of Bloomberg dated 24 August: “The accommodative stance will prevail as long as the economy requires it.” And he asked himself: “When do we start normalizing? It can be as soon as next quarter”, that is the current quarter. Oh, really?

Normalization – interest rates going up back to normal levels – cannot be done if there is no monetary framework to determine the equilibrium interest rate that meets a quantifiable inflation target. Without a framework, the MPC members, whatever their knowledge of basic economics may be, cannot know how to decide and how meaningful are their decisions. It has been announced that a “new monetary policy framework” (if ever there was one) “will be rolled out before the end of 2021.” Even if it is a form of flexible inflation targeting, the proposed framework will achieve nothing because, following large transfers of funds to the Public Treasury and to the Mauritius Investment Corporation (MIC) which sits on its balance sheet, the BoM does not have a well capitalized balance sheet for the effective conduct of its monetary policy operations.

To claim that the BoM has a sound balance sheet, Governor Seegolam must first define soundness. Has the BoM carried out an asset-liability study? What is the economic capital to total assets ratio that is required to cover all the risks that the BoM has?

The International Monetary Fund (IMF) has stated that the BoM has negative net worth because unrealized exchange rate gains (recorded in the Special Reserve Fund) cannot be accounted for as capital and given the transfers relative to the size of the BoM economic capital. Thus the IMF recommends an upfront recapitalization that would restore the BoM real capital to credible levels, via a transfer of marketable public debt instruments, which admittedly would lead to a substantial one-off increase in public debt.

The BoM is asking the IMF for technical assistance on recapitalization while talking about interest rate normalization that can be costly to its balance sheet! It does not have the required balance sheet strength to start normalizing interest rates. It has not even published its balance sheet for June 2021 as its accounts are still being audited. One would expect the BoM equity, driven by the sharp rupee depreciation two days before closing the accounts, to rise above Rs 30 billion. But the economic capital to assets ratio will remain too low when adjusted for the rupee depreciation, and it will look worse if balance sheet risks are taken into account. In case the BoM makes any mark-to-market losses on the MIC, its balance sheet will be screwed even more.

When the central bank sells foreign exchange on the domestic market, it should normally destroy the rupees it receives. However, it redirects the rupees out again through the MIC to the private sector. So the BoM is pumping a lot of liquidity into the banking system, a policy which would stand in contradiction with any inflation targeting framework that constrains it by law to do that.

The MPC believed that “the rise in headline inflation was mostly transient in nature” because of “unexpected supply shocks.” There cannot be transitory effects when the money supply is growing at double digits, which is in itself inflationary. The expansion of money cannot be undone by a corresponding increase in the production of goods, but it sets in motion all the negative effects of money printing, such as the diversion of real wealth from ordinary taxpayers to highly profitable banks through bailouts of big business groups.

It is too late now for the MPC to stop underplaying inflation risks. The Petroleum Pricing Committee will soon raise once again the retail prices of Mogas and gas oil, pending the next PRB salary award. Price growth is accelerating worldwide, Kenneth Rogoff, Nouriel Roubini and Mohamed El-Erian are highlighting worrying parallels with the stagflation of the 1970s, and there is a clear shift towards tighter monetary policy across the globe.

Same will occur here, but this will have little impact because Mauritius does not have a quantifiable inflation target, its monetary transmission mechanism does not work, and the BoM lacks the necessary credibility to set and anchor inflation expectations properly. Besides, the difference between the 3-month Treasury bill rate and the Repo rate remains too wide, and the bond market is too fragmented to supplement the interest rate channel.

So, the make-believe show will go on at the Bank of Mauritius Tower.

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