Rameswurlall Basant Roi: Monetary and exchange rate policies,
and challenging reforms undertaken by the Bank of Mauritius
Address by Mr Rameswurlall Basant Roi, Governor of the Bank of Mauritius, at the annual dinner
for major economic stakeholders, Flic-en-Flac, 17 November 2017.
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Distinguished guests
Ladies and gentlemen
Good evening
I am pleased to welcome you, once again, to the Bank of Mauritius Annual Dinner.
Ever since I initiated this annual ritual of holding a dinner with major economic stakeholders way
back in December 1998, I have often been told by a few that my speeches tend to be lengthy. I
have a problem. And the problem is that short speeches take too long to write; it also requires an
exhaustive use of my cerebral capacity. Long speeches take less time to write. This evening, I'll
ask for your forbearance once again because the Bank of Mauritius is 50 years old.
There cannot be a more fitting occasion to travel back into 50 years of central banking policies
than one of golden jubilee celebrations. In an address that I gave exactly two weeks ago on the
occasion of the Inauguration of The Bank of Mauritius Museum, I focused on the institutional
development aspects of the Bank over the 50-year period. This evening, I have chosen to give a
very broad brush stroke of monetary and exchange rate policies as they have evolved in
Mauritius and of the financial sector reforms and regulatory and supervisory reforms undertaken
by the Bank over the years.
Against a backdrop of high unemployment rates and widespread poverty, the overriding need for
leading the Mauritian economy into a self-sustained growth path had set the agenda for
monetary, exchange rate and fiscal policies quite soon after independence. The rupee was then
linked to the Pound sterling at the rate of £1 = Rs13.33. In view of the predominance of the United
Kingdom in the trade and payments position of Mauritius, a fixed relationship between the pound
sterling and the rupee was found to be favourable to the expansion of trade and capital flows
between the two countries. In a global context of fixed par values, a single currency peg for
Mauritius facilitated the mechanics of trade and payments both within the sterling area and with
the rest of the world.
For any country in a dreadful state of underdevelopment seeking to foster economic growth, the
link to the Pound sterling was clearly a major handicap. Because of the link to the Pound sterling,
interest rates in Mauritius had to move synchronically with interest rate movements in the UK.
The Bank's ability to pursue an independent monetary policy was thus severely constrained. In
other words, the prevailing interest rates in Mauritius were unrealistic as they were not at levels
consistent with the economic development objectives of the time. The pressing need for creating
conditions conducive to sustained growth required financing at rates of interest affordable to risk
takers, more so in an economy with a plethora of drawbacks and deficiencies, including
investors having limited commercial skills. The Bank had thus purposively effected successive
rounds of interest rate cuts in 1969 and 1970 that severed the connective relationship between
its policy rate, that is, the then Bank Rate, and the Bank of England key policy rate. With an
expansionary monetary policy stance combined with an expansionary fiscal policy stance, began
an eventful chronicle of macro-economic policy making in Mauritius.
As opposed to a free market system, Mauritius had in place a regime of direct monetary control.
The then Bank Rate, deposit rates, lending rates and yields on Government papers were all
administratively set by the Bank of Mauritius. Transfers and payments for international trade
transactions and capital transfers required prior approval of the Bank of Mauritius. This regime of
direct monetary control and exchange control, seen in the light of the then prevailing economic
and financial conditions, were arguably a legitimate strategy.
In the early years of the 1970s, selective credit controls by economic sectors were introduced for
channeling funds to priority economic sectors with limits set on the overall bank credit expansion
with a view to containing the surge in aggregate demand in the economy. Quite expectedly, bank
credit grew far above the desired rate. The inordinate bank credit expansion in a contextual
excess liquidity situation largely attributed to the then sugar boom, the oil price shock of 1973
combined with an across-the-board increase in wages and salaries had given rise to double-digit
inflation rates, thus putting a stop to a very long period of price stability. Rising cost of living had
made it compelling for the Government to introduce what is today known as the annual cost of
living compensation. Inflation had turned out to be a serious policy concern. In today's free
market context, one would have ordinarily expected the cost bank credit to go up, meaning that
interest rates would have had to be stepped up. Instead, the costs of bank credit to export
promoting and import substituting enterprises were intentionally kept low, reflecting the authority's
objective of creating an enabling environment for the expansion of the manufacturing sector.
One of the most dramatic events that marked the first half of the 1970s was the breakdown of
the Bretton Woods system on the 15th August, 1971. Overnight, the world financial system had
moved from a fixed exchange rate regime to a floating exchange rate regime. Exchange rates of
the world's major currencies had ceased to be linked to gold, directly or indirectly. Their
determination was thereafter left to the inter-play of market forces. Many developing countries
had adopted some kind of a pegged exchange rate regime which meant pegging the national
currency to such a major reserve currency that best served the country's economic and financial
interests. The Mauritian rupee had continued to be pegged to the Pound sterling. Since the
Pound sterling floated as did other major currencies in the wake of the breakdown of the Bretton
Woods system, the rupee floated along with.
A flush of liquidity, unsterilized, that had swelled aggregate demand side-by-side with an ever
growing fiscal deficit also heavily financed by the central bank money had triggered a tension in
the exchange rate of the rupee. The tension was exacerbated by a weakening of the Pound
sterling as from May 1975. Weeks later, on the 30th June, the Pound sterling suffered one of its
sharpest falls. The effective depreciation of the pound sterling against other leading currencies
compared with the Smithsonian agreement of 1971 was nearly 30 per cent. It meant that along
with the Pound sterling, the rupee also had depreciated significantly thus adding further
pressures on domestic prices. The double digit inflation rates had turned out to be a major policy
concern.
Inevitably, the exchange rate regime had to be reviewed. On the 5th January, 1976, the rupee
was de-linked from the pound sterling and pegged to the Special Drawing Right (SDR) of the
International Monetary Fund at the central rate of SDR1 = Rs7.713759. Seen in the light of the
trade pattern of Mauritius, the SDR, a basket of currencies with the US dollar having the
preponderant weight, was obviously an import-biased basket. The principal objective of the new
peg, while intended to help minimize volatility of the exchange rate of the rupee, was to ward off
pressures on internal prices stemming from the external front. So much was the Government
concerned about the inflationary conditions in the economy that the new peg was decided upon
even at the expense of deteriorating external payments position. The economic development
objective was not adequately reflected in selection of the peg. Whereas the peg to the SDR
favoured imports on the one hand, the qualitative and quantitative controls on imports were
designed to check imports on the other. It did not make much harmonic sense in policy making.
Because of the preponderance of the US dollar in the SDR basket, the peg of the rupee to the
SDR could only stabilize the exchange rate of the rupee against the currencies of its major
trading partners during a period of relative stability in the US dollar. In a world economy where
authorities were desperately grappling with the problems arising out of the breakdown of the
Bretton Woods system and the unprecedented oil price shock of 1973, the resulting volatility of
exchange rates of major currencies seemed to have been taken lightly in deciding on the
appropriateness of the new peg. Given an export-oriented strategy, the appropriateness of the
new peg has remained a moot question.
In spite of a relatively tight monetary policy stance, demand conditions, fueled by an expansionary
fiscal policy, had continued to be buoyant with the result that the balance of payments posted
successive years of deficits. There was a clear and persistent gap between the level of import
demand and the country's foreign exchange earning capabilities. The basic causes of the deficits
were the adverse terms of trade, the high level of public expenditure and deficit financing, the
excessive growth in wages and salaries and the distortions in the domestic cost price structure.
All the policy sins committed by decision makers were ultimately disastrously reflected in the
balance of payments position of the country. The ill-effects of unchecked fiscal deficits year in
and year out on the economy via excessive monetary expansion were conveniently left at the
doorstep of Bank of Mauritius for resolution. The emerging precarious situation was indicative of
an urgent need for bold measures. Instead, Government had recourse to foreign borrowings in
an attempt to postpone painful adjustment measures. Humans, being what they are, the moment
for under-spending almost never comes. Like fat people at a wedding feast, fiscal policy makers
told to themselves they would eat less after the party was over, to make up for it. But in public
finance, there is never a good time for fasting. The die was already cast. Bold measures, as
always, need bold political courage. The second oil price shock of 1978 gave yet another blow to
the economy. The foreign exchange reserves of the Bank of Mauritius had dwindled. The
situation was desperate.
Drastic measures could no longer be delayed by having continued recourse to foreign
borrowings. In October, 1979, the IMF agreed to an economic and financial programme under a
Stand-by Arrangement. On the 23rd October, 1979, the Mauritian rupee was devalued by 22.9
per cent against the SDR basket to foster, inter alia, export-led growth. The devaluation was
expected to restore the profitability and external competitiveness of Mauritian exports and to
encourage import substitutions in the economy. The economic and financial programme was
designed to stabilize the economy by bringing about a balance between the demands for and the
supply of resources and to correct the balance of payments disequilibrium in the medium term.
The measures under the programme included an exchange rate depreciation supported by
restrictive budgetary, incomes and credit policies. The objective was to depress the demand for
imports by way of the resulting higher rupee import prices. But, against all principles of good
economics, the government had decided to grant a massive across-the-board increase in wages
and salaries thus mitigating the positive outcome expected of the devaluation of the rupee. A
central banker's job, it's often said, is to take away the punch bowl just as the party gets going.
Way back in 1979, Government had decided to keep the bar open. Bad politics destroyed good
economics.
The economy continued to face a number of difficulties which were caused by factors beyond
the authorities' control. Adverse weather conditions which prevailed in early 1980 had led to a
heavy shortfall in sugar exports in 1980-81. A fall in the rupee price of sugar exports which was
due to the weakening of the pound sterling weakened the country's external payments position. A
realignment of the external value of the rupee became inevitable and the rupee was devalued
once more - not to use the euphemism "re-adjustment" - on the 27th September, 1981, by 16. 7
per cent in terms of the SDR. Two massive devaluation in six years reflected badly on the fiscal
policy performance of the Government.
But we do have to recognize that the world economy was facing numerous challenges
throughout the 1970s. The external economic environment was far from being hospitable to
countries in a state of under-development. The breakdown of the Bretton Woods system had
given rise to serious disturbances. The unprecedented oil price shocks of 1973 and 1978 had
unleashed destabilizing forces the world over. Authorities were learning for the first time since the
end of World War II how to cope with a situation never seen before and resolve new problems
posed by the two traumatizing events. The world economy had dipped into its worst economic
recession since the end of the post-World War II. Stagflation, a state of high inflation rates and no
growth, characterized the world economy. Governments and central banks the world over were
having a very hard time resolving problems never known before. In Mauritius, recurrent strikes by
trade unions, demands for higher wages and salaries, recurrent inclement weather conditions,
high inflation rates fueled by high prices of oil and high unemployment rates were certainly not
ideal conditions for a take-off to self-sustained growth. It was a decade of restlessness and
crises in many respects. Admittedly, the economy did however undergo meaningful
transformation. Policy mistakes were made. Right policies would have lessened the pains
economic adjustment later. There are great lessons that all of us need to draw from the policy
mistakes of the past. If we don't learn from our experience, we'll never learn at all. I was
dismayed to see how the honest economist became a lonely voice of reason, and thus, a very
valuable voice, but ignored most of the time arrogantly rather than nonchalantly. Ultimately,
society, in particular the less privileged class, paid the price of the policy mistakes and arrogance
of the charlatans.
It cannot but be appropriate - indeed very appropriate - at this juncture of my address this
evening, to underline that the then Bank of Mauritius Act had an abhorrent sentence that read as
follows: "The Minister may from time to time give such directions to the Bank as, after
consultation with the Governor of the Bank, he considers necessary in the public interest." Even
where directives were not formally issued, the Bank was required to seek the nodding approval of
the Minister on many policy matters. Obviously, the Bank was not an independent organization.
Having gone through the trials and tribulations in the field of monetary policy making for years and
spent a greater part of my life in the central banking community, I have to say that it's the
responsibility of one and all to preserve and protect the independence of the Bank of Mauritius in
policy making and implementation from deplorable baskets of fake economists, self-seeking
advisers and imposters in the veiled pursuit of self-interests. It's in the best interest of society to
have a central bank that is truly independent. Independence of the central bank must be treated
as sacrosanct. Never ever forget how a mafia-infested Italy was saved in the not so distant past
from catastrophic situations. Two institutions are said to have saved Italy: the Vatican and the
central bank of Italy.
By 1982, the world economy had bottomed out of one of its worst recessions since the end of
World War II. A new era in monetary and fiscal policy making began. On the fiscal side, the sales
tax that evolved into what we refer to as VAT (Value Added Tax) was introduced as part of a
wellmeaning and determined effort to curb the budget deficit. On the Bank of Mauritius side, a
fundamentally important strategic policy move was made. As I mentioned earlier, the rupee had
been linked to the SDR with a view to reducing the exchange rate variability of the rupee. With the
steady strengthening of the US dollar especially since 1981, the SDR had appreciated against
other major currencies which in turn resulted in an appreciation of the rupee on a trade weighted
basis. More or less the same problems were baked in the SDR peg as in the Pound sterling peg.
The time was up to do away with the SDR peg. With effect from the 28th February, 1983, the
rupee was delinked from the SDR and pegged to a trade-weighted basket of currencies, which
was more representative of the external trade pattern of Mauritius. The pegging of the rupee to
the new and a much simpler basket of currencies was expected to be more effective in
stabilizing its exchange value. It was a heavily export-biased basket designed to be a perfect fit
for an export-oriented growth strategy.
Concomitantly, a number of key measures was announced for implementation decidedly.
Government had given its unwavering political commitment to pursue the measures to the finish.
Never in the history of Mauritius were monetary and exchange rate policies so harmoniously
orchestrated and finely tuned with a host of fiscal and trade liberalization policies for the
achievement of a common economic goal. In the scheme of things, trade liberalization
meant, inter alia, elimination of quota on imports, removal of import licenses, gradual reduction of
tariffs and customs duties etc. On the fiscal side, the pre-eminent measures were a planned
reduction of the then high corporate tax and income tax. A prudent wage policy was deemed a
key element in the overall policy package to beef up the competiveness of the Mauritian
economy. On the central banking side, a few policies aimed at complementing measures for
strengthening competiveness and financial sector reforms were set as an agenda for immediate
execution. The export sectors were the first policy target. The Bank's exchange rate policy was
immediately geared towards one prime objective: achieve and maintain the competitiveness of
the export sectors. Following the introduction of the new currency peg, the Bank of Mauritius
monitored the exchange rate of the rupee on a daily basis. Corrective steps were taken as and
when they were deemed necessary. In this exercise, constant attempts were made to keep the
exchange rate of the rupee (I mean real effective exchange rate of the rupee) stable. The
exchange rate of the rupee, deftly managed, in an imperfect financial market eventually enabled
exporters to better predict costs and prices of their products.
The previous two currency pegs had not permitted the re-alignment of the exchange rate of the
rupee on a regular basis. The new peg did. Investment in the economy shot up. The
manufacturing sector, in particular the export sectors, underwent an unprecedented expansion.
The economy fired in all its cylinders. Entrepreneurs mushroomed. Like boats in the rising tide of
economic prosperity, new enterprises floated profitably. Exports shot up. The economy attained
a state of full employment conditions. The foreign exchange reserves of the Bank of Mauritius
rose to levels never attained before. Economic prosperity reached the lowest strata of the
population. Government revenue collections improved substantially despite cuts in corporate and
personal income tax rates and reduction in tariffs and customs duties. It's certainly not my
intention to claim that the unprecedented economic prosperity of the second half of the 1980s is
attributable solely to the Bank of Mauritius. Far from it.
I am sure, you will agree with me that entrepreneurship and industrial success do not occur from
a void. They thrive in the soil of political structure and a culture comprising many essential
elements. Those combined elements give rise to synergy and to a mood of optimism. A critically
important element in addition to the ones I mentioned earlier, was the decision to go for financial
sector liberalization. The objective of doing away with exchange control was announced in 1984
and accordingly measures were taken to gradually do away with the regime. By the mid-1980s,
the foreign exchange reserves level of the Bank of Mauritius had reached more than comfortable
levels and the budget deficit drastically curbed to a point that Government repaid quite a chunk of
its external repayment obligations ahead of due dates. In August 1986, the Stand-by Arrangement
with the IMF was over. Economic recovery was well under way. The balance of payments
position for Mauritius had improved considerably. The then prevailing economic conditions did not
warrant yet another Stand-by Arrangement with the IMF.
The launch of offshore banking in August 1989 portended an acceleration of the elimination of
exchange control. Proper sequencing of financial sector liberalization required that the inter-play
of market forces be promoted in the financial industry. It was a strenuous walk away from the era
of financial repression. Ceilings on bank credit expansion - the long established method of
containing bank credit expansion - began to give way to market forces. The Bank gradually let go
the administrative determination of interest rates in the economy. Effective open market
operations imperatively required market determination of the prices of Government debt
instruments. In 1992, the Bank moved away from a rule-of-thumb method of determination of
prices for Government papers to a method of weekly auctioning. While the process of financial
sector liberalization was well under way, Mauritius adopted Article VIII of the Articles of
Agreement of the IMF in September 1993. Prior approval of the Bank of Mauritius was no longer
required for transfers and payments of international trade transactions. By July 1994, the
Exchange Control Act was suspended.
A new framework for monetary policy making was adopted and a Monthly Monetary Policy
Committee Chaired by the Minister of Finance with the support of late Prof. Maxwell Fry of the
University of Birmingham was set up. Mauritius was among the very few countries in the world to
have had a Monetary Policy Committee in 1994. In subsequent years, the monthly meetings were
held in house under the chairmanship of the Governor.
With the suspension of exchange control, began a full-fledged market based financial services
industry in Mauritius. Normally, a market based financial industry presupposes fiscal discipline
and, more importantly, rigors in public finance if monetary and financial stability has to be
maintained, particularly, in relatively smaller jurisdictions. In the years just after abolition of
exchange control, government borrowings from the central bank had reached very high levels
because of expanding budget deficit. Excess demand for foreign exchange on the domestic
foreign exchange market invited the Bank to more than frequently intervene on market up to a
point it no longer was willing to proceed with intervention for fear of depleting its foreign exchange
reserves. It was a typically monetary economics textbook illustration of what happens to the
financial markets via the current account balance of payments when the fiscal position of
Government is persistently out of line with economic realities. The end result was a chaos in the
domestic foreign exchange market. The market ran short of foreign exchange. The rupee
depreciated at an accelerated pace and the Bank of Mauritius, for some reasons, failed defend
the rupee. The market desperately needed a shock therapy.
In the dying days of 1998, the Bank of Mauritius gave a counter shock to the money market by
causing yields on treasury bills to shoot up and selling them directly to the public. Central bank
financing of the fiscal deficit was soon completely replaced by financing from the public. The
Bank regained its lost credibility and equilibrating forces worked their ways into the market. Order
in the market was restored. The tight monetary policy stance of the Bank along with the
"massaging" of the exchange rate of the rupee in a highly imperfect market gave the country, for
the first time in its history, four successive years of current account surpluses in the initial years
of the new millennium.
Both the domestic money market and the foreign exchange market were still in their fledgling
state of development. Even five years after the suspension of exchange control, players in the
money and foreign exchange markets were still operating with the same frame of mind as in the
days prior to the abolition of exchange control. They shied away from such elementary
operations as forward sales and purchases of foreign currencies. The risk-averse attitude was
worryingly pervasive. Since the Mauritius Sugar Syndicate (MSS) was the single largest seller of
foreign currencies in the market, the Bank forcefully drove the MSS to actively engage in forward
sales of sugar export proceeds. It had required the CEO and the accountant of the MSS the gall
and guts, the audacity to persuade their very conservative Board of Directors to be innovative.
The then treasurer of Barclays Bank, a forward-looking young professional in finance, with the
explicit support of the Bank of Mauritius threw his weight in the game and gave the kick-start for
an innovative approach of treasury management. The domestic money and foreign exchange
markets wherein millions of US dollars are traded today started right then and there. It's in the
best interests of our financial industry and, by extension, to the economy as a whole that these
two markets grow healthily at a sustainable gait, without which the effectiveness of monetary
policy transmission mechanism is seriously impaired.
One of the most important contributions made by the Bank of Mauritius in the past seventeen
years finds its roots in a fundamentally important amendment to the Bank of Mauritius Act in
2004. The dual licensing regime, one for offshore banking and the other for domestic banking,
introduced in 1988 before the launching of offshore banking in Mauritius in 1989, was done away
with; it was replaced by a single banking license regime. The removal of the regulatory wall
between offshore banking activities and domestic banking activities was a turbo-charged enabler
of the widening and deepening of the domestic money and foreign exchange markets. Isn't
awesome that the foreign exchange reserves of the Bank of Mauritius have gradually risen to a
record level of about US$5 billion despite consequential declines in export proceeds over the past
several years? No importers, no Mauritian travelling abroad, no student studying abroad has had
any problem of foreign exchange for ten years unlike it often used to be in the past. The Mauritian
economy has had ten years of enduring stability in the domestic foreign exchange market. We
often take this for granted and insult the man, the institution that gave the country this precious
gift of stability. That stability, indeed a very rare gift to any economic system for so long a time,
ought to have been taken full advantage of for purposes of durable social and economic
development. There are risks of instability in the offing that hopefully will be effectively tackled by
the Bank and other agencies in the years ahead.
Thus far, the Bank has taken the stand that if the risk-taking behaviour of financial institutions
cannot be regulated perfectly, it must impose some kind of prudential ratios to curb the volume of
transactions. Otherwise the Bank would commit the same fallacy as gun control opponents who
argue that "guns do not kill people, people do". As we are unable to regulate fully the behaviour of
gun owners, we have no choice but to restrict the circulation of guns more directly.
In an ever changing technological environment, new risks, new threats and greater regulatory
challenges keep emerging. They intensify the regulatory burden for achieving financial stability.
Our current regulatory and risk management systems are designed to retrospectively identify at
what point in time a thief stole your money, not to alert you when he is actually stealing it. They
are expected to change soon with the Bank's risk-based supervision approach. Regulation and
supervision of financial institutions is fast moving to a state of things where you might possibly
beat the system but not the house. It does not necessarily go to say that the Bank will be
regulating for zero failures. Such an approach would of course stifle financial innovation.
Human nature. I come back to an important element in Hyman Minsky's financial instability
hypothesis. The longer people make money by taking risk, the more imprudent they become in
risk-taking. It's self-fulfilling when the going is good. If everybody is simultaneously becoming
increasingly more risk-seeking, the value of things like, say, privately issued cryptocurrencies,
goes up. This increases the ability to lever and the game keeps going. Human nature is
inherently pro-cyclical. Human beings are not inherently given to equilibrium; they're inherently
given to manic depression.
Once the process of financial sector liberalization was over, the Bank of Mauritius threw its
weight on setting in place the building blocks for financial stability towards the end of the 1990s.
The Bank came up with a completely new regulatory and supervisory framework for
deposittaking institutions.
The Bank of Mauritius has since made relentless efforts to improve the jurisdiction's institutional
set up and constantly update its regulatory standards. A successful regulatory authority needs
independence in the exercise of its powers. The Bank of Mauritius was made legally independent
in the Bank of Mauritius Act 2004. Along with the independence, the Act made allowance for the
setting up of a Monetary Policy Committee. In the great spirit of responsible central banking, I
have done what could possibly be done to maintain the independence of the Bank.
Ladies and gentlemen, on behalf of the Board of Directors of the Bank, myself included, my wife,
Meera, and the staff of the Bank, I wish you all Happy Holidays and the very best for 2018.
Thank you.