R Basant Roi: Present challenges of monetary policy in Mauritius
Address by Mr R Basant Roi, Governor of the Bank of Mauritius, at the annual dinner with major
economic stakeholders, Sugar Beach Resort, 28 November 2003.
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Ladies and Gentlemen
Good evening
I am pleased to welcome you to the Bank of Mauritius Annual Dinner.
Right from the year I set the tradition of holding an annual dinner with the major economic
stakeholders in the country I focused mostly on regulatory and supervisory issues in my addresses.
Intentionally, I chose certain regulatory and supervisory issues as the leading themes of my addresses
for reasons that I strongly believe should be clearer by now.
Tonight I shall briefly outline the present challenges of our monetary policy in the context of an
external environment characterized by uncertainties. Before I proceed with the main theme of my
address let me reiterate a few remarks I made in the post February 2003 months this year. The
perceptions that emerged in the wake of the discovery of a fraud at the Mauritius Commercial Bank
(MCB) inevitably make it compelling that I should re-emphasize some of the remarks. The guiding
principle of any regulatory and supervisory authority in any economic and financial system is to first
and foremost attempt to save troubled financial institutions. The legal frameworks of regulatory and
supervisory authorities are designed to promote financial stability rather than to jeopardize financial
stability. This is what is envisioned in the Bank of Mauritius and the Banking Acts. The Acts are an
instrument that empowers the Bank of Mauritius to promote and sustain monetary and financial
stability. Regulatory and supervisory authorities the world over do not use any of the provisions of their
laws to defeat the very objective of the laws. Arbitrary decisions motivated by emotional or even
personal considerations should be set aside in favour of a genuinely professional approach of
sustaining the soundness of banks in situations similar to the one the Mauritius Commercial Bank
found itself in. The regulatory and supervisory authority cannot but exercise its independence of mind.
Without being presumptuous the MCB/NPF case was handled by the Bank of Mauritius in a manner
that best serves the interests of our financial sector and of our economy. I should like to re-underline
that supervision of banks is control and procedure oriented and not transaction oriented. Viewed in the
light of determined steps taken by the MCB in the realm of risk management along with a number of
other prudential measures taken in the months after the discovery of the fraud, the MCB/NPF case is
expected to be over soon as far as the Bank of Mauritius is concerned. Regulatory issues relating to
the Worldcom and Enron scandals in the US were dealt with and settled within a few months. Our
banking industry is blessed in having to surmount only one tyranny: adverse publicity motivated by
considerations that go beyond acceptable norms of conduct. The Bank of Mauritius will ensure that the
steps taken by the MCB to fully revamp its internal controls and procedures are carried through to the
finish and that internal controls are appropriately exercised and procedures are strictly followed.
Suffice it to say that the MCB/NPF episode, despite the traumas associated with it, serves a good
lesson to our financial industry.
Having said that let me turn to the main theme of my address tonight. As I explained in April last at a
Seminar a full appreciation of the Bank's monetary policy stance requires a perspective stretching
beyond a few months or even beyond a single year. A few months or even a year is rather a short time
to really gauge what monetary policies of central banks can accomplish on a lasting basis. Monetary
policy tends to impact on economies with a long and variable lag. Unforeseen events having
undesirable consequences for economies can take place in minutes. Predictability of the course of
monetary policy is disturbed in such circumstances.
Policies in the post World War II were quite predictable. They were predictable because of the steady
economic performance of the leading economies of the world in the context of a remarkably stable
international socio-political and economic and financial environment. Central banks and governments
all over the world enjoyed full sovereignty in policy making. In sharp contrast, the international
sociopolitical and economic context is far from being that predictable today. Additionally, in the wake of
financial liberalization across the world, with an estimated US$1.2 trillion being traded daily, capital
moves in and out of countries with a remarkable ease and at a speed never witnessed before. The
monetary policy stance of one country affects the monetary policy of another and in this process part
of our sovereignty in monetary policy-making is thus lost. Central bankers necessarily have to
constantly watch their radar screens and determine for themselves how to steer their monetary policy
in the best interest of their economies. "The manner in which central bankers must operate can be
compared to the decisions people make whenever they cross the street. If there is no traffic, there is
little risk, and pedestrians don't need to worry about the speed with which they cross the street. But if
the road is heavy with fast moving traffic, it's a different story, and safety demands that pedestrians
wait until they are confident they can make it to the other side. The same holds true for central bank
governors."
The introduction of the Euro, the September 11 attacks that impacted seriously on the US economy
which is an importer of the last resort, the ever growing instability in the Middle East, the
disagreements over trade policies and tendencies for countries to resort to protectionist measures in
one form or the other, volatility in the exchange rates of major currencies in the international
exchanges as well as the weak performance of most economies across the world have not made
monetary policy making here and abroad a plain sailing endeavour. Successive years of uncertainties
intensified by events beyond the control of central banks have increasingly blurred visibility. Central
banks have to constantly chart a safe way forward in this world of unexpected twists and turns of
events.
Five years ago, substantial capital outflows triggered by a loss of confidence in the rupee had brought
down the foreign reserves of the Bank of Mauritius to unacceptable levels. The rapid weakening of the
Euro in the international exchanges following its introduction in January 1999 translated into a
significant appreciation of the rupee. And that appreciation of the rupee was a quick reversal of the
preceding three years of rapid depreciation of the rupee. The mood of pessimism that emerged in the
wake of the September 11 attacks brought down the world economy to the throes of deflation. Central
banks around the world effected a series of cuts in interest rates in a bid to revitalize their respective
economies. Notwithstanding the policies adopted by central banks, the leading world economies
entered a period of balance sheet recession in recent years. In the wake of drastic fall in equity prices,
many companies the world over could no longer afford to maximize profits. They chose to restructure
their balance sheets for corporate governance so demanded. However, the household sector
continued to save money and the business community almost stopped borrowing money even at low
rates of interest. This is a peculiar situation or rather a fallacy of composition problem that exacerbated
the recessionary trend in the world economy. Monetary policy becomes much less effective when only
few companies are willing to borrow in this type of a recession. Fiscal policy takes over as an
absolutely important instrument to boost up aggregate demand as well as to keep money supply from
shrinking.
In such troubled waters the navigational hazard is impaired visibility, which is quite often the case.
Monetary policy judgments become a question of balancing risks more so in a small open economy
like ours with all its vulnerabilities. Observers from outside the walls of the central banks may find
monetary policy making a mechanical process as described in textbooks hardly realizing that in such
circumstances policy decisions are more about weighing probabilities. This is an area in policy making
where even thinking people do differ in the judgments regarding the course of policy actions. I cannot
claim divine insight. Nor do I think anyone of us here may claim having been gifted with such an
insight. However, it would be surprising if all of us always agreed in the judgments. When everyone
agrees with each other all the time no one is really thinking enough. Criticisms of the Bank of Mauritius
policy stance are profoundly appreciated so long as the criticisms are educated criticisms.
The hazard posed by troubled waters abroad and the third party threat to the competitiveness of our
Export Processing Zone has rendered the conduct of our monetary policy quite a puzzling exercise.
Basically, the conduct of monetary policy in recent years has aimed at bringing down the rate of
inflation. The informal inflation targeting approach of monetary policy making has paid good dividends.
The average inflation rate in the first five years of the 1990s was 6.8 per cent, 6.1 per cent in the
second half of the 1990s and 5.2 per cent in the last five years. For the current year the rate of inflation
is forecast at close to 4 per cent. Clearly, the tendency is for the rate of inflation to either post a further
marginal decline or to stay at the current rate of around 4 per cent. That excessive monetary tightening
could adversely affect growth performance of our economy is a consideration that is well borne in
mind.
The successive cuts in interest rate like in several other countries have induced borrowings but not to
the desired extent. The pace of bank credit expansion is currently subdued. Some corporate bodies
are borrowing in foreign currencies substituting for borrowings in rupees. While the rates of interest on
foreign borrowings are lower compared to the rates of interest charged by local banks, borrowers need
to be mindful of the risks involved. Risks associated with external borrowings could turn out to be high.
With the upside risk of inflation being minimal in the foreseeable and the need for re-aligning interest
rate parity being felt in order to prevent a built up of short-term foreign liabilities, the Bank of Mauritius
effected a further cut in the rate of interest yesterday.
Against a backdrop of four successive years of surpluses recorded in the current account of our
balance of payments and less than buoyant aggregate demand in the economy, the Bank faces a
policy dilemma. The market is flushed with liquidity for quite sometime. Excess supply of foreign
exchange has given rise to a situation of excess rupee liquidity. In the last two years the Bank of
Mauritius purchased foreign currencies on the domestic market for an amount equivalent to over
US$500 million. The rupee counterpart of the purchases amounted to around Rs14 billion that has
ultimately landed in the balance sheet of the Bank of Mauritius as well as in the balance sheet of
Government. The interest burden on this rupee counterpart of the foreign currencies purchased by the
Bank is indeed heavy. To what extent the Bank can keep buying foreign currencies on the market
remains a complex policy question should the considered view that the current exchange rate level
have to be maintained.
Given the volatility of exchange rates on the international foreign exchange markets should we take
the exchange rate of the rupee as a given price to us ignoring all considerations regarding domestic
economic fundamentals? Economics textbooks teach us that in a market economy, the invisible hands
of the market promote economic efficiency. Do we systematically take what the international financial
markets decide as given to us despite the common belief that the invisible hands of the market often
suffer from arthritis? Sometime back a Council member of the European Central Bank likened the
behaviour of currency markets to herds that all ran in the same direction. He had this to say, "I have
met a lot of sheep who know they are running in the wrong direction. But they only want to run in the
opposite direction if they are certain the rest of the herd will follow." The problem is how best the
determination of the exchange rate of the rupee in our foreign exchange market reconciles domestic
economic fundamentals with what the international financial markets dictate to us. The Bank's policy
concern is about the need for stemming excessive foreign exchange inflows while sustaining the
current exchange rate levels. This is a policy dilemma not only specific to Mauritius but also to giant
economies like China and others. The Bank of Mauritius has but only one instrument to strike an
appropriate balance and that is interest rate.
In the last 30 months the Bank of Mauritius reduced interest rate on 9 occasions. The Lombard rate
was reduced step by step from 12.5 per cent to 9.75 per cent. The Prime lending rates of banks fell
from 11 per cent to 8.5 per cent; it will be further reduced as a result of yesterday's cut. However,
borrowers with default risk pay a premium over the Prime lending rates of banks. The higher the
default risk the higher is the premium. Monetary policy has its limits; it cannot influence the premium in
either direction. In this policy scenario savers face the vicissitudes of interest rate not only in Mauritius
but the world over. Our household sector has traditionally placed its savings with banks. Risk averse
investors, particularly those depending on their pensions for a living, have not had the benefit of
riskfree investment avenues. In December 1998 the Bank of Mauritius started with the sale of Treasury
bills over-the-counter to individuals. Over Rs4 billion from more than 11,000 individual investors were
soaked up by the Bank of Mauritius. Evidently the market for Government debt instruments has a
growth potential in Mauritius.
The sale of bills was subsequently suspended in view of our decision to develop a secondary market
for Government debt instruments. There have been many requests from the public to the Bank of
Mauritius for the regular sales of Treasury bills over-the-counter. Though helpful as a rudimentary
method of conducting open market operations in a less developed market, the sale of Treasury bills
over-the-counter by the Bank of Mauritius is not the way forward. We have decided that Treasury bills
and over time other Government debt instruments be traded on the Stock Exchange of Mauritius. Our
Stock Exchange has good operating characteristics for trading in Government papers. We expect the
market to eventually develop into a bond market with an efficient system of good price discovery. The
Bank of Mauritius, the Stock Exchange of Mauritius and Stockbrokers have made united efforts to start
trading sometime in the next few weeks. The Stock Exchange of Mauritius and stockbrokers will come
up with more details this December.
The Bank of Mauritius has a keen interest in the development of the market for Government debt
instruments. Such a market would provide the Bank with a good medium for the conduct of its
monetary policy.
Ladies and gentlemen, my address tonight is based on a decision to make the monetary policy stance
of the Bank of Mauritius increasingly more transparent. It is an adopted practice among central banks
in most countries to move for transparency in the area of monetary policy making. I for one do really
believe in it and will move further in this direction. Before concluding may I say that the Bank of
Mauritius will live up to the challenges of monetary policy in the years ahead. In an uncertain external
environment the Bank has so far charted the best possible course to support non-inflationary growth.
The Bank will pursue the course in the same spirit.
May I on behalf of the Board of Directors of the Bank of Mauritius and on my own behalf wish you and
your family Merry Xmas and a Happy New Year.