R Basant Roi: The monetary policy stance of the Bank of Mauritius
Keynote address by Mr R Basant Roi, Governor of the Bank of Mauritius, at a seminar organised by
the Mauritius Export Processing Zone Association, Pointe aux Piments, Mauritius, 23 April 2003.
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President of MEPZA
Ladies and Gentlemen
I am pleased to be here with you this morning. I am equally pleased to have been given the
opportunity to speak on an aspect of economic policy that has been for one reason or the other the
subject of recurring sound-biting criticisms. Let me at the outset put it clearly that I am not here to reply
to the criticisms that have been leveled against the Bank's policy. Criticisms do provide opportunities
for central bankers to come out and explain their policy stands. Criminologists claim that few acts of
violence are committed after a good meal. This prolongs the lives of speakers. I have had a hearty
breakfast this morning. I do not intend to deliver a long speech on account of my throat. The risk is that
one of you might cut it. Central bankers are accustomed to saying the right thing at the right moment
and to leave unsaid the wrong thing at the most tempting moment.
Central banks, anywhere in the world, are never short of criticisms. The Bank of Mauritius has never
been exempt of vitriolic remarks. Before July 1994 when the Exchange Control Act was suspended
repeated releases of repressed emotions through random shootings of caustic remarks against the
Bank's policies were quite common. In the wake of the liberalization of our financial system the
monetary policy stance of the Bank has received less appreciation than it deserves. While the
objective of the monetary policy of the Bank is well appreciated by some of us it is less so by others
presumably because of considerations driven by self-interest. A short-term view or rather a myopic
view of the Bank's monetary policy stance in a world economy that is highly demanding in terms of
economic and financial efficiency is tantamount to losing sight of the forest because of the trees.
I shall attempt to give a perspective to the monetary policy of the Bank for your benefit. I view this as
being important simply because a full appreciation of the Bank's work and results does require a
perspective beyond a few months or even beyond a single year. A single day, a few months or even a
year is rather a short time to really gauge what monetary policy of the Bank can accomplish on a
lasting basis. Monetary policy takes time to make its beneficial effects felt in any economic society. But
I do also reckon that a few months or even a single month or a single day may sometime appear to be
a long time. Events having undesirable consequences for the economy can take place in minutes.
We live in an economic society wherein the role of money is taken for granted. The basic importance
of money in the economy is unwittingly overlooked. Buyers and sellers, savers and investors and
borrowers and lenders are, as you are aware, linked through money. It goes to say that money which
links them should have our confidence if our economy has to perform well. Money that keeps its value
will have the confidence it deserves. As is usually said among central bankers it is the democratic right
of every citizen to see that the length of a metre or the weight of a kilogramme does not vary over
time. Why then should the value of money change over time? Clearly, the basic objective of monetary
policy of the Bank, which is the sole issuer of currency in the country, should be to preserve the value
of money.
The Bank of Mauritius is the nucleus in the process of money creation in the economy. It is mistakenly
believed that the Bank has the intrinsic power of simultaneously achieving a multiplicity of objectives.
This is a gross misconception. Paradoxically, there is also a common tendency for some in the
exporting community to believe that inflation need not be the prime consideration of the Bank. This is
also an incorrect view of what should be the objective of our monetary policy. Our business community
and the public at large would be badly served if the Bank's monetary policy stance irresponsibly fuels
inflation. Suffice to say that inflation creates uncertainty, breeds inefficiency and makes the economy
less productive. Worst, it creates inequity. Those who gain from inflation necessarily gain at the
expense of others. In fact, the Bank's power to print money is limited by the leverage available to
monetary policy. The Bank uses this leverage to enhance the economic performance of our country. In
simple terms, the Bank manages liquidity in the economy - which in turns affects expenditure - in such
a manner that is consistent with the capacity of the economy to grow but, as far as possible, without
giving rise to inflationary pressures. Monetary policy would not be doing justice to all of us if it
unleashes forces that create inflation.
What is the 'ideal' rate of inflation then? Ours is a small economy and highly open to international
exchange and international economic and financial influences. As such it is quite inflation-prone.
There is no such thing as an 'ideal' rate of inflation. The best policy outcome can only be price stability.
Taking into consideration the character of our economy, an inflation rate of 3 to below 5 per cent
sustained over time is believed to be tolerable. A rate of inflation in this range may be kept in sight as
an anchor for the monetary policy of the Bank of Mauritius. The sustained policy effort in the last few
years underpinned by the absence of a consequential increase in wage bill in the economy helped
bring down the rate of inflation. For the current fiscal year the rate of inflation is expected to be around
5 per cent. Importantly, the pressure behind inflation appears to have lost some of its intensity.
I wish to underscore that the problem of inflation would have been greater today had not the Bank of
Mauritius progressively pursued a restrictive monetary policy stance in response to the intensified
inflationary pressures following the rapid depreciation of the rupee in 1996, 1997 and 1998. Beginning
1999 we pursued a policy of monetary tightening with a view to arresting the rapid depreciation of the
rupee thereby stopping the flight of capital. Had the depreciation of the rupee and the resulting flight of
capital not been arrested the foreign exchange reserves of the Bank would have dwindled to only a
few weeks of imports. Inflation rate would have eventually risen to double digits. Seldom do we realize
that with the least policy mistake in 1999 we would have subsequently knocked at the door of the IMF
for a Stand-by Arrangement. Monetary tightening, that is, the high interest rate policy relentlessly
pursued over time helped stabilize the foreign exchange market and also check monetary expansion
to a rate consistent with the objective of reducing the rate of inflation.
It is therefore a misconstrued view that the Bank of Mauritius is pursuing a high interest rate policy.
This is not how I would like to put it. The Bank is pursuing an inflation fighting policy. All of us know it
well. Savers do demand higher interest rates to protect themselves from higher inflation rates. A
monetary policy stance that eventually brings about sustained low and stable inflation rate creates
conditions for sustained low interest rates. We are all well aware that it is only in those countries that
have a good track record of confidence in their money through policies that generate low and stable
inflation that we find low interest rates. A good track record of low inflation does set the ground for low
interest rates. Low inflation rates precede low interest rates. The converse is invalid.
Lending rates of commercial banks are often said to be on the high side. There is no doubt an element
of truth in this contention. However, it does not necessarily go to say that commercial banks alone are
to be blamed for the high lending rates. Often borrowers too share the blame. You might recall I have
since 1999 pressed upon banks to reduce their non-performing loans to a tolerable level.
Non-performing loans are one of the reasons that explains the tendency to charge high lending rates
to borrowers. In any banking system the 'free lunch' has to be paid by someone. Generally depositors
and honest borrowers are made to pay for the bad and doubtful debts through lower deposit rates and
higher lending rates respectively. I do not see any justification for rogue borrowers to clamour for low
rates of interest. Banks need to make good credit appraisals while making lending decisions failing
which lending rates would continue to be prohibitive even to honest borrowers. The good news is that
banks have seriously undertaken to bring down their non-performing loans to acceptable limits.
Let me now turn to the exchange rate of the rupee. Exchange rate is evidently important. Its
movements and levels have a strong bearing on medium and long-term growth prospects of our
economy. As such the exchange rate of the rupee has a lot to do with monetary policy. Monetary
policy is effective only in a market based financial system. In any capitalist system the financial
markets are the most market-oriented. Undue intervention in such markets over a protracted period of
time will most likely turn out to be counterproductive. In such a framework confidence is fundamentally
an important ingredient that the Bank of Mauritius can provide to financial markets in the formation of
judgements regarding interest rate and exchange rate. It goes without saying that the Bank of
Mauritius should constantly seek to build confidence in the rupee. Confidence in the external value of
the rupee cannot be maintained if confidence in the internal value of the rupee is not maintained. This
is what price stability is basically all about. Let me stress that it does not go to say that we should have
an exchange rate target. As you are well aware, the exchange rate of the rupee reflects international
as well as domestic market conditions. Over the 12-month period ended March 2003, it may be
observed that the US dollar has weakened significantly on international financial markets. The
Japanese yen, Pound Sterling and the Euro have appreciated against the US dollar. The rupee
depreciated on average by 10.2 per cent against the Euro, 6.7 per cent against the Pound sterling and
1.7 per cent against the Japanese yen but appreciated by 0.5 per cent against the US dollar. In
trade-weighted nominal effective terms, the exchange rate of the rupee depreciated by about 8 per
cent. In real effective terms, the rupee recorded a depreciation of about 5 per cent. There is nothing to
suggest that the exchange rate of the rupee is in any way responsible for the erosion of international
competitiveness.
Once again concern has recently been expressed about the appreciation of the rupee vis-à-vis the US
dollar. In pressing their claim for a higher rate of depreciation of the rupee, some have even leaned on
the Turkish case. What is not mentioned, however, is that the double digit rate of depreciation of the
Turkish currency has also been served with a helping of high inflation rate of 27 per cent and high
short-term interest rate of 42 per cent. Let me say once again that this is far from being a Turkish
delight!
It is more appropriate to view exchange rate developments over a period of time. The more we
integrate with international financial markets, the more we have to allow markets work their way
through. The exchange rate of the rupee has recently been likened to price determination in a specific
market. Well, in so far as we are trying to promote a competitive foreign exchange market, the Bank of
Mauritius is quite comfortable with this reference. Indeed, we welcome it because the market under
reference is the only market in Mauritius that is closest to the textbook model of perfect competition.
Currency appreciation or depreciation cannot be a panacea for all our economic ills. We should not
forget that appreciation or depreciation of a currency could be a mixed blessing. In terms of
macroeconomic policies, the authorities usually have to make a policy trade-off between the extent of
exchange rate adjustment and the inflation rate. It must, however, be emphasized that the way forward
for Mauritius is for it to become competitive through the achievement of real productivity gains. A
deliberate policy to depreciate the rupee can only be a temporary solution and not a permanent one. A
lasting solution to long-term competitiveness depends not on exchange rate changes but on
productivity growth. Short-term exchange rate accommodation can only serve to postpone the need to
address the real issues relating to restructuring, good management and productivity improvement. Any
attempt to rescue employment in the Export Processing Zone through the depreciation of the rupee
cannot but be a temporary one.
Finally, let me reassure firms in the Export Processing Zone that the Bank of Mauritius will continue
with the pursuit of a monetary policy stance that does not jeopardize the maintenance of low and
stable inflation keeping in view certain short-term considerations. The monetary scene in Mauritius
today does not at all support the view that the economy is in a state of 'fundamental disequilibrium'.
There is no precise definition of 'fundamental disequilibrium'. The IMF has a working definition to judge
whether or not an economy is in a state of 'fundamental disequilibrium'. Of the six broad criteria that
define the presence of fundamental disequilibria in an economy none of them is palpably present in
the current state of the Mauritian economy. Instead, Mauritius is for the first time in its history recording
four successive years of current account surpluses in its balance of payments. The overall balance of
payments surpluses are significant. The foreign exchange reserves position of the Bank of Mauritius
has attained unprecedented level. Inflationary pressures in the economy are contained. Inflation is on
a declining trend. Although the rupee has in the past months appreciated against the US dollar partly
due to the surpluses generated in the current account of the balance of payments there is no evidence
that the exchange rate is mis-aligned. The Bank of Mauritius is pretty conscious that persistent
appreciation of the rupee over a protracted period of time could potentially lead the economy to a state
of 'fundamental disequilibrium'.
While guided principally by the objective of sustaining low and stable inflation, monetary policy will
continue to strike the desired balance between short-term and long-term considerations in the best
interest of the economy. Once I likened the conduct of monetary policy to drawing a heavy
paperweight with a piece of elastic - either the heavy paperweight does not move or it flies across the
table and hits you in the face. This analogy seems closer to reality than the organized sound-biting
criticisms.
I wish you well.
Thank you.