Rundheersing Bheenick: Local currency bond trading and risk
management
Opening address by Mr Rundheersing Bheenick, Governor of the Bank of Mauritius, at the
Workshop on Local Currency Bond Trading and Risk Management, organized by the
Financial Markets Association of Mauritius, Balaclava, 24 March 2008.
* * *
It is a great pleasure for me to address you this morning at the opening of this Workshop. I
consider the theme which you have chosen "Local Currency Bond Trading and Risk
Management" quite topical at this juncture of the development of our domestic financial
market. I salute the initiative of the Financial Markets Association and I would also like to add
my own welcome to our resource person, Dr Graeme West.
I understand that this is the third workshop organized by the Association after those held in
2003 and 2006 which focused on Treasury and Risk Management, and Derivatives,
respectively. Do I detect a slight increase in frequency here? Does this reflect the quickening
pace at which things are happening in the financial sector these days? Be that as it may,
such workshops help to enhance the skills of participants and enable them to keep up with
the continuous innovations that characterize the changing financial landscape.
Skilled professionals and technicians are at the root of all innovations. A well-functioning
bond market will help to create more growth and stability, not only in Mauritius, but also in the
region.
As we all know, a deep and liquid bond market is a key component of a thriving financial
centre. An efficient and mature bond market contributes directly to macroeconomic and
financial stability. It constitutes an alternative source of funding which can help the corporate
sector to reduce over-reliance on short-term foreign currency loans. Currently, in the
absence of a properly functioning local bond market, issuers who qualify for bond financing
must have recourse to international financial markets to finance their local projects and have
to bear the attendant exchange rate risk. Local currency bonds can thus help to protect such
issuers from foreign currency shocks. The improved financial intermediation resulting from an
active bond market also brings such microeconomic benefits as efficiency gains and
diversification of tools for both borrowers and savers.
Let me reaffirm that, as a trusted partner in economic development, the Bank of Mauritius is
committed to promoting the development and efficiency of all markets, whether the foreign
exchange market or the domestic money market and we keep a watchful eye on the stock
market and other asset markets.
We see a need to add greater depth to the market. Central banks and governments share
the responsibility to facilitate and promote the development of local bond markets, remove
market friction and unnecessary restrictions, and provide an environment that is conducive to
both supply and demand, that is to both the issuers and investors. Bond market development
has been targeted by the central bank over the past years through various initiatives. This
included the establishment of an appropriate market infrastructure that facilitates
costeffective and secure trading, and a transparent price discovery process. With regard to
secondary market development, you all know that we set a Secondary Market Cell within the
Bank in 1994. We established a Primary Dealer System in 2002. Treasury Bills have been
listed on the Stock Exchange of Mauritius since 2003. We have re-introduced sales of
Treasury Bills and Treasury Notes at the counters of the Bank of Mauritius last July.
The deepening of local currency bond market across a range of maturities will encourage
increased participation by institutional investors. We have started issuing medium - to long -
term bonds on a more regular basis to develop a benchmark yield curve for Government
securities across the whole spectrum. This will facilitate the development of a corporate bond
market. In 2007, the European Investment Bank, with the State Bank of Mauritius and West
LB from South Africa as lead managers issued Synthetic Mauritian Rupee debt in the
international market. We are now considering a proposal from the World Bank for the
Government to allow them to issue Mauritian rupee denominated or linked bonds
In the end, however, there is only so much that the authorities can - or should - do. Whilst
these initiatives add up to the necessary conditions for market development, they are unlikely
to prove sufficient on their own. However good the infrastructure may be, it is for the players
themselves, that is the issuers, investors and the financial intermediaries to eventually
determine the shape and size of the market. It is also of paramount importance that market
players adopt a participative approach for the development of the money market, as the
existence of trading limits are impeding the development of these markets.
Allow me now to dwell a little on the challenges that a small country like Mauritius is currently
facing in the conduct of monetary policy. Today, the Bank of Mauritius finds itself confronted
with the important challenge of reducing the rate of inflation, which stood at 9.0 percent at the
end of February 2008, and preserving the competitiveness of the export-oriented sectors.
And we must meet this challenge against a backdrop of unprecedented capital inflows which
are driving up the exchange rate of the rupee.
With globalization, a small open economy receiving such large capital inflows faces the
daunting task of managing these external flows to ensure macroeconomic and financial
stability. Interventions by the central bank to purchase large amounts of foreign exchange
from the market have an expansionary impact on the domestic money supply and pose
severe challenges for the conduct of monetary policy.
Since mid-December 2007 the Bank has purchased a total amount equivalent to US Dollars
193 million from the domestic foreign exchange market. To sterilize the excess liquidity
stemming from these capital inflows, the Bank has to issue central bank paper as we now
have a separation of debt management from monetary management. This entails the issue
of a huge amount of Bank of Mauritius Bills for monetary policy purposes, which has a
potentially adverse impact on the central bank's balance sheet. The Central bank, as
regulator, has a different role and a slightly different perspective compared to commercial
banks, Our mandate is price stability, financial stability and the promotion of economic
development. In the pursuit of these objectives, profitability becomes a secondary issue and
at times like the present, we have to dip into our reserves to meet the costs. When balance
sheet considerations conflict with other public interest, there is no doubt in my mind which
way the Central Bank should lean.
We must explicitly recognize that there are costs for the central bank in running monetary
policy. That is why the central bank is required to strengthen its balance sheet in order to
manage the shocks impacting on the economy. The central bank's capital and reserves have
to be strong enough to be able to sustain repeated intervention in the money market. Given
the uncertainty surrounding the nature of capital inflows, it would also be prudent for the
central bank in a small open economy to build up reserves as a cushion against a possible
reversal of capital flows.
Presently, we have Treasury and Bank of Mauritius Bills with maturities of 91 days up to 364
days. Treasury notes with maturities of 2, 3 and 4 years and bonds with maturities ranging
from 5 years to 29 years are issued on a regular basis. Lately we have introduced a 14 day
Special Deposit facility. We feel that there is a gap between the 14 day Special Deposit
Facility and the 91 day bill and in order to close the gap and manage the persistent excess
liquidity in the system, the Bank is contemplating the issue of Central Bank papers with
maturities of 1 and 2 months.
Let me say a word about exchange rate, a subject of much interest right now. As a matter of
policy, the Bank allows the free play of market forces to determine the exchange value of the
rupee. Our intervention in the domestic foreign exchange market is not aimed at offsetting
market forces, or at targeting any specific exchange rate. Our only objective is to smooth out
unwarranted volatility in the rupee exchange rate and improve the functioning of the market.
In a brief interview that I gave to the "Business Standard" newspaper in India last week, I
said that even if our economy was suffering from a deluge of foreign exchange inflows, most
of the foreign exchange operations were confined to the spot market. This is why we want to
encourage the development of a vibrant futures and forward market that will help in creating
an active foreign exchange market and introduce newer instruments for exporters and
entrepreneurs to hedge and trade in the financial services sector.
As regards the issue of risk management, it is a correct practice these days to use
derivatives to hedge against unwanted volatilities. Derivatives can bring substantial benefits
to the commercial community, in facilitating hedging and business planning. Such
instruments enable financial institutions to offer a progressively wider range of services and
achieve greater efficiency in the intermediation process.
Unfortunately, this is one area where Mauritius is lagging behind. The market for derivatives
has not picked up significantly compared to other emerging market economies. I strongly
believe that the domestic financial market is mature enough to engage in derivatives trading
under proper regulation. The Bank is now considering the necessary measures that need to
be implemented to stimulate the development of this market. I know that. In many quarters,
derivatives have a murky reputation. We do not believe that derivatives necessarily lead to
market manipulation, which would be bad for a small market like ours. Rather, we see
derivatives as enhancing the efficiency of financial markets and this is why we are
determined to put in place in the near future the necessary building blocks for its rapid
development.
We are conscious that derivatives involve multiple extra policy responsibilities for the Bank.
Derivatives and derivatives-trading have the potential to bring disaster if not properly
supervised. Therefore one of the areas that the Bank will concentrate upon therefore is to
ensure that risks are properly identified, and managed, and that downside risks which might
threaten systemic stability are avoided.
As we move into these new pastures designed to deepen the financial market and broaden
the range of financial products and instruments, we feel that it is also the right time to
encourage Rating Agencies to start operations in Mauritius. In any case this move will also
be beneficial to the sector as we move on to implementation of Basle II. The Bank has
already stated its intention to sell data held by the Mauritius Credit Information Bureau to
accredited Rating Agencies. All these concerted initiatives will certainly take us in the
direction of developing the local bond market.
We also welcome the recent initiative taken by the Mauritius Bankers Association to
kickstart discussions relating to the netting of financial contracts and applicable law of securities,
based on the Model developed by the International Swaps and Derivatives Association
(ISDA).We hope to move rapidly in this direction at the level of the legislative support
required.
The Bank is once again pleased to associate itself with events such as the present one. My
predecessor, Governor Basant Roi initiated this arrangement with your Association and I am
happy to follow. We believe that it is part of our role to develop the skills of our treasurers
and we try to achieve this through our participation in events such as this one.
Finally, I would like once again to commend this initiative of the Financial Markets
Association to organize this workshop and I am sure that participants will make the most of it.
I now have the pleasure to declare this Workshop open. I hope you will find it instructive and
rewarding.
Thank you.