The Mauritian economy has grown steadily despite weak activity in Europe, its main trading partner. Growth was supported by fiscal stimulus and accommodative monetary policy. The economy is operating slightly below potential, domestic investment has fallen, and the planned medium-term fiscal consolidation has been delayed. Outlook and risks: The economic outlook for 2014 is broadly positive with growth projected at 3¾ percent and inflation at 4½ percent. The main short-term risk would be renewed Euro area financial stress; medium-term risks relate to weak future reform efforts. Fiscal policy: The 2014 fiscal stance is neutral. Staff recommended initiating fiscal adjustment already in 2014 to smooth the planned medium-term adjustment. Staff projects debt to be sustainable, but recommended additional medium-term fiscal adjustment efforts to safely reach the legally-mandated 2018 debt target. Monetary policy: The moderately accommodative monetary policy is appropriate but should be forward looking to anticipate inflationary pressures. Excess liquidity has to be removed to improve the monetary transmission mechanism despite likely, but justified, losses for the Bank of Mauritius. Staff suggested sharing the cost of monetary policy. External sustainability: Standard quantitative measures together with a persistently high current account deficit, weak export performance, and wage growth in excess of productivity suggest a moderate overvaluation. International reserves appear adequate. Long-term growth: Staff suggested fiscal adjustment and structural reforms to reduce external vulnerabilities and improve long-term growth. Reforms to public enterprises, social safety nets, pensions, local governments, and the general business environment could lift longer-term growth rates to reach high income status faster than projected. Financial sector: The financial sector remains well-capitalized and profitable. Stress tests show a broad resilience of the system. BOM started using macro-prudential tools and is improving coordination with the nonbank supervisor.
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