IMF Executive Board Concludes 2017 Article IV Consultation with Mauritius

On November 21, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mauritius, and considered and endorsed the staff appraisal without a meeting.

Mauritius is seeking to become a high-income economy within the next 10 years. In the past 30 years, political stability, a sound macroeconomic environment and a strong track record of implementing economic reforms allowed Mauritius to successfully transform itself from a monocrop economy into a diversified services-based middle income country with low levels of poverty. To achieve advanced economy status, the government intends to pursue an ambitious growth strategy anchored on significant public investments in infrastructure and improvements in the business environment.

Growth in 2017 is projected at 3.9 percent in 2017, and about 4.0 percent over the medium term. International reserve buffers have improved substantially. The authorities have taken steps to mitigate financial stability risks and are well-advanced in modernizing financial sector regulation. However, the vibrant Global Business Sector faces pressure from international anti-tax avoidance initiatives. Fiscal space is limited, fiscal risks are increasing, and there are signs of building inflationary pressures.

Executive Board Assessment

In concluding the 2017 Article IV Consultation with Mauritius, Executive Directors endorsed staff’s appraisal as follows:

The macroeconomic outlook is broadly positive, but vulnerabilities are emerging. Economic activity is expected to remain robust, driven by the government’s ambitious Public Investment Program, and supported by continued dynamism in the tourism sector and financial intermediation activities. While headline inflation is expected to recede in the second half of 2017, it is likely to finish the year around 4.0 percent under current policies. The main sources of risks to the outlook include further slowing of manufacturing exports and the pace of implementation of the PIP.

The macroeconomic policy stance needs to be recalibrated to address the growing imbalances. Evidence is mounting that the business cycle has shifted phase: the output gap is closing, core inflation is increasing, and demand for credit is rising. Accommodative fiscal and monetary policies have contributed to a weakening external position and the overvaluation of the real exchange rate has increased. A countercyclical policy mix is required to safeguard external stability.

Further revenue mobilization efforts to build fiscal space, support the fiscal anchor and preserve debt sustainability are required. While staff supports the revised debt anchor, indications are that under current policies, the debt target would be missed. A tighter fiscal stance would then be required for Mauritius to meet its goals of improving infrastructure, and promoting inclusive growth while preserving debt sustainability. Higher tax efficiency could yield additional revenues of about 0.8 percent of GDP. Continued improvements in public investment management, and identifying pressure points in debt management should also be elements of the fiscal strategy. Moreover, a tighter fiscal policy would contribute to safeguard external stability, and curb real appreciation pressures.

A tightening of monetary policy is warranted to address growing underlying inflationary pressures. While current inflation trends may partly be reflective of a changing seasonal pattern, the expected increase in international oil and controlled prices and the anticipated introduction of the minimum wage policy by the Ministry of Labor in 2018 are likely to have second round effects, and increase inflation expectations. A tighter monetary policy stance should be implemented by mopping-up excess liquidity in sufficient quantities so as to bring interbank rates in line with the policy rate and regain control of money market conditions.

Clarifying the monetary policy framework will help increase policy coherence. While the primary objective of the central bank is to maintain price stability and promote “orderly and balanced” economic development, there appears to be no consensus on the definition of price stability and on the role of the nominal exchange rate in the conduct of monetary policy. The perceived multiplicity of objectives risks overburdening monetary policy, can result in policy inconsistencies, and potentially undermines the credibility of the BOM’s capacity to anchor inflation expectations.

Announcing a medium-term inflation objective will prove instrumental in the implementation of a new policy framework. An inflation objective of about 3 percent could serve as the foundation for the BOM’s policy actions and communication. More fundamentally, setting price stability as the overriding policy objective in the medium-term will allow the BOM to better navigate the inevitable policy trade-offs that are set to arise. Strengthening the operational independence of the central bank will improve its capacity to deliver on the price stability mandate; while allowing more flexibility of the exchange rate will help address the emerging inflationary pressures and improve resilience to shocks.

Staff welcomes the substantial improvement in international reserve buffers, in line with past Fund advice. As reserve buffers now stand inside the optimal range of international reserves, the FX intervention policy should be geared towards maintaining reserve coverage at least at 100 percent of the adequacy metric, opportunistically building reserves and curbing excess volatility.

The authorities are well-advanced in modernizing financial sector regulation and should now address salient banking sector issues. Having implemented many recommendations of the 2015 FSAP, the authorities should take additional steps to shore up financial stability. These include lowering the still-high stock of NPLs through a more stringent approach to writing-off legacy exposures, and safeguarding the longer-term FX funding needs stemming from banks’ swift expansion abroad. In addition, a formal macroprudential body could be established.

Efforts to address the concerns raised by the OECD and the EU about the tax regime should be prioritized. The GBC sector, to which banks remain highly exposed, will need to adjust its business model as Mauritius transitions to a jurisdiction of higher value-added, and ensure compliance with FATF standards, particularly on AML/CFT supervision and entity transparency. A significant decline of GBC activity could pose risks to external and financial stability if not properly managed.

Further reforms are necessary to meet emerging cost competitiveness challenges. While recent reform efforts will likely bolster Mauritius’ position in the Doing Business rankings, broader structural reforms in areas such as the labor market, higher education, innovation, governance and anti-corruption (e.g. effective use of AML tools and strengthened asset declaration system) policies will be key drivers of Mauritius’ economic transformation going forward. Simplifying the wage-setting mechanism will improve competitiveness, while strengthening current efforts to boost the labor supply of youth and women will contribute towards closing gender gaps and reduce inequality.

Attaining the next level of economic development will require Mauritius to overcome the variety of policy challenges outlined above. A bold, coordinated, strategic vision, guided by strong and independent institutions, is necessary to guide the economic transition. Early signs are promising, with both the pending formation of the National Economic Development Board and the drafting of the Financial Services Sector Blueprint, important welcome steps towards harmonizing the policy direction and implementation across sectors. Considering Mauritius’ track record of reinventing its economic model, there are grounds for optimism that the country will successfully manage the reform process.

Staff encourages the authorities to phase-out the Exchange Rate Support Scheme (ERSS), and to expedite work on other measures to support the export-oriented sector. In staff’s view, there are less distortionary avenues to support the export-oriented sector, and removing the structural bottlenecks that hinder competitiveness should be the focus of work currently underway to address the sector’s problems. Staff recommends approval for the temporary retention of the Multiple Currency Practice (MCP), on the basis that the ERSS is temporary, does not materially impede the member’s balance of payments adjustment, does not harm the interests of other members, and does not discriminate among members.

[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
[2] The Executive Board takes decision under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.