The Minister of Finance, during several interventions in the National Assembly on 14 and 15 May, repeatedly affirmed that the current level of foreign exchange reserves, which stands at around 12 months of 2019 imports, is ample and adequate to meet a balance of payments crisis.

A few examples follow. « Sachez que la Banque de Maurice, possède des réserves équivalentes à plus de 12 mois d’imports, un ratio bien plus élevé que les standards internationaux, plaçant la barre à 6 mois de reserves. »  

Again, « Jamais, dans l’histoire de Maurice, les réserves officielles n’ont atteint un tel niveau de couverture. Ces chiffres, sous la loupe continuelle des instances internationales : FMI, Banque mondiale et bailleurs de fonds pour n’en citer que quelques-unes.»

And in gauging the impact of the Covid-19 crisis on our external payments situation, he observed « l’impact sur la balance des paiements pourrait se traduire par une baisse des réserves d’environ un milliard de dollars, toutes choses égales par ailleurs. Dans cette perspective, cela signifie qu’une couverture équivalente à 11 mois d’importations de biens et de services sera préservée. C’est donc une couverture plus que confortable que nous réussirons à maintenir, bien supérieure aux standards internationaux »

Adequate Reserves

The strong confidence shown by the Minister about the level of our external reserves is at odds with the assessment of the IMF regarding the adequacy of our reserves. A country holds foreign exchange reserves mainly for precautionary purposes against the likelihood of exchange rate pressures, disorderly market conditions and a balance of payments crisis. The IMF has developed a framework, with an ARA metric (see Box), to assess a country’s reserve needs depending on its specific economic characteristics, including its potential risks and vulnerabilities, and sources of external shocks.  

The current level of Mauritius reserves currently amount to only USD 7 bn, compared to its reserves needs, based on the IMF’s ARA metric, of about USD 20 bn. The ratio of reserves to the IMF ARA metric for Mauritius, published by the IMF on its website, is only 37%, compared to the advisable range of 100% to 150%, which indicates a woefully inadequate level of reserves.

The comparative ratio for emerging countries stood at 120% at end 2019. For a significant offshore financial centre like Mauritius, the size of its other liabilities, inclusive of sizeable deposits of GBCs and of non-residents with banks, weighs heavily on its vulnerability.

IMF Policy Advice

The IMF reports on reserve adequacy in its annual country consultations. The 2019 IMF Staff Report for Mauritius provided an adjusted analysis of the reserve adequacy level, and makes clear recommendations on reserve policy. In computing the ARA metric of a desirable level of reserves, the importance of other external liabilities in the balance of payments was reduced by including only GBC deposits with small and medium size banks, net of liquid assets.  

The actual level of reserves thus stood at 120 percent of the adjusted ARA metric at end 2018, which is within the advisable range of 100-150%.  But, if all the external liabilities of the offshore sector were included in the ARA metric to take full account of the liquidity risks associated with the foreign currency funding of banks, the reserves level would be only 29% of the unadjusted ARA metric.

Although the IMF assessed that external reserves were broadly adequate, it recommended that further reserve accumulation was desirable to build stronger buffers against external shocks, in view of the large size of the global business sector.  The widening external balance, and deteriorating external competitiveness from an overvalued exchange rate, were seen as sources of concern.  Further IMF recommendations included the adoption of insurance mechanisms such as swap arrangements or credit lines by the Bank of Mauritius with other central banks to deal with large adverse financial shocks.  

IMF policy advice to build reserves clearly implies that current reserves are lower than the desirable level.  The Mauritian authorities responded, as stated in the IMF Report, that “given the vulnerabilities associated with a large offshore sector, further reserve accumulation may be warranted”.  It is disconcerting therefore, to say the least, that the Minister of Finance should be so categorical in declaring a comfortable level of reserves. Especially as the IMF recommendations were made well before the Covid 19 crisis and the resort to central bank reserves to finance an excessive budget deficit.

Record Reserves

The trumpeting about the record level of our reserves is far from deserved, when it is known that reserve accumulation in Mauritius has largely been driven by the need to hold back the appreciation of the rupee in response to large capital inflows related to offshore business.  The IMF estimated the overvaluation of the real effective exchange rate of the rupee at around 17% in 2018.

A former Governor of the central bank was even pressured by the then Minister of Finance to buy foreign currencies and discontinue a strong rupee policy.  The central bank added to reserves reluctantly, because the costs of sterilization of forex purchases impacted adversely on central bank profits, even leading to losses.  

It is simply astounding that the Minister should include central bank reserves, largely liquid assets, along with commercial bank foreign assets, which mostly comprise cross border lending, adding up to figures that are «extremement rasurrants».  The foreign currency assets held at banks derive mainly from the on-lending of foreign deposits that can be a potential source of crisis, not part of the solution.

External Risks

There is no intention of «semer la panique» or being an «oiseau de mauvaise augure» in highlighting external risks in a small open and vulnerable economy like Mauritius, currently battered by a global pandemic.  A worsening of global financial conditions or of domestic market confidence could disrupt financial flows and aggravate the external imbalance, which is already hit by vanishing exports and tourism revenues.  Spillovers of a possible reversal of capital flows on the banking and financial system could be highly destabilising.

Govt cannot take a laid-back approach on the adequacy of our reserves, in the wake of Covid 19, and following the inclusion of Mauritius on the EU money laundering blacklist.  Similar to the stated hope that the EU blacklisting would not be effective by October 2020, a misplaced confidence in reserves adequacy could have potentially disastrous consequences.  

Reserves declined by USD 0.6 bn in the first quarter of 2020. Foreign exchange is scarce, with with de facto rationing by banks, as the central bank is not intervening sufficiently to relieve forex shortages.  The announced balance of payments deficit of Rs40 bn for 2020 does not yet account for any likely capital outflows.  

The unchecked provision for fiscal deficit financing from the central bank’s internal reserves, followed by the latest announcement of a massive Bank of Mauritius grant to Govt of Rs60 bn, or 12% of 2019 GDP, will shatter public confidence in price and exchange rate stability.  

The EU blacklisting is already leading to negative responses from offshore clients and foreign investors, banks, and regulatory institutions, notably, the Reserve Bank of India, which will undermine the stability of financial flows. Hedgers and speculators are already taking positions to profit from rupee depreciation.

Riskier Reserves

In the context of the current external risks and stresses, it is unthinkable that the central bank should use its foreign reserve assets for development purposes.  Reserve assets are external assets that are readily available and under the control of the central bank for meeting balance of payments needs, for forex market interventions, and for maintaining confidence in the rupee and the economy.

If our reserves were higher than the level required for precautionary purposes, it would not be objectionable to invest part of the non-precautionary reserves in less safe and liquid assets, such as equity or other debt securities.  Many central banks in fact transfer reserves not required for liquidity purposes for investment in riskier assets through longer term sovereign wealth funds (SWF). With equity markets in a tailspin, SWFs are reported to have incurred huge losses. Norway’s sovereign wealth fund, the world’s biggest, faces losses and forced asset sales for the first time to cover crisis fiscal spending by Govt.

The Bank of Mauritius will be funding from its external reserves a local version of a SWF, the Mauritius Investment Corporation, to enhance the financial wealth of current and future generations. It will not produce better results than the State Investment Corporation, and will soon be racing to join the ranks of unproductive and corrupted state-owned companies. Even if the central bank enjoyed plentiful excess reserves, engaging in such publicly-managed riskier investments is a dreadful venture.

Caution Advised

A responsible economic strategy should include a comprehensive assessment of all external risks.  It is hoped that the brash confidence vented by Govt on our reserve adequacy stems more from wishful thinking than a warped perception of reality.  A more cautious risk management in line with the appraisal of international financial institutions is warranted, as much is at stake.

On the whole, Govt has fared relatively well so far in coping with the onset of the Covid 19 health crisis. The risks of a drawn-out pandemic eventually leading to a financial emergency as well are not unreal, and we must strive to be better prepared.  

Sushil Khushiram
 
IMF ARA Metric

A standard measure of a country’s needs for reserves, known as the Assessment of Reserve Adequacy (ARA) metric, is estimated by the IMF, and provides comparability across countries.  

The ARA metric for emerging countries covers four areas of vulnerability in the balance of payments, namely (i) export income to reflect a potential fall in external demand (ii) broad money to reflect the risk of resident capital outflows, (iii) short-term debt to reflect rollover risks, and (iv) other liabilities to reflect the risk of non-resident portfolio equity and debt outflows.  It is expressed as a weighted composite of these four balance of payments aggregates.

The ratio of a country’s reserves to its ARA metric provides a measure of the adequacy of reserves relative to potential forex liquidity needs in adverse circumstances.  If a country is within a 100-150% range, its reserves level is considered adequate.

The ARA metric does not include import coverage. For countries with open capital accounts, the traditional measure of reserves adequacy as a percentage of prospective imports is not directly relevant.  Instead, debt and other external capital flows, which finance the current account deficit and imports, are considered as more important for assessing vulnerability.