Based on server Al online conversations spread between the start of 2023 and the end of April, this interview of the past boss of the central bank addresses without cliché the various issues of our “seriously diseased economy”. “harmful fiscal and monetary policies” in the context of rising inflation, depreciation of the rupee and the backlash of a world economy in crisis…

Your prognoses of the consequences of the loose monetary and fiscal policies since 2019 have been faultless. What’s your take on the state of the economy today?
Multiple organ failures. These are everyday disputatious wrangles on the grapevine. There is, however, no known algorithm that would allow the commons to gauge the severity of the presumed multiple organ failures. The responses of the Government to the strings of blistering allegations that spring up episodically against public sector institutions lack the force of credibility; they are pallid and are far from reassuring. Perceived or real, the sentiments are manifestly revealing.

Clawed into the clutches of the presumed multiple organ failures, resultants of which include an unprecedented exodus of brain power and a disconsolate brawn power eagerly seeking to emigrate, the economy appears to have long reached a menopausal state. Lately, it seems to be morphing into a state never known before.

Do you mean morphing into something better?
An expanding class of middle-class families drifting into poverty day after day betrays the apparent affluence shored up by speculative trading and by what looks like a rapidly grown unexplained black economy. Lost in the mania of easy wealth is the absence of value creation in the economy. Organic growth is conspicuously missing. The perceived exuberance, disconnected from underlying realities, makes it difficult, in particular for those unfamiliar with the sequence of events that lead to crises, to distinguish between a mirage and an oasis. The effervescence in consumer spending inheres some key features characteristic of bubbles elaborately dealt with in economic and financial crises literature.

The South Sea Bubble and many other fraudulent schemes outlined by the economist Charles Kindleberger, an intellectual architect of the Marshall Plan, in his monumental work on Manias, Panics and Crashes: A History of Financial Crises, features swindlers, fraud, corruption, dubious practices, risky loans extended to delinquent borrowers, all oiled by successive rounds of money creation on a large scale. The over-borrowing, the over-spending, the shady characters and the speculative excesses during the phase of euphoria and greed fatally end when money creation eventually comes to a halt.

Are we already in or heading towards some sort of a bubble-like situation? Between December 2018 and December 2022, money supply (broadly defined) has risen by as much as Rs250 billion, even after the Bank of Mauritius (BoM) soaked up more than Rs160 billion by way of selling US dollars. At the margin, every single rupee that leaves the vault of the BoM got multiplied by the banking system into more than Rs17.00.

Isn’t the exuberance supported by the vast amount of money being created also by a prospering unexplained black economy? Would the Government be able to sustain its expenditure levels without having recourse to any form of BoM financing? Would the economy that is already suffering from structural deficiencies be resilient enough to face the music once policy reversal becomes inevitable?

If you were to advise the Minister of Finance, what would you specifically propose to him?
Never try to wake up a person who is pretending to be asleep. It’s a foolish undertaking. I would simply drop a statement made by Bob Dylan paraphrased as follows: a system or country that is not busy being born is busy dying.

Three years ago, following the outbreak of the pandemic, I had suggested what, in the opinion of leading monetary economists are now advocating, would have been reckoned as the first best policy option with the least distortionary effects in the economy. That could have unquestionably saved the BoM balance sheet from gruesome deficiencies, reined in monetary instability, forestalled the simmering balance of payments crisis, safeguarded to a large extent the foreign exchange reserves of the BoM, sustained exchange rate stability, and mitigated inflationary pressures in the economy. Importantly, financial stability, a precondition for price stability, would have been safeguarded. I am absolutely certain that the economy would have been in a far better shape today.

Mired down by flawed arguments about the effectiveness of monetary impulses to stimulate the economy, the Government, disregarding the specificities of the economy, went ahead with a policy of pump-priming on a massive scale. This policy option implied a conscious choice for currency devaluation and inflation. Operation successful, patient dead. Rejecting sound economics and conjuring rococo theoretical justifications for men-in-the-street, the Government sleepwalked into a capital flight nightmare. The dismal outcome of the policy blunders was foreseeable.

How to Pay for the War, a 97-page famous tract by J M Keynes published in 1940, is an immensely useful read for our policy makers who made unforgivable claims that economics does not matter in crisis management. 

But those were exceptional times that needed exceptional measures. Isn’t it?
The art of economics consists in looking not merely at the immediate, but at the longer-term effects of any act or policy; it consists in tracing the policy consequences not merely for one group but for all groups. Of course, exceptional times needed exceptional measures. But exceptional times are not an excuse for harmful policies that are widely known to have dangerously deleterious effects in the economy in the medium and long term.

Exceptional times are also not an excuse for frittering away past gains. It’s disheartening to watch how an unprecedented buffer of BoM foreign exchange reserves, built diligently over more than 20 years, has been fast thinning out. Responsible monetary and fiscal policy-making would have spared society of the anxiety of an uncertain future.

The BoM had US$8.0 billion as forex reserves that represented far more than the conventional benchmark of three months’ worth of imports. Questions were raised as to why they could not be utilised in times of crises?
We’re not designed to know how little we know. Foreign exchange ‘reserves’ of the BoM must not be confused with the word ‘savings’ as is usually understood by the public at large. In some respects, these are different concepts.

The traditional metric for the adequacy of BoM forex reserves you referred to is absolutely irrelevant in the local context. This metric takes only imports into account; it was useful in the days of Exchange Control, when capital mobility was administratively restricted. Over the years, after the suspension of Exchange control and, more importantly, after 2005, when capital flows through our offshore sector accelerated, the domestic financial industry became increasingly more vulnerable to shocks than before. The risk of capital flight became a critically important variable in the metric. The least shock or the sheer suspicion of a possible shock could trigger massive outflows of capital, thus putting tremendous pressures on the foreign exchange reserves of the BoM and on the exchange rate of the rupee as a result. The US$8.0 billion foreign exchange reserves of the BoM in 2018 were thus found to be far from an adequate buffer against unexpected financial shocks in an uncertain world.

Since 2005, with the new BoM Act and the new Banking Act, the adequacy of foreign exchange reserves of the BoM necessitated the inclusion of capital in the new metric. The offshore sector holds billions of dollars as bank balances. A thorough study of the adequacy of the BoM foreign exchange reserves conducted in 2015 had concluded that, given the rapid growth and rising importance of the financial industry in the economy and of its vulnerabilities, a foreign exchange reserves of US$25-30 billion would constitute a safe level of buffer for withstanding shocks and sustaining financial stability as a result. Compared to this new metric, the US$8.0 billion was way below the desired mark. Doesn’t the current state of the domestic forex market and the impotence of the BoM confirm the meritsof the new metric? 

Is a smooth reversal of the harmful policies possible?
The severity of the disturbances on the domestic forex market is obviously a reflection of policy failures. A gradual reversal of the ultraloose monetary and fiscal policies is and should be possible. Smooth reversal? No way. It’s a painful uphill task.

As matters stand, there is no more dissembling policy alternative left in the Government’s policy toolkit to keep postponing corrective measures without further aggravating the already alarming macro-economic imbalances. Worst; growing populism has made it extremely difficult for politicians, present and future, to explain to the embittered public that sometimes painful choices need to be made. The revealed disinclination of the public at large to accept ‘delayed gratification’ is worrisome. Short-term pain for long-term gain is an attitude that does not seem to sit well with people anymore. It requires a clarity of mind, strategic thinking and smart salesmanship of tight policies for restoring macro-economic stability. 

Which specific policies are warranted under present conditions?
We can only speak about policies in a global manner. In the absence of reliable macro-economic aggregates and the lack of transparency in several key areas, it is hazardous to come up with specific policy proposals.

Do you mean to say that the statistics published by the authorities are not reliable for a proper economic diagnosis?
Some of our leading economic indicators suffocate common sense. I have studied price formation in the economy during most of my career and done inflation forecasting on an 18-month rolling basis with a good degree of accuracy.

For instance, let me take the official statistics on inflation rate in recent years. With 2019 as the base period, the rupee depreciated by more than 30 percent by the end of 2022. Over the same period, the domestic price of petroleum products shot up by more than 55 percent. As is widely known, several other inflation-boosting disruptions also occurred during the period. These are highly radioactive materials for high rates of price increases acrossthe-board. Yet, official inflation rate statistics was only 18 percent – unbelievably lower than the rate of depreciation and the rate of increase in prices of petroleum products over the same period. One cannot believe in the laws of gravity and still can see water running uphill. It’s glaringly aberrant.

With inflation grossly understated, many of the macro-economic aggregates cannot speak the truths about the trends in the real sector of the economy, however hard they are massaged and tortured. The chips do not fall in places where they should in the complex matrix of monetary and economic aggregates. The trails do not fit the maps. Anyone who is familiar with the techniques of national accounting aggregates will, I am sure, find even the growth statistics grossly overstated as a result.

The exchange rate of the rupee is a topical issue these days. How do you view the recent evolution of this rate?
Exchange rate instability is baked into the policymaking system of the country since 2019. The policy makers make the system, fulfil the system, and are the system. No wonder they have been skating on thin ice.

It is widely understood that the exchange rate ball game is played to raise Government revenue. The forex market is pretty well aware of who in the system calls the tune. Forex markets do not trust politicians, more so during turbulence. Independent central bankers are more trusted than politicians. The exchange rate of the rupee is therefore bound to be a one-way bet. Besides, a market that catches on to the impotence of central-bank interventions can go into free fall.

Neither the market nor the BoM is happy about the current forex market conditions. How best could this pre-occupying issue be resolved?
The seeds of forex market instability were planted by none other than the BoM itself. As such, the dice is loaded against the rupee.

The root cause of the disorderly forex market conditions is a crisis of confidence in the policymaking authorities. The amendments of the BoM Act in 2019 are the source of lasting monetary instability. Those amendments made before and after the 2020 pandemic do not have a sunset clause. Players in the domestic forex market construe the amendments as a BoM window perpetually opens for the Government to have free access to inflationary financing of its spending. This necessarily implies continuing pressures on the exchange rate of the rupee. Post-2019, rupee liquidity ‘flashed-in’ in the system and forex ‘flushed-out’ of the system continually. Of course, the money and forex markets should go berserk.

As long as the authorities fail to inspire confidence in their policies, they cannot expect the forex market to move in step with their drum beats. The BoM alone cannot resolve the problem. The Bank has regretfully allowed itself to be perceived as a mere signboard; it’s outflanked by the Ministry of Finance and confined to irrelevance. In these conditions, I wonder if even the best combination of an educated ‘mind-set’ and a sanitised ‘mouthset’ would succeed in restoring confidence in the policy makers.

What specifically would you recommend to restore stable forex market conditions?
In his book, The Design of Everyday Things, D. Norman describes what someone does when his car key doesn’t work. First, he tries the key as is done normally; it does not work. He tries holding the key at different angles; it does not work. He tries the key upside down; it does not work. He tries with another key; it does not work. He pulls and shakes the door handle vigorously. No chance. He goes around the car and tries the key to the other door. Still, it does not work… Finally, he realises that he has been trying the key on the wrong car. Similar mistakes have to be avoided by regulators and monetary policy makers when forex markets go berserk.

Whoever is overseeing the domestic forex market should stop fooling oneself with Polish blanket tricks where, to make his/her blanket longer, he/she cuts twelve inches off the top and sews it onto the bottom. What is called for here is not simply a change in attitude. A sea change in the nature of politics is imperatively needed. Capital is ‘cryptic’. Capital is a perpetually ‘frightened animal’. As matters stand, capital flight will remain a serious cause for policy concerns.

Banks are said to be holding on to their forex balances and are unwilling to sell on the forex market. How do you view this problematic situation?
Policies have gone blatantly wrong. One wrongdoing has fed into a cycle of wrongdoings. The nervousness of the local forex market is not like you are walking down the street and pregnancy strikes you mysteriously; it’s, of course, the consequence of a conscious decision. In the present scenario, the BoM is caught with its pants down.

Governments have the power of compulsion; the treasurers of banks wield market power. In a clash between the two powers, market power almost always wins in free societies. Arm-twisting is not a principled central banking policy. The treasurers are at a vantage point to undo the arm-twister.

The core issues hounding the forex market are not ‘market failures’ that call for regulatory actions; they actually are abominable ‘policy failures’ that call for remedial actions. Indisputably, the overall macro-economic policy game is corrupted. The onus for remedial actions is on policy makers, not on the banks.

Viewed from the standpoint of expectation (a topic richly dealt with in stock-market crashes and forex market crises literature), it’s rational behaviour for any forex holder to hold on to his/her forex balances. Central bankers always have to bear in mind that banks are, by definition, the riskiest enterprises on the planet; they have to protect their balance sheets at all times. Banks and export enterprises are not charitable undertakings; they are not schools of social ethics and have no political responsibility. Political responsibility rests with the policy-making authorities, not with banks.

''Governments have the power of compulsion… treasurers (of banks) wield market power.”

The depreciation of the rupee is hurting…
Of course, it hurts. It’s insufferable. Once the depreciation of the rupee rears its ugly head, the theft is immediate. Every Government that gives generously also takes compulsorily – and often it takes more than it gives. Governments get ‘bigger’ only if you get ‘smaller’. People, educated ones included, refuse to learn the simple lesson that they cannot keep getting something for nothing. Late Milton Friedman said it expressively, “There is no such thing as a free lunch.” Someone in the system has got to pay for lunch. When exposed to the overriding irrationality baked into human nature, the enticing myth that man is primarily led by reason falls gracefully. The ultimate price for the folly is the corrosion of the economy.

''In a clash between the two powers, market power almost always wins in free societies…”

When a currency is devalued, not because its sustained overvaluation was hurting the economy but because the Government felt the need to fatten the Special Reserve Fund in the central bank balance sheet for purposes of raising revenue, one should know that the society is in for deep troubles. An unforgettable one-liner by John Maynard Keynes (and by Vladimir Lenin also) goes as follows: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.” Devaluation of the rupee used to be abhorred. Now, it’s a recurring feature; it’s legal tender.

Consequently, inflation will remain a concern for consumers and a pre-occupying policy concern for the authorities if existing policies are stayed. Price stability does not seem to be one of the top-of-mind issues for the authorities.

In 2015, you did devalue the rupee. Isn’t it?
Absolutely true. I did. That was a one-off policy decision to adjust and realign a rupee that had stayed overvalued for quite some time. Due to market imperfections, currencies do go off the track; they are brought back on rail through central bank interventions on the market. The realignment was, of course, not driven by the need to inflate the Special Reserve Fund of the BoM. Let me reiterate a view that I have expressed in the past. Any currency should at all times reflect its true value. The views that the rupee should be strong or weak are basically flawed. In the long run, either of them, if sustained over a protracted period of time, is damaging to the economy. In free markets, it’s essentially what a country produces and exports that determines the lasting strength of the rupee.

''Every government that gives generously, also takes compulsorily… and often it takes more than it gives.”

The high rate of inflation is taking a heavy toll on household budgets. Do you think inflation-targeting by the BoM would help bring down the rate?
Late Milton Friedman had coined a memorable statement: “Inflation is taxation without legislation.” It’s the cruellest of all taxes. It’s a hidden tax and harms the poor the most.

Soon after Mauritius acquired the status of full capital convertibility in 1994, the BoM had adopted a monetary policy framework for achieving low and stable inflation rate (see the abridged version of a comprehensive paper on Monetary Policy Making in Mauritiusthat I had the privilege of co-authoring with late Prof Maxwell Fry, published sometime in 1994 or thereabout in a Quarterly Review of the BoM. Publication of the full version was disallowed by the BoM). The framework incorporated a basic model aimed at achieving a specified rate of inflation within a rolling time frame of 18 months. In the pursuit of its objective, the BoM initiated and maintained a fairly tight monetary policy stance for years. The regime is still referred to as ‘inflation targeting lite’.

Why was it called “inflation targeting lite”?
It’s a framework (intended to be refined over time) that lacks the rigours of a robust regime for achieving price stability sustained over time. A few key pre-conditions falling outside the authority of the BoM were not met. They were and still are about fiscal dominance and the political commitment of Governments to a belief in macro-economic stability. The political anchors and fiscal anchors have been missing. The scope of our conversation does not allow me to go into the details of the relevance of exchange rate stability and the importance of some amendments in BoM Act 2004 in the construct of a strengthened regime.

What then were the necessary conditions and why were they not met?
A robust inflation targeting regime in the local context imperatively requires that BoM advances to the Government and to any other financial institutions are limited to the bare minimum. As lender of last resort, the BoM would lend to banks only under exceptional circumstances.

Interestingly, as far back as when the BoM was established in 1967, given the specificities of the Mauritian economy, economists from the Bank of England had advocated that BoM advances to the Government, being inherently inflationary, should be strictly limited and at no time be allowed to exceed a fixed percentage of the tax revenue of the Government. This limit on the advances was introduced in the then BoM Ordinance and later in the BoM Act 1971. Seen from the angle of non-inflationary financing by the BoM of Government spending, this condition had imposed some sense of fiscal discipline on the Government.

Many years later, this clause was scrapped. The floodgate of inflationary financing by the BoM for Government as well as private sector activities was opened wide, and made legal recently. Lawfully, the BoM became a pyromaniac-cum-firefighter.

Any other pre-conditions?
At some stage, there used to be an understanding among policy makers at the Ministry of Finance that Government indebtedness should never exceed the conventional limit of 50 percent of the GDP. This legally non-binding principle was dutifully respected until it was eventually formalised. As is known today, the debt ceiling also has been scrapped, and fiscal discipline, an essential condition for a robust inflation targeting regime, has been done away with. Fiscal rectitude is no longer viewed as a politically winning ball game.

Does it go to say that we cannot expect much from the current inflation targeting lite?
Both the BoM and fiscal policy makers in the country have to understand and appreciate the complexities of the monetary and fiscal policy nexus. The success of an inflation targeting regime does not depend exclusively on the BoM. By this, I mean to say that anti-inflationary policies of the BoM have all the time been negated by inflationary financing of Government spending. Obviously, regular collisions between monetary policy and fiscal policy do not help contain inflationary pressures. Fiscal discipline is indeed a necessary condition for the success of an inflation targeting regime in a small open and trade-dependent economy like ours.

We have a big and expanding Government. Big Government means big Government spending. A small percentage increase in Government spending has quite an impact on aggregate demand and prices in the economy. Big Government spending, financed by overborrowing from external sources and/or from the BoM, has always been a troublesome destabilizer of the economy. The Government’s commitment to lasting macro-economic stability is an essential political anchor for price stability. Unfortunately, monetary policy objectives are not given due consideration and respect by our fiscal policy makers.

What, in your view, is in the store for our economic prospects?
We are past the tipping point since long. The economy is in a menopausal state at the trough of a cycle. With civility torn asunder, institutions having been usurped, traditional values upended, and society deconstructed; we should not be surprised that the boat we are sailing in is drifting like flotsam and jetsam in an ocean. Monkeys also fall from trees.

The overcast on the economy is disquieting. A seriously impaired central bank balance sheet, a strained fiscal balance sheet further strained with debt overload, along with an overall balance of payments deficit aggravated by capital flights, are upsetting. These are not trivial issues; they are symptomatic of a seriously diseased economy. The era of wishful thinking is over. Those who come to grips with the underlying economic realities now will look a lot less foolish in the future. Right policies, if willed by the authorities, should unravel the way out of our collective predicaments.