Hon. Prime Minister.

I gave an interview from afar to this leading morning newspaper a few days ago. In the interview, I extricated myself from the politics of the day and endeavoured to clarify the precise proposal made in your 2019- 2020 Budget Speech with regard to the early repayment of part of the outstanding public sector external debt drawing from the Special Reserve Fund of the BoM. This letter is in response to numerous approval messages I received from informed professionals in Mauritius, Washington DC and London who now have a better grasp of the proposed appropriation of the ‘notional’ money out of the balance sheet of the BoM. They now share my grave concerns regarding this proposal.

Being one of the few persons who are not only familiar with the nitty-gritty details of BoM operations but also with the economic consequences of every rupee that leaves the vault of the BoM for circulation in the domestic monetary circuit, I felt very strongly that I should enlighten the political class and the public at large as it is not given to everyone outside the BoM Tower, and, to some extent, even within Tower, to understand the issues at stake. I would have seen myself as a person devoid of any sense of belonging to and feeling for the country, had I let the proposal gone misunderstood by many of us.

As I have always said, the distinction between the humility of central bankers made with the right timber and the arrogance of central banking is blurred; it is more blurred when disagreements over policy formulation reach the boiling point. I do not claim excellence. Nor do I claim to be gifted with an infallible oracular capacity to see clearly into the future. Far from it. But, as a well-meaning citizen I laid down my arguments as forcefully as I could in the interview.

Hon. Prime Minister, I earnestly request you to reconsider the proposal as it is certainly not in the best medium and long term interests of our financial industry and the economy as a whole. Indeed, the public sector is carrying a staggering level of debt – a Gordian knot that could be cut by a sound policy package and not by decisions that are very likely to corrupt policy making right now and in the future and thus leading to a debauchery of our national currency. I recall the then Minister of Finance, Hon. Vishnu Seetanah Lutchmeenaraidoo, having given commitment in April 2015 to Mrs. Christine Lagarde, Managing Director of the IMF, that he would bring down the debt to GDP ratio to below 60 percent by the end of 2019. I also vividly recall having advised you to effect an early repayment of a part of the external debt which you did announce in your first Budget Speech. The decision was duly executed out of the normal revenue raising process despite a palpable reluctance expressed by a limited few at the Ministry of Finance. Credit goes to you, Hon. Prime Minister.

I have had the experience of being Governor of the BoM while you were Minister of Finance and subsequently Prime Minister of the Republic and Minister of Finance as well. I am more than inclined to believe that you may not have not been fully briefed about the dangers posed in the Budget proposal. I am afraid, you seem to have been sorely misled. Our small export-oriented economy is finding itself in the grip of a death wish. Policy makers are imperatively required to carefully weigh in the medium and long term political, societal, economic and financial implications of the proposal.

I, therefore, wish to highlight the following points and issues regarding the proposal in a much simpler style for your appreciation:

The foreign exchange reserves of the BoM and the Special Reserve Fund (SRF) are two very different animals in the balance sheet of the BoM. The Budget Speech refers to the SRF; it is completely silent on the forex reserves of the BoM. Any debate about the forex reserves of the BoM is absolutely irrelevant. It is pointless and falls far and away from the central issue at stake.

“Hon. Prime Minister, I earnestly request you to reconsider the proposal as it is certainly not in the best medium and long term interests of the economy as a whole.”

Going by the statement made in the Budget Speech, the debate must be centered specifically on the appropriation of the rupee- denominated ‘notional’ money in the SRF of the BoM balance sheet. It is clearly proposed to appropriate the ‘notional’ money by the Government.

It’s not a borrowing by the Government and as such the question of interest rate does not arise. It is ‘notional money’ converted into freshly printed money drawn out of the balance sheet of the BoM without the application of an interest rate and promise of repayment. As of what economic rationale would the BoM convert the ‘notional money’ into printed money? When situations warrant it, the BoM may create money but only by making advances to the Government and banks but at a price and with obligations for repayment. It would be beneficial to know what would be, from the standpoint of monetary management and monetary policy, the BoM Board of Directors’ and the MPC members’ justification for the conversion of the ‘notional money” into freshly printed money even if the BoM Act is amended.

Do the Board of Directors and the MPC have to stick to the amended law if, in so doing, it aggravates existing difficulties in monetary policy formulation and weighs on other mandated obligations of the BoM? Are they bound to adhere to a bad piece of legislation that is very harmful to economic and financial stability and ultimately to the wellbeing of the society as a whole? After all, the BoM Act stipulates that the BoM is responsible for financial stability. An amendment of the BoM Act in the proposed direction would find itself on a collision course with the provision in the Act that entrusts the Bank with the responsibility of financial stability. None of any step taken by the BoM should recklessly undermine its own goal of maintaining financial stability. An amendment of the BoM Act must not go against the grain of other provisions of the Act.

The magnitude of the ‘notional’ money varies with the movement in the exchange rate of the rupee. If the rupee depreciates, the rupee value of the forex reserves which appears on the asset side of the BoM balance sheet goes up. This includes the change in valuation. But the change in valuation appears on the liabilities side of the BoM balance sheet. This is one of the reasons why we always refer to the ‘foreign exchange reserves of the BoM’ as ‘Gross forex reserves of the BoM’ (see the table of forex reserves of the BoM Monthly Bulletin). The title in the column is ‘Gross International Reserves’. It’s not a net figure. The ‘accumulated valuation changes’ in the BoM balance sheet has a very conceptual significance, much different in character from the valuation figures of land, buildings, etc. in the balance sheets for other enterprises and institutions.

A rogue central bank can keep on increasing the value of its forex reserves in terms of local currency by depreciating the rupee thus giving the misleading impression that forex reserves are rising. Deducting the valuation change due to the depreciation from the figure of gross forex reserves would give the true picture of forex reserves position of the central bank. Conversely, if the local currency appreciates, the value of the central bank’s external reserves would decline. Accordingly, valuation changes would contract.

In the Asset and Liabilities statement of the Bank, the size of the ‘Valuation Changes’ accumulated over the years moves up and down on a daily basis depending on the direction and amplitude of the fluctuations in the exchange rate of the rupee.

It is a standard central banking practice to leave this ‘notional’ money on the liabilities of the BoM balance sheet untouched for purposes of the Government budget. It is not meant for use as Government revenue. Why?

First, it is a ‘theoretical’ or ‘notional money’. It is not the profit of the central bank as is ordinarily defined. It is tantamount to having recourse to the banknote printing press for the financing of Government spending. Second, instead of raising money by other means to meet expenditure, politicians, guided by short-term political considerations, do usually acquire the bad habit of opting for an easy way out which, definitely, is grossly out of line with prudent macro-economic management. The use of this ‘notional’ money for any budgetary purpose necessarily means inflationary financing of the Government expenditure. This is the worst of all the means of deficit financing.

These are the main reasons why many central bank legislations have a clause that prohibits central banks from lending to Government. In countries where central banks are de facto independent, this clause is much stronger. Central bank independence is less meaningful in countries that do not have a supporting Fiscal Responsibility Act. Fiscal irresponsibility and central bank independence do not make good friends.

Monetary policy has primarily one objective: to achieve a low and stable inflation rate and maintain price stability. Fiscal policy has many objectives: promote economic growth, achieve and sustain economic stability and achieve equity, that is, fair income distribution. Every rupee that leaves the central bank has more than one rupee impact (depending on the magnitude of the money multiplier). That is why it is called high-powered money in monetary economics. There are several periods in the economic history of post-independent Mauritius that were marked by releases of high-powered money on a large scale. The episodic releases of the high-powered money have had corrosive effects in the economy.

The budget proposal under reference thus completely disregards the monetary policy goal of the BoM. It’s fiscal dominance par excellence. In a liberalized financial system like ours, the conduct of monetary policy by the BoM is based on its balance sheets. A robust balance sheet provides the Bank with ample firepower to turn around the domestic financial markets in the desired direction. In contrast, a weak balance sheet, if made weaker by miscalculated steps, would eventually disempower the BoM and would require Government support to conduct monetary policy with taxpayers’ money. Short of Government funding of the BoM, an important arm of macro-economic policy making would be sacrificed in favour of short-term political gains.

Hon. Prime Minister, in my exit letter, dated December 17, 2017, addressed to you, I had already highlighted some of the issues I raised in the interview a few days ago. I had mentioned therein that economic ‘policy makers are in a uniquely privileged position to size up the formidable task of improvising a way forward for Mauritius in the global transition of power and ideas – a global transition the finality of which is unknowable’. The exercise of prudence is mandatory. By amending the BoM Act, you would be opening a can of worms that would eventually harm macro-economic and financial stability in ways hardly recoverable. You will be paving the way for future Finance Ministers to have liberal recourse to the BoM for free money without having to go for corrective fiscal measures in order to meet their short-term political objectives. Once the can is opened, the BoM would be reduced to the level of the defunct Mauritius Co-operative Central Bank Ltd.

I have placed before you my reasoned arguments in good faith. The budget proposal is a dangerous precedent. If at all it is decided to proceed with the proposal regardless of the clarifications I have provided, the use of the ‘notional’ money would be weaponized. The Mauritian rupee would finally bear the brunt. You would also sow the seed for lasting macro-economic instability. I suspect the IMF may have already sought clarifications with the Ministry of Finance and the BoM on this proposal. While I am aware that finance ministers cannot produce rabbits out of their fiscal hats, I would, nevertheless, urge you to take an educated view of the proposal and withdraw it in the best interests of the economy, although you have travelled quite a distance with it.

If we try to preserve the past, we will not be able to produce the future. No more room is left to kick the can down the road anymore. The sun may have already set on the Government’s ability to bring down its debt level without having recourse to tight measures. There is nothing like a long run of good luck to destroy a person. Mauritius, in my opinion, has had a long run of good luck. I extend to you my very best wishes.

Ramesh BASANT ROI, G.C.S.K.
Former Governor
of the Bank of Mauritius