There used to be a time when politicians and their nominees would selectively quote from IMF staff statements and reports in order to convince the population that all was well in paradise, that they could go back to watching the Premier League games or Hindi soaps and that we were an example for Africa but long gone are those days.  In a recent interview on the Mauritius Times newspaper, the Lord Meghnad Desai, the outgoing chairman of the MIC unknowingly perhaps jumped on the new message that has been cooking from the “so what!” school of thought over the past month, that is, “let the IMF say what it says. Who cares?”.  The interview in itself is puzzling and concerning at the same time.  Firstly, there seems to be a bit of a confusion when it comes to why central banks across the globe hold international reserves in the first place.   

Central banks gradually accumulate international reserves over decades primarily in order to have an insurance policy against external shocks and as a consequence of foreign exchange intervention in order to smooth the volatility of the local currency in free float exchange rate regimes. Given the large current account deficit of more than 15.6% of GDP for 2021, rising levels of external public debt and the sheer size of GBC deposits, the IMF estimates that Mauritius has barely enough reserves to cover external liabilities in a tail risk event as noted in its Article IV when saying that international reserves account for “103 percent of the Fund’s ARA metrics at end-2020, which remains within but closer to the lower bound of the 100-150 percent adequacy range”.  Furthermore, the accumulation of foreign exchange reserves is not cheap and the BoM also has liabilities in the form of monetary policy instruments set against these assets which is why it has struggled to pay any dividend to Government over the past few years.  When it comes to justifying reserves sales, the money “lying in US treasury bills with yields at low levels” argument is incorrect.  While it is true to say that developed markets fixed income yields have dropped significantly, central banks have across the globe modernized their international reserve management frameworks with the objective of preserving or moderately growing the real purchasing power of these international reserves over a full market cycle.   

Central bank have gradually over the past decade been diversifying their portfolios into global equities, emerging market equities and fixed income, corporate bonds, certain commodities like physical gold and even oil futures or options on crude oil, liquid alternatives and a select few of the more advanced central banks who understand that liquidity risk can be managed at the portfolio level also invest in private credit and private equity with longer investment horizons all as part of a well diversified and still relatively conservative portfolio.  Central bank boards also take asset liability concerns into account when designing their strategic asset allocation frameworks.  Central banks do not just invest in treasury bills unless you are under IMF emergency programs!  If the Bank of Mauritius cannot do better than achieving treasury bill returns, then it only has itself and its amended BoM act to blame.  This idea that one can sell international reserves when it is at the lower bound of the reserve adequacy threshold because it can make higher returns in local currency as was stated many times last year to justify this strategy is devoid of fact given the direction of the local currency, the returns both historical and expected in Rupee terms of foreign assets and the significantly higher risk of investing in local distressed, non liquid and wrongly priced convertible bonds.  Given the difference between the stock prices and conversion prices in those term sheets, given the inability of the MIC to convert the bond to equity whenever profitable to do so before 9 years which is not in line with how it is done globally, given the ability of the issuer to call back the bond at any time vs. the typical 5 year or 7 year call back feature globally , coupon rate, assumed credit spreads and given the overvaluation of the Rupee in the absence of any meaningful structural reforms in the economy, even low yielding and unattractive Government bonds globally will do better in Rupee terms than those MIC bonds.  Given the fact that drains do not generate free cash flows and nor can these investments be exited from (who will buy drains?), the investment company that is the MIC will be hard pressed to explain how they will generate high Rupee returns which would offset the opportunity cost of holding international reserves and investing in international asset classes! 

Since the pandemic, how many countries have even sold international reserves to bailout the private sector and how many with barely above 100% ARA adequacy thresholds have done so? Those who hold our external liabilities as assets do not take Rupees.     

To be fair, given the impact of the COVID-19 pandemic on corporate balance sheets, I was one of the few who early on supported and pushed the idea of creating a bailout fund acting as a backstop in order to prevent large bank losses driven by defaults by systemically important companies.  In a small country like Mauritius, credit concentration risk in banks as showcased in the Bank of Mauritius Financial Stability Report stress tests can impact banks too but the way the MIC was setup, funded and its governance structure have all been ill conceived from the start. The MIC was not meant to be the sole Sheriff in town because what we learned from the last Great Financial Crisis was that bailouts need to be fair, we cannot privatize gains while socializing losses on the taxpayer and we should not distort capital markets and risk pricing.  The state can bailout firms but also lets the market function and the cost of bailouts to private firms is high.  Be it the German Lufthansa deal by a much richer Germans or the other European and US bailouts, deals have not been as one sided as those done in Mauritius.  The Europeans love and care about the economies too! 

Banks hold capital for a reason and majority shareholders too must be willing to accept some pain and some equity dilution.  Furthermore, rather than being an off balance sheet bankruptcy remote entity funded by Government equity, it has become an on balance sheet subsidiary of a central bank with negative net-worth which has provided it with 79 Billion Rupees in debt/loans at amortized cost and 1 billion in equity investments.  An off balance sheet MIC was supposed to have also borrowed money from the market and from the central bank which would own MIC loans/bonds as an asset similar to how other bailout funds have been structured globally and in order to optimize the capital structure of the MIC on a deal by deal basis.  What we have done to the MIC on the other hand is a mess with quite the leverage ratio and any losses on these distressed assets and exotic investments in drains puts the entire central bank balance sheet in quite a precarious situation, even worse than now. A central bank with negative net worth and with the asset liability mismatches which are currently present on its balance sheet prints money to finance its liabilities and as many Mauritians who go grocery shopping or buy dollars or Euros these days have started to realize, it has a severe impact on the credibility and ability of the central bank in meeting its objective of price stability  Who cares right?  How many central banks in the world have structured bailout funds on their balance sheets anyway? They are not all clueless. 

The bigger, more worrisome take away from the Lord Desai interview however revolves around this new school of thought about the MIC not being about profits (a contradiction from the treasury bills argument made earlier) but about the economics of “love and care”. If the MIC does not make money then the balance sheet of the BoM will be impossible to fix. The asset liability mismatches are such right now that forget break evens on MIC deals, the BoM needs to make a lot of money on all assets to minimize the state’s recapitalization cost.  Who cares? 

The MIC should not be confused with a development company or the Government.  It is an investment company with high levels of leverage and a weak and desperate for returns investor with negative net worth.  In the private equity world, average returns for distressed debt investing is very high (20-30% IRR given the high risk) and commercial banks and company shareholders take quite the hit too and convertible bonds are bought at deep discounts.  Noone is arguing that the MIC should go that far but it should seek a middle path when managing public money.  Making a mere 11% annual returns in Rupees over 9 years and having an impact investing secondary mandate which would be measured by  quantifiable metrics such as number of jobs saved, new industries created, carbon impact of investments etc would be the professional way to handle the “love and care” part but also taking investment risks and balance sheet concerns into account. Real balance sheet concerns cannot be wished away with love and care.   

The other problem with this “love and care”  new age economics is that it should take the on the ground realities of the non financial Mauritian private sector into account where the form of capitalism that is practiced remains quite patrimonial. The Mauritian private sector itself is quite concentrated and effective control via a multitude of holding companies is held in a few hands.   The recent World Bank report on Mauritius in fact sheds light about the high levels of sector concentration (70%) which while partly explained by the size of the country also has “oligopolistic industries” which “typically recognize their interdependence – that is, one firm’s pricing and production decisions affect another’s - and so the incentives to collude is high.” These oligopolies who finance a myriad of often overlapping lobby groups and employ thousands in the country have a strong bargaining power with the Government of the day and in the media as well.  The mixing of patrimonial capitalism and patronage politics creates barriers to entry and hinders innovation and is a major factor behind why Mauritius will struggle to recover during this decade of de-leveraging.     

This partially explains the lopsided public private deals, quick amendments to labor laws, the real estate biases of every national budget and the many barriers to entry which do not get accounted for in those ease of doing business reports.  There is also a lot of unwillingness to go to the equity markets and engage in rights issues and dilute majority shareholder control.  Natural selection and free markets do not function well. Beyond some noteworthy exceptions especially in the offshore sector, between the oligopolies and the small time “chatwas” who get business contracts out of the blue, the rest are stuck in the middle doing their best to eek out a living in the Kingdom of Chatwapur.   The rest of the world has a pandemic too and the same sectors globally are also facing headwinds but they go to the equity linked market, the public equity market, the private equity market or the private credit markets to fund themselves at market rates while bailout funds aim to not distort risk pricing and only intervene to reduce tail risks to the system at fair prices.  Global markets are seeing record levels of new issuance of all types and investment banks are busy with mergers and acquisitions. That is perhaps the bigger picture tragedy of the MIC bailouts, business as usual in Mauritius.  Love and care for whom exactly?