In the wake of the 2022-23 Budget, this article reviews the latest fiscal developments and the related impact on inflation, debt and external payments.

High fiscal deficits supported by heavy central bank financing are driving the economy deeper into an inflationary spiral. The forlorn hope that the country will grow out of heavy indebtedness based on overoptimistic GDP forecasts is now resting more on default through inflation. External stability is seriously threatened by worsening trade and current account imbalances that are weakening the rupee and depleting foreign exchange reserves. In the absence of stronger fiscal adjustments, the economy is edging closer to crisis.

 Fiscal deficits

The consolidated budget results for 2021/22 reflect a strong recovery in taxation supported by additional CSG proceeds, raising revenue to a peak of 26%, compared to 22% in the pre- Covid year 2018/19, as shown in Table 1. Revenue gains are spurred both by stronger real GDP growth and rising inflation. Despite a shortfall in capital spending, current expenses, including Covid-related wage and employment subsidies of about Rs4 bn, increased significantly, and total expenditure remains high at 36% of GDP.

Table 1: Fiscal deficits in Rs bn

Notes: 1. Budget and Special Funds are consolidated 2. Revenue in 21/22 excludes Rs8 bn of exceptional income from CEB, MPA, and FSC 3. Expenses in 21/22 include Air Mauritius and BAI bail-out expenses of Rs12 bn and Rs2.4 bn

Budget window-dressing has sunk to new depths with the failure to account for the payment of Rs12 bn to creditors of Air Mauritius from the proceeds of the sale of Airport Holdings to the Mauritius Investment Corporation (MIC) for Rs25 bn. Instead, these bailout expenses have been netted out, and only the net equity proceeds of Rs13 bn are recorded in the budget. Unless proven otherwise, this is an appalling example of deceitful accounting. Amazingly, this substantial sale of Govt-owned shares has not elicited any public announcement so far, either by Govt or the MIC.

The official budget deficit for 2021-22 is estimated at Rs25 bn, or 5% of GDP, but it omits Air Mauritius bail-out expenses of Rs12 bn, as well as BAI bail-out expenses of Rs2.4 bn, disguised as equity investment in the National Property Fund for further injection in the National Insurance Company. In addition, a sum of Rs8 bn of exceptional income from CEB, MPA, and FSC, tantamount to a Govt grab of their accumulated reserves, should not be treated as revenue in line with IMF Govt finance statistics. Adjusting for these items, the consolidated budget deficit stood at Rs48 bn, or close to 10% of GDP.

The 2022-23 budget is expecting a further boost in revenue on the assumption of an optimistic GDP growth forecast, and high inflation. Expenses will remain steady while capital spending is projected to double. The official budget deficit for 2022-23 is estimated at Rs23 bn, or 4% of GDP, but this excludes net spending by Special Funds amounting to Rs19 bn, or 3.3% of GDP. The consolidated deficit for 2022-23 is Rs42 bn, or 7.3% of GDP, but the final budget outcome may hover around 6% in view of the usual capital spending shortfall.

Prior to the Covid pandemic, revenue and expenditure averaged around 21% and 25% of GDP respectively. As from 2019-20, expenditure is rising twice as fast as revenue in relation to GDP. The increase in basic pensions and other social benefits accounts for almost half of the increase in expenses between 2018-19 and 2022-23. Following the steep expansion in social outlays, and higher capital spending, expenditure in the post-Covid years is running at over 30% of GDP.

Revenue on the other hand has been invigorated by the CSG payroll tax by almost 2 % points of GDP, but the rise in VAT and other taxes is attributable to the inflation factor rather than to real GDP growth. Projected revenue of 26% of GDP in 2022-23 cannot be maintained without persistent high inflation. A fiscal deficit of over 5% of GDP is therefore not sustainable. The introduction of the CSG, the curtailing of petroleum subsidies, and greater excise taxation on tobacco and alcohol are insufficient efforts at fiscal consolidation.

 Inflationary financing

Fiscal profligacy has taken public indebtedness to elevated levels, and fuelled inflation through an excessive recourse to central bank financing. During the last 3 financial years – 2019-20, 2022-21 and 2021-22, consolidated expenditure totalled Rs500 bn, while revenue amounted to Rs335 bn, resulting in a consolidated fiscal deficit of Rs165 bn.

As shown in Table 2, two thirds of this deficit was financed by the Bank of Mauritius (BoM) and MIC for a total of Rs118 bn – Rs 18 bn from BoM internal reserves and Rs15 bn of borrowings from BoM in 2019-20, Rs60 bn from BoM internal reserves in 2020- 21, and Rs25 bn from MIC in 2021-22. This undue reliance on central bank money has contributed to the current inflationary pressures, accompanied by rupee depreciation.

Besides borrowing from domestic sources, Govt also resorted to external loans from the African Development Bank, the Agence Francaise de Developpement, and the Japan International Cooperation Agency for a total of Rs33 bn. However, a budgeted IMF flexible credit line of Rs8 bn in 2019-20 did not materialize. As a sign of growing desperation, the bottom-barrel reserves of CEB, MPA and FSC are being cleaned up for Rs8 bn in 2021/22.

The surplus balances held by Special Funds (SF) rose by Rs34 bn over the last 3 financial years, as spending in these funds remained below the amounts transferred from the budget. Consequently, Govt had to borrow more to meet fiscal deficit financing needs, raising gross public sector debt. The hullaballoo about SF surplus balances offering fiscal space for greater spending makes absolutely no sense. A drawdown of these SF balances is simply a means of financing a given fiscal deficit, along with borrowings. More generous social expenditures to better compensate for the higher cost of living will entail a wider fiscal deficit.

Table 2: Financing of fiscal deficits in Rs bn

* Financial years, 2019/20, 2020/21 and 2021/22

** Assuming equity sale to MIC

For 2022-23, there is no projected resort to BoM money printing, which leaves a gaping hole in meeting fiscal financing needs. As another sign of serious discomfiture, the budget estimates for 2022-23 include an equity sale of Rs22 bn, unidentified and undeserving of any word of mention in the budget speech. A previous budgeted equity sale of Rs4 bn in 2020-21, seemingly for Maubank, never happened. The NIC has now been suggested as another potential candidate for sale. Selling such Govt-owned assets in current economic conditions is fraught with uncertainty, and it is not unlikely that MIC will be called once more to pick up the tab.

‘‘Govt relied on easy money for a free lunch, except that inflation is now eating the lunch.’’

Supply disruptions due to the Covid epidemic and the Ukraine have led to surging inflation in the global economy, including Mauritius. Financing large and unsustainable fiscal gaps by central bank financing will further fuel inflation and rupee depreciation, unless fiscal consolidation is pursued with more vigour. While inflation helps to bring more tax revenue, it also puts pressure on social spending, leading the budget into an inflationary spiral.

When Govt argued that there was no alternative but to finance social spending and Covid-related wage and employment subsidies with central bank money, economists warned of the impending inflation risks. The greater priority was to protect the poor and vulnerable from a drastic erosion in purchasing power, rather than stubbornly engage in unaffordable social spending. To avoid taking right but unpopular decisions, Govt relied on easy money for a free lunch, except that inflation is now eating the lunch. Govt is reaping the consequences of its irresponsible policies, and will eventually be compelled to make the needed fiscal adjustments to pull back from a headlong drive into spiraling inflation, like in Zimbabwe, Venezuela or Lebanon.

Inflation has surged sharply this year, reaching 11% in April 2022 compared with a year earlier, due to the cumulative impact of a 25% depreciation of the rupee since Jan 2019, and to recent global increases in energy and commodity prices following the Ukraine war. Inflation is expected to rise even further as the full effect of the Ukrainian crisis feeds through domestic prices. Monetary policy is totally ineffective in checking inflation, since the BoM’s primary role has been subverted from inflation control to financing Govt.

 Public debt

In spite of outsized fiscal gaps and financing needs, a reduction in the public debt to GDP ratio is foreseen in the coming years. Public sector debt (PSD) is estimated at 87% of GDP in June 2022, lower than the figure of 96% of GDP in June 21. The MIC/BoM equity transaction of Rs25 bn in Dec 2021 provided Govt with enough financial resources to avoid further borrowing and thus hold back on debt. But with adverse consequences for rupee depreciation and inflation.

The PSD budget estimate for June 23 is even lower at 78% of GDP. The decline in the debt ratio over the two financial years is partly due to real GDP growth of 6.9 % and 8.5% annually, and also on account of soaring inflation. The impact of inflation alone is to reduce the debt ratio by around 5 % points annually. In effect, Govt is partially defaulting on its debt through inflation.

Table 3: Public sector debt in Rs bn *

*In lieu of equity sale

Revised PSD data are shown in Table 3, excluding a negative consolidation adjustment, and including an SDR allocation made in Aug 21. To meet the official debt ratio forecast in June 23, Govt must realize a large equity sale of Rs22 bn. Without the budgeted equity sale, the PSD ratio would be 3.5 % points higher. The PSD revised total would then stand at 84% of GDP in June 23.

Inflation helps to reduce the debt ratio by increasing nominal GDP and tax revenues. But a strategy of debt default by inflation will work only for a short period as fiscal expenditures catch up with rising prices, resulting in even more social spending to offset inflation. The 2022-23 budget illustrates how debt and inflation are starting to feed on each other, heightening the risks of economic disaster ahead.

 External situation

Fiscal deficits not only determine the course of public debt, but also impact on the external accounts by widening the current account deficit and putting downward pressure on the rupee. The external balance has deteriorated as tourism receipts dried up, with net exports of goods and services rising to 25% of GDP, and a current account deficit of around 15% of GDP in 2021. Exclusive of net global business inflows, the current account deficit is at a peak of 25% of GDP. Although the global business sector attracts substantial capital inflows, foreign exchange reserves have come under strain, and the rupee has depreciated significantly.

At end May 22, gross official international reserves amounted to USD7 bn. The BoM has also been borrowing to shore up its foreign reserves, in larger amounts reaching USD1.2 bn. Net external reserves stood at only USD5.8 bn in May 22. The last time foreign reserves stood below USD6 bn was in Dec 2017, some 5 years ago. Since Sep 21, the BoM also appears to conduct covert transactions with certain banks to window-dress the level of forex reserves at the end of each quarter.

The forex market remains in chronic short supply, and there is a tacit measure of exchange control imposed by the central bank on banks to limit the drain in foreign reserves. This led to an acute shortage of foreign currency in April 22, which required an exceptionally large BoM intervention. After a slight and short-lived attempt by the BoM to strengthen the rupee, it has again resumed its depreciation trend. Market sentiment indicates continued rupee weakness ahead. The limited hike in BoM’s policy interest rate in response to global monetary tightening is unlikely to deter capital outflows.

Major turbulence on global financial markets in April 22 adversely affected the BoM’s external portfolio of shares and fixed income investments. Significant valuation losses on its external reserves appear to have wiped out all of BoM’s internal reserves. The BoM will have to engineer more rupee depreciation to rebuild its capital reserves by June 22.

Despite the similarities with the 1970s oil crisis, and the recent Sri Lankan crisis, Mauritius holds adequate external reserves to meet normal financing requirements for the next few years. But sudden and unexpected shocks cannot be ruled out. However improbable, the pervasive uncertainties of the global economy as well as domestic vulnerabilities could contribute to a collapse of market confidence, precipitating capital flight and a foreign exchange crisis.

 Conclusion

Tolerance for high inflation will aggravate domestic and external imbalances and also undermine growth prospects. Short of fiscal consolidation, the current size of fiscal deficits is too large to ensure mediumterm public debt sustainability, to control inflation, and to stop the drain in foreign exchange reserves.

Although the scope for reducing Govt expenditures other than social benefits and employee compensation is limited, fiscal consolidation through revenue measures, the targeting of social expenditures, and pension reforms is essential. The ruthless elimination of waste and corruption, and a thorough review of public outlays to maximize value for money is equally critical. Without sound fiscal management, the reckoning from a dire economic outlook is looming closer.