Last week, in an Op-Ed, aptly titled, “Pourquoi paniquer si le dollar coûte moins cher?” in this very paper, Mr. P Forget bandied across some pertinent observations regarding thedoggedly disturbing trends in our domestic forex market that began in September 2019 – three months after the announcement of the appropriation of funds from the BoM balance sheet without an obligation to repay. Ever since, the BoM has purchased only once a relatively tiny amount of US dollars on the forex market. Interventions by the BoM have been on the selling side of the market. As there is no written history of any forex market crisis resolution in the past, I thought that a narrative of the BoM experience in restoring forex market stability might be useful to our policy-making community.

April 1996. It was nearly two years after the suspension of the Exchange Control Act. The domestic forex market was still in a fledgling state. The replacement of the then frazzled management by some new arrivals, though warranted, had instantly made the domestic forex market nervous. The sudden jittery market conditions conveyed a clear message: market players disapproved the new arrivals. In brief, a flawed BoM policy stance set forth a depreciating trend of the rupee and foreign currency shortages made its first ugly appearance. The absence of timely corrective steps in the ensuing months to stem a nascent turbulence in the forex market had triggered disorderly market conditions. Think of a small snowball, rolling down a hill, gathering more mass as it goes. The snowball effect on the forex market eventually turned out to be costly.

Public outcries about shortages of forex and the rapid decline in the value of the rupee forced the BoM to intervene by way of selling US dollars on a regular basis without heeding to the fundamental cause for the capital flight that had gathered momentum. The forex reserves of the BoM dropped from a peak of about US$750 million in 1997 to a low of about US$500 million in 1998. The more the BoM intervened on the market the more rapidly the appetite for US dollars grew - and the more the rupee depreciated. The accelerated depreciation of the rupee lasted for so long that even exporters expressed frustration regarding the BoM’s inability to contain the chaos. Credibility of the BoM sank to its lowest level ever.

The rapidly deteriorating forex market situation was seen by the then politically astute Prime Minister, Hon Navin C Ramgoolam, as an ominous sign of a political disaster in the making. If not effectively countered, a colossal political damage would become inevitable. Seizing the co-incident blast of a BoMscandal connected to the issue of a new family of banknotes, the Prime Minister had literally sacked the two principal policy decision makers at the BoM.

A new team from inside the BoM took over the policy-making rein. A contractionary monetary policy stance was immediately adopted. Several weeks of aggressive open market operations (that extinguished over Rs5.0 billion advances to the Government from the BoM balance sheet) were conducted in conjunction with a technically strong and clear-cut open mouth policy as part of a confidence building exercise. The yields on treasury bills were raised to a high of over 13 per cent which implied a substantial upward revision of interest rates. The attractiveness of investment in foreign currency denominated instruments faded away and the interest rate parity in favour of the rupee was restored. The forex market regained confidence in the BoM’s policy stance and the domestic forex marketeventually stabilized as a result of which the declining trends in the value of the rupee were arrested. Importantly, for the first time in the economic history of the country (BoM forex reserves plus banks’ foreign currency balances) a record level of forex reserves of US$1.0 billion was attained by the end of December 1999, that is to say, within 13 months of the implementation of an aggressive monetary policy stance. Takeaways from this crisis resolution are as follows: --

(i) The forex markets, if not effectively handled in time,can turn out to be dangerously more powerful beasts than central banks. A market that catches on to the impotence of central bank interventions goes into free fall;

(ii) The policy decision-making team at the BoM imperatively has to be adept at financial and monetary analysis;

(iii) Credibility is not available on the shelves of supermarkets; it is earned over time. Central bankers necessarily have to be credible to command respects on the markets;

(iv) The money and forex markets hate opacity; timely information and reliable statistics are essential ingredients for their efficient functioning. In particular, transparency of the BoM balance sheet is critically important;

(v) The extent of misalignment of the exchange rate of the rupee, market intelligence and behavior etc. have to be thoroughly gauged and studied before strategizing smart interventions on the market. As always, decisions to intervene and the size of interventions should rest exclusively with the BoM. Shrewd, wily, adroit and unfailingly tactful interventions are likely to have the desired impact. Bulky and flash interventions signal panic; they are counterproductive;

(vi) In the kind of fully liberalized financial sector that we have, the BoM monetary policy operates through its own balance sheet. To resolve any kind of crisis in the money and foreign exchange markets, the BoM necessarily has to have a ‘fortress’ balance sheet. With a severely weak balance sheet, the BoM would be ill-equipped to restore exchange rate stability. You do notget into a gunfight equipped with a knife. The outcome of the gunfight is a foregone conclusion;

(vii) Humility is a key factor. But the arrogance of central banking is a virtuous characteristic;

(viii) Traders on the forex market are not the usual tribes ofcivil servants; they are eagle-eyed professionalsconstantly on the look-out to make money. The forex market is not a school of social ethics; it has no political responsibility;

(ix) Finally, a rabbit born in a stable does not become a horse.

The end results of the sustained aggressive monetary policy stance in conjunction with a stability-oriented fiscal policy stance, under the then Ministers of Finance, Hon Vasant K Bunwaree and Hon Paul Berenger, teaches important lessons to the younger generation of our policy makers: for the first time in our economic history the current account of our balance of payments had posted four successive fiscal years of surplusesover the period 2000 to 2004. Indeed, it was a spectacular balance of payments performance. The accumulation of foreign exchange reserves by the BoM began slowly on the strength of the current account surpluses at first and gathered momentum with the elimination of the dual bank licensing regime in the Bank of Mauritius Act 2004. For the first time in the BoM history, record transfer of profits amounting to Rs5.7 billion were made to Government over the four years. The arrogance of central banking paid handsome dividends. Once upon a time, politicians, in particular Finance Ministers, respected the independence of the BoM. Respects infused a burden of institutional responsibility.

Thomas Sowell, a brilliant American economist, whose economic insights are given less than deserving recognition once wrote, “The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.” In a lucid elaboration of common sense, I had hinted in this very paper, after the outbreak of the recent pandemic, to a set of measures that would have had far lesser pressures on the foreign exchange reserves of the BoM in later years than the pursuit of any policy which involved money creation en masse. As expected, they were ignored. 

The readily available US Federal Reserve Bank policy style was blindly opted for without paying the slightest attention to the unspoken truth that the biggest and most profitable US industry is the business of creating of US dollars out of thin air: between 65 per cent and 70 per cent of the existing stock of US dollars circulates outside the US.

The Fed operates in a paradigm altogether different from ours. No wonder the central banks of countries with reserve currencies, in particular the US, gave up the use of money supply as an intermediate monetary policy target in theirendeavors to achieve and maintain low and stable inflation rate, as far back as in the late 1980s. The reason was that money created by them is not measurable!!!!!! 

The annual seignioragegains – what President de Gaulle had referred to as an ‘exorbitant privilege’ - to the US is said to exceed a trillion US dollars every year. Remember the infamous statement to the world by the US Treasury Secretary during the breakdown of the Bretton Woods System in 1971, “the US dollar is ours; the problem is yours.”

Geopolitically and otherwise, US is currently paying the price for having strayed outside economic laws for too long. The unfolding economic crisis in the UK says a lot about recent policy errors. US ‘threw economic textbooks out of the window’ and printed too much dollars; China accumulated too much dollars and, reportedly, it’s now getting rid of them while several other countries are shifting to bi-lateral payment and settlement arrangements in non-US dollar currencies. A recession is in the offing.

We foolishly picked up policies from the US policy toolkit.Policy makers in Mauritius with airy fairy views took pride in making insane statement to Financial Times journalists that “we threw all economic textbooks out of the window during the pandemic” without realizing that astute foreign investors would find it laughable. Such shallow wisecracks passed as devastating epigrams and the ripest wisdom. When expressing support for policy choices made by politicians, our ignorance never allows us to escape the consequences thereof. Every irresponsible policy choice has an associated cost. This chicken does come home to roost. Indeed, it has. As was foreseen, it is hurting.

If money creation out of thin air was ever a sound formula for alleviating or eliminating poverty, there should have been no poverty at all anywhere in the world. Money creation meant for financing consumption rather than production does impact adversely and seriously on our balance of payments position and eventually on the domestic foreign exchange markets. The economy is flushed with rupees. In the absence of wealth generating growth, holders of large rupee balances, in the current high inflation environment have no other domestic avenue for investment than to switch to foreign currency-based investment. Viewed from this standpoint, holders of large rupee balances cannot, in any manner, be typified as speculators. In fact, players on the domestic forex market are behaving rationally. The question that should be set is “who gave rise to a build-up of large rupee balances in the hands of the public?”

In December 2019, US$1.0 billion in the forex reserves of the BoM balance sheet corresponded to Rs 81 billions of money supply (M2, money supply broadly defined) in our economy; in August 2022, the US$1.0 billion (after netting the BoM forex reserves of estimated external borrowings) corresponded to Rs 143 billions of broad money supply (Source: BoM Bulletins). Essentially, this means that the risk exposure of the economy to a balance of payments crisis on a large scale has assumed an insanely dangerous dimension. One needs not be a rocket scientist to find out how an increase in money supply of close to Rs200 billion in only 31 months came into being. Worst, a central banker’s job, it is often said, is to take away the punch bowl just as the party gets going. These days the bar is being kept open. Alan Blinder, another brilliant US economist, argued in one of his papers that politicians use economics the way a drunk uses a lamppost – for support, not for illumination. 

Absent capital inflows, getting back the domestic forex market to orderly conditions necessitates a significant rise in interest rate failing which a balance of payments crisis would become inevitable. But a significant rise in interest rate would substantially raise the cost of internal debt servicing (to the dislikes of the MoF) besides also imposing higher interest cost burden on enterprises. The high risk of foreclosures under conditions of sluggish growth cannot be understated. Financial stability considerations consequently make their appearance into the picture. The entire puzzle gets wrapped up in yet another dilemma: the deplorable state of the BoM balance sheet has incapacitated the BoM to stir the course of the market. Prospects for an aggressive policy stance without adding to inflationary pressures are unimaginable. Our policy making community has been on a policy path that has led to a cul-de-sac. How do policy makers extricate themselves from such a checkmated situation?

Political maturity calls for owning and solving policy errors. The first law of getting out of a hole is to know when to stop digging. Are we still digging? I do not know. What I do know is that getting out of the hole requires the courage of picking up the textbooks on monetary economics thrown out of the window. Squandering central bank money on a national scale on consumption as a way of economic salvation, more so in the context of a small highly open and foreign trade-dependent country that is, by definition, subject to a set of thoroughlydebated and accepted vulnerabilities, is recklessness at its worst.