I have read with a lot of interest articles and interviews in the local press by a number of seasoned economists, politicians and financial specialists on the expected impact of Covid-19 on the Mauritian economy, the different funding strategies that policymakers need to consider while they scramble to keep our economy afloat during this crisis of unprecedented nature and scale and the short and medium action plan required to put our economy back on track once Covid-19 is behind us or has been largely contained both locally and globally. 

While most if not all these articles seem to converge at the understanding that in exceptional times like this one exceptional measure that defy prudential norms of policy-making need to be adopted, the disagreement seemingly lies in the financial engineering needed to fund these exceptional measures as well as the extent of the funding. The object of this article is to look at two unconventional ways of shoring up an economy in periods of huge economic distress, demystify the notions of quantitative easing and helicopter money, discuss their pros and cons, and assess their effectiveness in the current context and whether conventional economic tools cannot finally provide the munitions to the challenges at stake. 

Understanding what is at stake for Mauritius 

As a country without any resources except human power, the sun and the sea, Mauritius has undeniably managed to embrace, post-independence, a successful transformation agenda based on an outward-looking development business model. As Covid-19 unfolds, this highly rewarding business model is being seriously tested, at least in the short term. The tourism and textile sectors are under severe stress as planes are grounded and delivery mechanisms stall. Other activities that gravitate around the tourism and hospitality sector, including the construction sector, are also in serious pain. There is currently a total absence of visibility on the duration of the pandemic and the breadth and depth of its impact on Mauritius. 

While the IMF predicts a contraction of 6.8 % of GDP, our policymakers are tabling on a shortfall of 7 to 11 per cent while other analysts point to alarming figures of 15% or even 20%. It is anybody’s guess on what the exact contraction will be by the end of 2020, but at least everybody agrees that the drop in national revenue will be massive, ranging from a conservative Rs 30 billion to an astounding Rs 100 billion in 2020, with all its incidental ramifications on public finances, company closures, furloughs or strait lay-offs, and social cohesion. 

Although there is the hope of a rebound from a low base in 2021, this will depend not only on how fast Mauritius turns the page on Covid-19, but also on how well we manage our policy responses to the crisis, how successful our main economic and trading partners are in managing the sanitary crisis, how fast the huge disruptions in the supply chain we are currently witnessing are reversed, how quickly global demand rebounds to its pre-Covid levels, how quickly travellers start flocking in planes to cross international waters and at what pace consumers resort to their pre-Covid-19 consumption behaviours. 

Policy responses and support programme 

In response to the Covid-19 threat, we have witnessed a battery of fast policy responses from policymakers, ranging from 150 basis points cut of the repo rate, wage assistance schemes to the formal sector, income support schemes to the informal sector, to moratoriums for payments of interests and capital, amongst a host of other measures. These measures were important to provide a fillip to companies facing fast dwindling revenues and unable to generate sufficient operating income to service their debt payments. They were also important to prevent lay-offs in the formal sector and maintain social cohesion in the informal sector. 

In essence, the policy responses have helped in keeping our economy afloat while dealing with the urgent sanitary conundrum during the six-week lockdown period. The real challenge now is to prepare for a long-haul battle against an invisible enemy whose derailing impact may last months and even extend into 2021 and beyond. Whether the contraction in GDP is of the order of Rs 30 billion or Rs 100 billion in 2020, it is very clear that a massive support programme needs to be worked out with urgency, its objectives clearly defined, its recipients identified to prevent abuses from undeserving parties and the terms and conditions of the support clearly delineated so that government can recover its investments post-crisis. As the policymakers apply their minds to come forward with an effective and well-crafted support programme, other than sizing up the amount that would be needed which can be ramped up under different scenarios, they must also be working on the optimal policy-mix of measures that would achieve the desired results at the lowest costs for taxpayers (tens of billions of rupees at stake). 

Should the support programme be weighted more towards fiscal policy measures or monetary policy measures? Would conventional economic tools do the job or should we rely on unconventional tools, such as quantitative easing, helicopter money, negative nominal interest rates, because conventional tools have reached their limits or because the government needs to stick to certain pre-defined norms of fiscal prudence? To answer these questions and measure up the relevance of unconventional tools, it is important to have a closer look at them and assess their effectiveness with regard to the specificities of the challenges that Mauritius is currently facing.

Demystifying quantitative easing and helicopter money

Unable to boost the economy to the desired levels in spite of bringing interest rates to near-zero levels, central banks in the western world, namely in the US and  Europe, resorted to aggressive quantitative easing during the great recession of 2008. Quantitative Easing (QE) implies the purchase by Central Banks of government bonds, mortgage-backed securities and even corporate bonds (ECB)  from commercial banks and other financial institutions on the secondary market with the purpose of reducing long-term interest rates, increasing money supply,  stimulating bank lending by raising commercial bank reserves, boosting investments, and promoting more buoyant asset markets. 

Analyses of the effects of QE indicate a strong boost to financial markets but a largely ineffective impact on the real economy. The newly created money went directly into the financial markets, boosting bond and stock markets in developed and emerging markets to their highest level in history. It seems that the first £375 billion of QE by the Bank of England led to about only 2% growth in GDP. In other words, through QE, it took £375 billion of new money just to create some £30 billion of extra spending in the real economy. Its policy effectiveness is, therefore, questionable as it relies on boosting the wealth of the already well-off section of the population with the hope that the latter increases its spending and stimulates economic growth via the ‘trickle-down’ theory of wealth, a theory which has largely been discredited through a series of tax cuts in the US for the wealthy that had no impact on growth and resulted in larger deficits

Some economists argue that, instead of QE, a far more effective way to boost the economy would be for Central Banks to create electronic money, acquire very long term government bonds or even perpetuities on the primary market at very favourable rates (Bank of Japan currently doing so at negative rates) from the government, and allow the government to spend it directly into the real economy to needy households, an unconventional practice coined as Helicopter Money (HM). They argue that HM would have an immediate effect in boosting demand rather than waiting for higher asset prices to feed through the economy. HM also avoids the criticism levelled against QE of exacerbating wealth and income inequality by supporting wealthy asset owners. 

On the downside, critics of HM argue that it undermines fiscal responsibility, and may to lead to depreciation of the currency or depletion of international reserves in case of regular intervention by the Central Bank to defend the local currency. More important for the current debate, if the shock is, first and foremost, on the supply side, it can lead to inflation. Unless done within prescribed limits and seen to be temporary, HM may translate into much higher bond yields as investors price in higher future inflation, resulting in higher borrowing costs both for governments and the private sector. Some critics also cynically argue that with nominal interest rates dwindling to near-zero levels in periods of severe economic distress, governments might as well borrow very long term from the public as the servicing of the debt may fall to very low levels even at the long end of the curve, avoiding thus to compromise the independence of the Central Bank.

Effectiveness of QE and HM 

After having analysed the pros and cons of the above unconventional tools, it is important for us to assess their relevance in the crafting of the policy response to Covid-19 in Mauritius. First, we need to recognize that we face a supply shock and not an immediate demand shock that would call for swift Keynesian inspired policies to restore effective demand. Demand is not being pushed down because of a lack of purchasing power but rather because covid-19 has stopped production. This does not mean that policy-makers need not intervene to support workers and firms but the nature and reasons for the intervention have to relate to the problem of supply disruption, at least in the initial stages of the crisis. 

The arguments for intervention are to reach out to sustainable companies whose revenues have dried out, maintain people in employment, ensure that people have food on their tables and maintain social cohesion. Given that the source of the problem is not one of weak effective demand, the transmission effect and the effectiveness of monetary tools would understandably be fairly muted. Lower rates of interest would probably help some companies which still have their heads above water, but not necessarily those with fast dwindling revenues that are unable to pay salaries. A new loan at a lower rate of interest or refinancing of existing loans at lower rates would be largely insignificant for them under current circumstances. What these companies need are either loans with zero interest and capital repayments for two to three years at least, equity capital, or a mixture of both. In an environment clouded with uncertainty and fear (look at the VIX index), companies and households will in all likelihood timidly engage in new projects on the back of new borrowings. 

Given that the repo rate is still at 1.85%, it would be preposterous to consider QE as a policy alternative because there is still room to reduce rates further, on the one hand, and we are not yet in a situation of rapid dwindling money supply and liquidity crunch, on the other hand. Moreover, since we do not face a Keynesian effective demand problem, QE would be even more ineffective than it has been in Europe or the US in supporting the real economy. Once Covid-19 has been contained, fear has been tamed and stakeholders’ confidence rekindled, an accommodative monetary stance would then be more effective in helping accelerate the road to recovery. 

HM would, for reasons described above, be potentially more potent if it is targeted to the right people and the deserving sustainable companies, and it is a one-off time-bound exceptional measure. However, it raises questions on the independence of the Central Bank, carries the stigma of a failing state (Venezuela, Zimbabwe) and. may generate higher inflation and pressures on the value of the local currency. In any case, HM is a means for the public sector to put money in the pockets of households that have lost income and for supporting firms through the lockdown. The same impact can be obtained with more transparency, simplicity and accountability by making the payments out of the Government Budget. Financing the associated budget deficit has the advantage that it needs not require action by the Central Bank. 

Opting for conventional fiscal measures 

Consequently, instead of using unconventional tools, of which QE and HM are only a subset, recourse to conventional fiscal measures of unprecedented magnitude with some twist of monetary support constitutes the preferable option with higher expected rates of impact and transmission. The local market is flush with liquidity and in case the local market is unable to fund the requirements of the massive support programme, recourse to IMF and other DFI’s at very competitive rates and conditions should be considered, bearing in mind the currency risks that borrowings in foreign currency would entail. It is also very clear that prudential norms of fiscal management regarding budget deficits and sustainable debt-to-GDP ratios are bound to explode into pieces during the crisis. 

Given the task at hand and the costs involved, it is fundamental that a careful screening is undertaken to ensure that funds flow only to companies that really need support and that are solvent cum sustainable and that convertible structures of funding with options largely in favour of government be considered. On the determination of the wage assistance support to be provided to deserving and solvent companies, determining a support threshold that is sustainable if the Covid-19 conundrum lasts for a longer period than expected is fundamental. A fairer balance of support between the employees in the formal and informal sector may also need to be considered. Careful thinking needs to be applied to the timing and terms of the unwinding of the support programme. 

In an interesting article, Adam Triggs and Homi Kharas of Brookings Institution, argue that while most recessions so far have either originated from a supply shock, a demand shock or a financial shock, Covid-19 is seemingly offering all of the above shocks in one package. Many economists posit that Covid-19 is, first and foremost, a supply shock problem, which may evolve into a demand shock and ultimately into a financial shock if the supply side origins of the problem are not effectively and timeously dealt with. Dealing with a potential three-headed monster effectively and decisively constitutes one of the toughest challenges that policymakers around the world will probably ever have to face. 

Considering the different policy options, sizing up the costs, the trade-offs and the expected outcomes will undoubtedly form part of the policy-making quagmire in the coming days and weeks. In the above article, we have tried to underscore why, in our view, aggressive conventional fiscal tools on a scale never seen before measure up better to the two other forms of unconventional financial engineering, on the condition that notions of fiscal prudence are placed on the back burner due to the imperatives and urgencies of the day. 

(Note: The above article has been written in my personal capacity and does not reflect the official views of the SEM on the subject matter)

By Sunil BENIMADHU
Director Stock Exchange of Mauritius