Globally, high inflation, lower growth, and tighter financial conditions are the key takeaways from May and so far in June, and this is not a good omen to say the least. US and European inflation have yet to peak and June numbers are likely to be worse than those of May. US and European inflation will likely peak later in the year but will remain elevated over the medium term. Global macro and inflation nowcasters, through the aggregation of hundreds of high frequency macro data are clear: economic momentum is faltering across the globe while inflation pressures are still rising to such an extent that the risk of recession and a stagflation shock in Europe in particular is now on top of both fiscal and monetary policy makers’ minds. With the exception of consumption, so far more resilient, at the expense of savings, the triggers behind such a rapid and continuous downturn in growth dynamics are numerous, but the greatest impact seems to be coming from tighter fiscal and monetary conditions on the one hand, and from inflation’s effect on demand on the other hand.

In this context, and given the acceleration witnessed in core inflation globally, a measure which showcases the spread of inflation beyond food and energy prices, monetary policy will continue to be tightened in a more significant manner in both developed and emerging economies in order to control for second round effects. Countries like Mauritius which lag behind on the tightening front will continue to see their currencies depreciate given rising interest rate differentials. High levels of inflation imported from abroad when combined with the continued debasement of the Rupee will continue to keep inflation in the double digits in the short term and well above pre pandemic levels in the medium to long term. Just one month and a half ago, the Bank of Mauritius sold USD 200 Million in foreign currency which allowed the MUR/USD to temporarily appreciate to 42.95. This when coupled with other factors including a drop in the value of international reserves likely due to the global market selloff led to a decline in the level of its economic capital below the MUR 10 Billion minimum in April 2022 forcing it not to publish its monthly balance sheet which is quite the feat for a regulator to do.

The drop in economic capital below MUR 10 billion does not account for the real market value of Mauritius Investment Corporation’s mis-priced convertible bonds and securities (which have zero conversion option value given bad structuring) with their obscure “scenario based valuation models”. The MUR/USD has been depreciating since and is now back above 44. The April 2022 foreign reserves liquidity template published by the BoM also shows some USD 1.484 Billion in contingent foreign currency liabilities. One also notes the evolution of the amount of securities lent and on repo at USD 1.2 Bn. All this serves to show a better than reality balance sheet with inflated gross foreign reserves and the lack of gun powder. Central banks cannot default on domestic liabilities given their control of the printing press but they need to be careful with foreign liabilities, both on and off balance sheet. This notion that a central bank can maintain any independent monetary policy, have no capital controls and try to fix the exchange rate of the Rupee at the same time has back fired because it defies the law of economics. Only tightening of interest rates can help offset some of the depreciation pressure.

The first observation about the Budget is that the forecasts are wrong and that the quality of nominal growth will be poor given the role of inflation. While the Mauritian economy has continued to recover at a 6.9% clip over the last 12 months, this remains substantially lower than the 9% projection the Government made last year. Given what is happening globally, the 2022/23 8.5% GDP forecasts are unrealistic and will simply not occur. On the other hand, inflation numbers, as measured by the GDP deflator have been well above projections made last year at 6.9%. In many ways, nominal GDP growth which includes both inflation and real growth numbers have allowed budget revenues to come in line with 2022 revenue forecasts made last year. In layman terms, the Government is relying heavily on inflation in order to achieve its revenue, fiscal deficit and debt to GDP targets. For 2022/23, Mauritian growth will begin to slow as Europe slows further. This is likely to start to occur by the third quarter of 2022 while inflation is likely to once again beat budget forecasts. More worryingly, core inflation which strips out food and energy prices continues to accelerate in Mauritius and was clipping 8% year on year in May 2022. In layman terms, inflation is now spreading across the economy and the central bank neither has the will, any quantifiable target and nor the fire power given its balance sheet woes to do anything much about it beyond some partial offsets to rising interest rate differentials.

The second observation then is that the Government will once again rely on inflation more than real growth in order for revenue and debt targets to be met. The political bet is that doling out money from this inflation game will fool most people. The medium term 2023/24 and 2024/25 growth forecasts of 5% are as unrealistic given the lack of structural reforms in both the public and private sectors, unfavorable demographics, high debt levels, low multiplier effect of the real estate centric nature of foreign direct investments, the current quality of the labor force, the lack of openness to immigration and anemic productivity growth. With private debt at more than 95% of GDP as per the 2020 World Bank data and with public debt not far behind, that too thanks to the central bank’s monetization of the deficit, Mauritius remains engaged in a slow deleveraging process that relies too heavily on loose monetary policy and hence on inflation to deflate the debt. In this marriage of convenience between the public and the big cats of the private sectors, high inflation benefits those with large pools of assets and will continue to lead to rising wealth inequality. Based on fundamentals and after the base effects wear off, the Mauritian economy can over the medium term only reach a potential output growth rate in the low 3% range. Any growth above potential would by definition be inflationary anyway.

The third observation then is that these unrealistic medium term GDP growth numbers are driven by the need to show stable inflation, inflated nominal GDP and lower public debt to GDP numbers but given the accuracy of previous forecasts, neither the IMF nor Moodys are likely to be very impressed.

The fourth observation is more alarming. The Government currently has MUR 36.256 Billion in cash stashed away in various special funds with a further MUR 3.949 Billion excepted during this fiscal year. Many in the opposition have in fact jumped on this and argued that more money could have been doled out to the poor and that fuel prices could have been reduced further. Most of this money came from the Bank of Mauritius. There is a complete misunderstanding of how a central bank works in Mauritius and the media is also sometimes too eager to give pretend experts too much lime light which creates more confusion. All this money did not really exist before. The accounts of a central bank should not be confused with those of a company as many accountant commentators are doing now. The central bank essentially created the money out of thin air and credited the account of Government at the central bank when the transfers were made.

Thankfully, the Government’s track record on implementation and spending it has been slow. This money was not generated through any wealth creation driven by an increase in the factors of production which would not be inflationary. This is printed money that is waiting to now be spent by Government. It is money the Government should not have at its disposal. The minute the money is doled out and pushed into the real economy, it will be like pouring oil on the inflation fire. This notion that the Government should use more money from special funds to give it to consumers or the poor so they can spend it in a country where we mainly import most of what we consume is beyond absurd. Printing money to relieve inflation woes is quite the exotic concept that only banana republics would consider as normal. This will lead to more inflation and more currency debasement.

All our politicians including the “experts” who get too much media lime light have lost the plot and are creating a false narrative that we have more money than we think. As mentioned earlier, the central bank is significantly under-capitalized given all the risks it has on its balance sheet and the level of economic capital for it. Even when the Bank of Mauritius sells international reserves in the domestic foreign exchange market in exchange for Rupees, it should technically then destroy the Rupees which is how central banks function when they sell foreign exchange. What is however happening with the MIC is that the Rupees are being redirected outwards via the credit channel and soon venture capital because apparently the staff at the MIC are experts at everything from banking to convertible bond structuring to land development and now to venture cap. When the MIC disburses money, this is also net liquidity injection into the economy and is inflationary. Even Sri Lanka’s central bank has not gone that far but we seem to think that this is fine.

The fifth observation is that there is more loosening rather than tightening to come despite high and rising inflation. For the planned launch of the Central Bank backed digital currency to gain buy in, the Bank of Mauritius will need to remunerate these CBDCs. As more people buy in, the liabilities of the central bank will expand and unless it plans to go into a deeper hole than it is in now, it will need to offset these liabilities with an increase in assets be it via the purchase of longer term Government bonds or via more credit risky lending via the MIC. This is the only central bank in the world that has a wholly owned subsidiary that does what the MIC does. The MIC also has little to do with a sovereign wealth fund and how such funds are funded.

Either the rest of the world is filled with idiots or the joke is on us in thinking that things could be so easy. The expansion of assets by the BoM over time could lead to a setup which counters the impact of any monetary tightening and in fact lead to permanent loosening which will continue to impact inflation and the currency.

What should be done with the money from the special funds is that it should be sent back to the BoM where it came from. On top of this, the central bank will need to reduce the level of excess liquidity in the system via cash reserve ratio increases (no balance sheet to keep on issuing monetary policy instruments) and tighten monetary policy further. Central banks cannot fight inflation that is already there but tighten to tame inflation that is coming 18 months to 24 months from now. Core inflation is too high. The private sector must learn to adapt and restructure rather than playing rentier. The Government should focus on reforms, tell the people the truth about the need to live within our means and the opposition should stop playing politics with printed money while pretending to care about inflation. Inflation certainly makes the private and public sectors happy especially when both have a lot of debt to deflate and when the former has a lot of land assets to monetize but unless we find the right balance between some inflation, structural reforms, a much lesser degree of monetary accommodation, more meaningful public and private sector debt restructuring and asset sales at realistic prices, we risk seeing more social tensions between the haves and the have nots.