The Bank of Mauritius recently published its May 2022 and June 2022 balance sheet which confirms the strong need for it to be recapitalized as soon as possible. A central bank is not like your typical corporate and cannot be viewed as such. The central bank exists to bring about price and financial stability.  When it comes to price stability, central banks have various frameworks all across the world that they follow from monetary targeting, exchange rate targeting to various forms of inflation targeting. In the case of inflation targeting, the target itself must be quantified, specified in advance  and the timeline by which the central bank will achieve the inflation target must at least be understood by the market.  The level of inflation that is known today is already in the bag so to speak. The central bank cannot fight something that is already here and nor can it control global commodity price dynamics.

Central banks that have an inflation target aim to deliver on their target that is well understood by the market by anchoring inflation expectations over the medium term. Central banks aim to influence second round effects by influencing demand and that too, over an 18-month to 24-month period.  In an inflation targeting regime, both flexible and fixed, the level of inflation that is chosen to be targeted is subject to debate. It depends on the country and the context. One factor to consider is the distribution of consumption patterns by income strata. The inflation rate for example is calculated on some average consumer basket and is subject to various biases over time. It is important to have a good understanding of the distribution of incomes in Mauritius and then make a decision in terms of what that appropriate level of inflation should be set to.

There are various channels for monetary policy (in our case the policy rate which is currently the repo rate) to impact prices and output. One of those channels is the exchange rate channel which obviously the central bank can partially influence via the yields that it can influence in the secondary bond market and in the money market.  When it comes to influencing behavior of various market and economic participants over time, credibility is key. The central bank must conduct various open market operations for example, which the markets should view to be in line with its mandate. The level at which the key policy interest rate should be set at depends on the level of inflation that it is targeting over the medium term and on other factors as well which are all very clearly specified and dependent on the specifics of the framework that is being used.

 A central bank that is targeting an inflation rate of 4% over the medium term when current inflation is let's say it 10% cannot claim to have a tight monetary policy stance  when a 3-month treasury bill is at 1%.  It is important for the central bank to conduct various costly monetary operations in order to bring the market to a place that is in line with its monetary policy stance. The central bank needs a balance sheet to do this.  Whether they be treasury bill yields especially at the shorter end of the yield curve  or the interbank rates, all these yields need to be very close to the policy rate else the policy rate becomes meaningless. If you look at the repo rate right now it is a 2.25% but then if you go and look at the Treasury bill rate in the secondary bond market or at the interbank rate they are well below this level. The reason why they're so low is simply because in this environment of excess liquidity, the central bank doesn't have the balance sheet to align short term market rates to the repo rate because it would cost it a lot of money to bring these rates much closer to the policy rate. Obviously that impacts its credibility.

 The level of economic capital that is required to conduct effective monetary policy needs to be estimated quantitatively by looking at all the risks that exist on its balance sheet.   Central Banks typically now look at tail risk measures such as value at risk or expected shortfall at a very high confidence level and assess various risk factors to ensure that they have an adequate level of economic capital to conduct credible monetary policy. There should be no debate about the central bank not having enough economic capital to deliver on its mandate.  The fact that we are even talking about it is already a problem.  We're talking about it because the government has created a hole on the balance sheet and a big hole at that given all these transfers.

Currently in Mauritius, the central bank does not have a quantifiable inflation target that it is accountable for and so when we talk about price stability, we don't really know what that even means.  We also have no idea about how long the central bank aims to achieve whatever inflation number it has in its mind.  The central bank also appears to have changed its focus from year on year inflation to a headline inflation rate which frankly is something that historically various governments have used as a smoothed number during wage negotiations with labor unions. Central banks which have an inflation targeting mandate will look at year on year inflation which simply looks at the change in prices between this month compared to the month of the previous year rather than some moving average number which is hard to interpret and was never meant to be used as a policy anchor but as a wage negotiation anchor. The inflation target has to be very clear to your financial market for you to be able to influence expectations. 

Before we dwell on the specifics of the latest balance sheet, the context is very important. The central bank has made large transfers to the government and all this money is currently sitting in special funds. All this money that was transferred from the Bank of Mauritius to the government is not money that was generated from any real economic activity. This is called money printing and by definition this is inflationary.  Printing money and then transferring it to government is no amazing feat in itself.  This is not something the government should be congratulated over. It is very easy in fact to print money and transfer this electronically to the government accounts at the Central bank. 

The likes of Zimbabwe and Venezuela have done this in the past too and it did not work so well then either.  The amount of money found in special funds is not a symbol of our economic strength but rather a symbol of our economic weakness and desperation to fund an unsustainable fiscal path.

We're not really richer than we think. When we print money and transfer it to the government which then spends this money or distributes it in any way shape or form. In a country where we import most of what we consume, this can only lead to depreciation and more fuel to the inflation fire. Whether you look at the opposition or the current government, few have any plans to return all that printed money back to the central bank. The minute this money gets spent it is going to create problems for us and also add to the excess liquidity problem which we already have.  The banking system currently has 30 billion rupees in excess liquidity.  There's a lot of money already flying around all over the place looking for viable deals yet to be found and that 30 billion would have been higher had the Central Bank not increased the cash reserve ratio requirements from 8% to 9% in July of 2022.  This notion that the central bank is tightening monetary policy is timid at best given the level of negative real interest rates and given the amount of liquidity that exists in the system that is not being mopped up despite the CRR increase.  Excess liquidity distorts everything including credit spread mispricing which is prevalent in the local corporate bond market and damages the transmission mechanism of monetary policy. In layman terms, it makes the central bank ineffective.  The Central Bank can counter this by mopping up a lot that liquidity but it needs a balance sheet to do that because these things are very costly and that's where the problem is right now.  The CRR increase is less costly but it can be highly distortive to the market given that it is a very crude and outdated tool when compared to open market operations.  A central bank can of course manage the level of economic capital that it has by controlling and managing the level of assets and liabilities.

The latest publication of the Bank of Mauritius balance sheet leads to the following observations.   In February of 2022, the Bank of Mauritius had some 128 billion rupees of Bank of Mauritius monetary policy instruments outstanding. This instruments are used to control the level of excess liquidity in the system. In essence, the central bank removes rupee liquidity in the system in order to maintain rates within some range by issuing Bank of Mauritius bills and notes in exchange.  The June number however stands at 107 billion rupees. In a nutshell, the Bank of Mauritius reduced its liabilities and relied more heavily on the cash reserve ratio increase. That's one way in which it managed its balance sheet and tried to keep the level of economic capital from falling further.  The increase in the CRR requirements ensured that interest rates locally did not collapse as it reduced the amount of Bank of Mauritius monetary policy instruments outstanding.  We should also understand here that despite this, interest rates in Mauritius when compared to inflation are highly negative.  The second observation relates to the numbers for May 2022.  The level of economic capital during that month stood at 13 billion rupees but you must also strip out the 5 billion comprehensive loss. If you do this, the level of economic capital as at May would actually stand at less than the 10 billion minimum or at 7 billion rupees.  We should also remember that this number would have been negative had the currency not depreciated so significantly between March and May 2022.  The third observation from the balance sheet is that during the month of June, cash and cash equivalents which come from international reserves on the asset side increased by around 34 billion rupees.  As stated in the latest IMF article IV, the level of international reserves in Mauritius has been highly influenced by the amount of money that commercial banks locally place at the Central Bank and secondly by foreign borrowings. Typically these would be offset under other liabilities and liabilities to banks and should not have a major impact in the level of economic capital.  However, if we look at the foreign reserves liquidity template, under memo items, we do see that the central bank is including 1.2 billion dollars in securities on repo and securities lending in section 1 of that template and is very much part of its assets.  There is a degree of bloating of assets that is going on and that's perfectly legal but it is important to take into account when thinking about the real level of economic capital when compared to the one that is being shown from an accounting perspective.  The fourth observation is that if we compare the value of securities held at fair value through profit and loss in February 2022 and June 2022, we see that the Bank of Mauritius has indeed suffered some losses in its investments although those foreign investment loss numbers are being largely offset by the significant depreciation of the rupee during that same time period.  Had the Mauritian rupee not depreciated, such losses would have taken the Central Bank balance sheet into negative territory.  This brings us to an interesting comment purported to emanate from the central bank which is doing the rounds in the media. This essentially relates to the Bank of Mauritius allegedly not being able to publish its monthly balance sheet on time because fund managers did not report these numbers on time given heightened market volatility. This is a very odd statement emanating from a regulator of a global financial center. Even in the private equity markets, one can obtain pricing or some type of estimation much faster than this and I assume that the Bank of Mauritius is not investing in private equity with international reserves given its 2019 amendment to the bank of Mauritius act in terms of how it explicitly ranks liquidity and then security and then return in that order when it comes to international reserves. All other marketable securities whether they be equities or any type of fixed income security or gold have real-time pricing in financial markets.   Heightened volatility doesn't make prices disappear. In 2022 all derivative instruments are also valued on a daily basis. Everything is marked to market. If this statement was correct, this would mean that the entire global financial system would have already collapsed by now which is obviously not the case.

There should be no reason why it would take so long for fund managers to provide valuations to the Bank of Mauritius.  More clarity is needed in that statement unless it was made in error. In fact, the Bank of Mauritius should contact the regulators of these fund managers if they're not providing valuations in a timely manner. They should be able to provide that daily or regulatory action in the relevant jurisdiction should be taken against them.  Such things just do not happen.

Interestingly, the Bank of Mauritius has not actually published its March and April balance sheet numbers. It has skipped it preferring to report the May 2022 and June 2022 numbers instead.

Even if the fund manages took more time than usual which is a very odd thing to happen in this day and age and would have likely led to regulatory action on them by international regulators by now, why are they not reporting the March and April numbers and publishing them but yet somehow reporting the may and June numbers ?

 By just doing some simple mathematics, it is obvious that this is more likely  because the balance sheet numbers for March and April would have been  much worse than those of May and June because the rupee had yet to depreciate significantly after the much advertised 200 million dollar largest ever  intervention wherein the Bank of Mauritius sold foreign exchange in the market which made the rupee appreciate significantly over that weekend.  Given that the Bank of Mauritius has a large percentage of international assets to total assets and that it reports its accounts in rupees, a sudden and significant appreciation of the currency when its level of economic capital is so weak would have caused it to go into negative territory.  There is an argument to be made about why the central bank reports its accounts in rupees when most of its assets are in foreign currency. In fact many central banks actually report their accounts in terms of a currency basket that matches the currency distribution of imports or imports and external debt.  It could also have a mix which would include the rupee but not exclusively so.

The central bank in Mauritius should also look into such things especially when the appreciation of the rupee is the biggest risk factor it likely faces and especially when the depreciation of the currency which benefits its balance sheet goes against its price stability mandate.

The Central Bank is not like a normal company but that is not to say that it can run without an adequate level of economic capital either no matter in what currency or basket of currencies the balance sheet is being reported in.

When a central bank has an economic capital that is negative, it means that it needs to print money to finance its liabilities and that goes against its inflation targeting mandate or price stability mandate. The Bank of Mauritius is also planning to launch a CBDC in the near future and these will even complicate the way in which it manages assets and liabilities. CBDC in the current context can also complicate monetary policy making given how it can influence the level of assets the central bank holds over time to offset its liabilities.  It is important for the central bank to conduct an independent asset and liability study that takes all the risks that it has and plans to have on its balance sheet into account especially those coming from international reserves, CBDCs and the Mauritius investment corporation.  Of course it must look into the currency in which it is reporting its balance sheet first.

Based on that assessment of economic capital requirement based on a quantitative assessment of various tail risk measures and scenario analysis including stress tests, it must seek to be formally recapitalized over some time frame by the government. This means that the government will need to refund the Bank of Mauritius all that money sitting in special funds (and cut spending) and on top of that the government will need to borrow money which will increase public debt.  This will completely mess up the budget and spending plans of the government.  This may not be something the government wishes to do but it is something that is in the national interest to do else we do not have a central bank that is credible and that functions for all practical purposes of conducting monetary policy and meeting the mandate of price and financial stability. Spending printed money is not a grand idea and the sooner the government realizes this the better.

The last observation I will make relates to the downgrade of Mauritius to Baa3 with outlook stable which was driven by a degradation of our institutions including as mentioned in the Moody's report concerns about the central bank and its balance sheet and the wholly owned subsidiary that is the MIC. Interestingly, the Mauritius Commercial Bank, the largest commercial bank in the country got a slight upgrade to the outlook at least from negative to stable meaning that Mauritius and the Mauritius Commercial Bank now have the same credit  rating. This doesn't happen all the time but it is quite interesting that while the central bank has seen its balance sheet being largely  cannibalized (because of the transfers, the cost of the bailouts to the private sector  born by the MIC) and has been highly criticized in the way in which it has kept the Mauritius investment corporation on its balance sheet and brought all sorts of credit risk on it when it's already has an economic capital problem, that at the same time a commercial bank has seen its profitability and capital position improve.  It is indeed an interesting country where the central bank balance sheet gets cannibalized while the bailouts that it does to the private sector via the MIC allows a commercial bank to get an upgrade in the credit rating.  The issue is not about the bailout in itself but it is about the extent that we went to and the risk and burden sharing.

 Let there be no mistake that had the central bank not created the MIC and backstopped a lot of that credit risk to its own balance sheet that the situation would not have been as positive for the banking sector.  The way the BoM structured the MIC and the way it priced some of those convertible bonds and the way it bought over-priced land and the way it doesn't take the fact that many of the companies it bailed out had problems well before the pandemic started is the problem.

A lot can be said about equitable burden sharing and on who gets the shorter end of the stick in Mauritius. Paradise is indeed an interesting place to live in when we go to such an extreme no one else on the planet has gone to save a largely patrimonial non-financial private sector that has more often than not been asset rich on paper but very free cash flow poor in practice.