A devalued idea

A perfect storm is brewing on the economic horizon. The silent sliding of the rupee against the US dollar is a manifestation of Mauritius’ economic woes. We are witnessing a sharp decline in the momentum of domestic exports, a stunted economic growth, worsening public finances, an increasing year-on-year inflation, rising international oil prices, mounting forces of protectionism on our export markets and, last but not least, a political climate not conducive to instilling confidence into investors, let alone implementing long overdue economic reforms. Under these conditions, a desperate government may cave in to the demand for further rupee devaluation.

However, the belief that currency manipulation can spur export-driven economic growth is a devalued idea. By manipulation, we mean that the value of the currency is not determined freely, but is artificially weakened by the Central Bank to stimulate the country’s net exports. This can be done in three ways: by purchasing foreign currencies on the domestic exchange market, by cutting interest rates or by printing money. In all cases, the supply of rupees increases while the supply of foreign currencies decreases, which induces market players to sell the local currency, thereby leading to its depreciation.

The underlying objective of devaluation is to sell more Mauritian goods to foreign buyers, and to reduce the rupee’s buying power, making imported goods less affordable to the local population. Some call this “improved competitiveness” when, in fact, the country gets poor in terms of domestic purchasing power.

True, the US dollar has been strengthening on the international market. But the monetary policy of the Bank of Mauritius has also contributed to lowering the rupee’s value. Within eight months, the Key Repo Rate has been slashed twice by a total of 65 basis points. Money supply has expanded at a brisk pace with Narrow Money Liabilities (currency with public and transferable deposits) growing by 12.7 per cent year-on-year in November 2016 compared to 8.0 per cent in November 2015. Between the two dates, the Bank made a net purchase of 611 million dollars.

The rupee is trading at its lowest against the dollar, with an exchange rate of nearly Rs 37, slipping from Rs 32 two years back (depreciation of 15 per cent). Inversely, the rupee’s value rose vis-à-vis the pound sterling, from Rs 53.50 on the Brexit referendum day of 23 June to Rs 44.40 on 13 October 2016 (a 17 per cent appreciation on a point-to-point basis). With respect to the euro, the rupee has remained more or less stable at around Rs 39. All in all, the Mauritius Exchange Rate Index based on the currency distribution of merchandise trade climbed from 94.4 in December 2014 to 101.5 in December 2016, indicating a 7.5 per cent depreciation of the rupee.

The fact remains that although Mauritius exports mainly to Europe, 59 per cent of its total exports were traded in dollar in 2015, according to Statistics Mauritius. And 71 per cent of its total imports were paid in the US currency. Export-oriented enterprises import many of their inputs and machines: the high import content of exports mitigates to a large extent the gains of devaluation. Domestic-oriented firms are also hurt as their production costs soar.

An insidious policy of devaluation has been pursued for many decades. While exporters have obtained more domestic money for a given amount of foreign money, the industry has not developed. The number of manufacturing jobs fell from 132,500 in 1990 to 111,700 in 2015. Jobs have instead been created in the tertiary sector which employed 355,300 people in 2015, accounting for 62.7 per cent of total employment. With the change in the economic structure, devaluation cannot grow a service-based economy.

The Governor of the Bank of Mauritius asserts that, while both sectors are vitally important for Mauritius, there is no exchange rate level which is good together for the exports sector and the financial sector. In his mind, “there is not an optimal, model-produced exchange rate level”, but the Bank aims “to have an exchange rate that is broadly stable at an adaptive and equilibrium level”.

An equilibrium exchange rate actually does not exist. Any exchange rate can be the equilibrium value for a business operator at a point in time. An exchange market is a continuing process, not a state of equilibrium which presupposes that competition has ceased. Expectations of future exchange rates are but a small part of the problem of dispersed information. Relative quantities, prices and values are always changing and exist only as a tendency.

There is no point in looking for equilibrium as an ever-receding goal. The Central Bank had better tighten its monetary policy, for devaluation means monetary expansion. Exporters are the first to use the newly created money to buy replacement factors of production at current prices. As the early receivers of the money, they realise greater profits from higher sales. Over time, the new money causes all prices to rise, undermining wealth-generating activities. Wholesalers and importers lose sales, consumers have less purchasing power, and pensioners see their real incomes decline. In effect, the rich owners of the export industries have been subsidised by their fellow citizens who are the late receivers of the new money. The temporary benefits of the exporter are the result of a transfer of wealth, not of manufacturing efficiencies.

To be efficient, we must address the problem of rigidities in the economy, such as labour laws, licensing and institutional bottlenecks. What Mauritius needs to revive its ailing economy is not a weaker rupee but structural reforms.