Tuesday, October 28, 2008

The financial crisis and its impact on Mauritius

Article publié le Mercredi 22 octobre 2008

The economic outlook in the US and EU, the two largest export markets of emerging countries, has worsened as the credit crisis has deepened and some major players are in recession. How does this affect us?

The now famous “financial crisis”, which started in the US markets in July 2007, has already had a spill-over effect on European banks and other global major banks and economies. A recent observation that sums up of how people view the current situation: “On the left side of the balance sheet, nothing is right, on the right side of the balance sheet, nothing is left.” Though some might argue that most economies are decoupled with one another, we believe that the Mauritian economy and local stock market is fairly correlated with US and European economies. From February 2008, the local stock market and Mauritian economy (which have seen growth forecasts trimmed) have been put under enormous pressure and major players such as the Central bank have been in the dilemma of sustaining growth or inflation control, thus the split in the Central Bank Monetary policy.

Between the positive assurances of our ministers and the pessimistic outlook of our lobby groups, it can be hard to make sense of how the financial crisis has and will continue to affect the Mauritian economy. Being a small and open economy, Mauritius can hardly be sheltered from global economic hiccups. Over the past six months, exports to Europe, our main trading partner have come under increasing pressure and tourism receipts have slowed. Over the next year, the current account deficit is likely to widen and volatile capital inflows should continue to slow. Despite a favourable interest rate differential, the Mauritian Rupee has come under sustained pressure since the end of April and has since then depreciated by 17% vs. the USD putting a negative dent on inflation. The medium term outlook for the MUR/USD remains uncertain but biased towards the downside unless a sudden large inflow of Foreign Direct Investment. On its part the mere fact that Europe may be in deeper trouble than the US has had a negative impact on the EUR and the USD has rallied from 1.58 to 1.34 USD/EUR. Volatility in the MUR/USD exchange rate has shot up in recent months and the recent 40M dollars worth of dollar sales in the FOREX market has done precious little to break the Rupee’s volatile trend. Hence the Rupee has been negatively affected by the crisis so far. Over the next twelve months, the Bank of Mauritius is likely to be forced to sell more dollars in the market as our trade balance deteriorates (supply of forex dries up as export receipts slow) which in turn is likely to absorb in a certain amount of Rupee liquidity out of the money markets. The crisis seems to have redirected the priorities of the Monetary Policy Committee towards growth rather than inflation. Real interest rates in Mauritius are negative and detrimental to long term growth.

Growth picture towards the downside

Mauritian stocks too have not been sheltered from this crisis. While sensitisation by the media has certainly contributed to a certain degree of panic and aberration in the prices of certain stocks, local fund managers have continued to increase their cash positions and have reduced their exposure to the hotel stocks favouring instead the relatively more stable and liquid bank stocks. This in our view puts a floor on the prices of these stocks as our market remains dominated by institutional based funds. The grey outlook for Europe has darkened significantly in recent months, so too is the performance of our hotel stocks. Whilst many have sold in panic, investment professionals have already priced in the less rosy earnings outlook for 2009 and have substantially raised the cash level of their portfolios starting July 2007 and June 2008. Once there is more certainty as to when Europe and global economy will recover, we may see rotation towards hotel stocks again which is not likely to happen any time soon or before first half 2009.

On the inflation side we have noticed that it has negatively affected profitability across the board as operating costs have increased drastically. The growth picture, as we see it, is biased towards the downside in 2009 but GDP growth should, we believe, remain above 4%.

However, we believe that there is value to be found in many stocks, with many of them trading at a Price Earnings Ratio below 10, for investors with long term view. There will be a lot of volatility in the coming months and while prices remain biased towards the downside in the short term, if you are patient and have a well diversified portfolio, we would certainly recommend staying in this market for now or coming in when prices are so depressed.

As many believe that the current crisis can be judged in retrospect as the worst one since Second World War we believe that the global economy is in better and stronger shape than it was in other crises, thus has no reason why it will last forever. Despite the financial pain, stock markets will surely forget this financial hangover when the next speculative party begins. Financial markets aren’t dancing now, but they will surely dance someday, it is not the first crisis and surely will not be the last one. Investors must remember that the stock market is forward looking and is a leading indicator of economic activity as it tends to recover before the economy or falls fall before a recession. If Europe recovers in 2010, then our stocks should begin to recover in 2009.

Shekar GOPAL-Business Development Manager [Ipro Investment Professionals Ltd]