Monday, November 3, 2008


Article publié le Mercredi 29 octobre 2008.

Besides tourism and textile – that are undoubtedly going to suffer from the general slowdown, the property and stock markets are likely to feel the brunt. The authorities must make the right decisions.

It is said that the global financial crisis will be hitting mainly our textile and tourism industries which account for 15% of our gross domestic product (GDP). A slowdown of the Mauritian economy, which is a likely eventuality in 2009, will be caused by real factors in the form of falling export orders and tourist arrivals. The Finance minister seems to be prepared to spend his way out of these exogenous shocks. A fiscal response, if well targeted, can help avert a recession. On the other hand, a misguided monetary stimulus through a lowering of the key Repo rate would give an endogenous shock to the economy.

At present, the crisis is doing collateral damage to two of our sectors: the stock market and the property market. Both are asset markets sharing the common belief that they will keep rising no matter what happens to the real economy. This is an illusion but it has led Mauritians to become reckless in their speculations. Now the stock bubble bursts and the real estate boom starts to unravel.

The Semdex has crashed 770 points, or 37%, since its peak of 2,101 points achieved on 18 February 2008. Although the values of the blue chips remain within their fundamental worth, stockholders prefer to convert assets into cash. For their part, many property owners are still convinced that real estate is the one sure bet in economic life. But they have pushed property prices so high, in some cases up to three times their original value, that they can only fall back drastically as the supply of new buyers runs out.

“The resource gap,as measured by the difference between saving and investment, stood at 4% of GDP in 2005, exploded to 7.2% of GDP in 2006, narrowed to 3.8% of GDP in 2007 but widens again to 5.8% of GDP this year. ”

The substantial rise in the prices of real estate assets and capital goods has been fuelled by negative real interest rates on the back of an inflation rate higher than term deposits rates and even treasury yields. Our economy has been buoyed up by an investment boom in the most capitalistic sectors, namely the construction industry. According to the Central Statistics Office, the 11.3% real growth in private investment estimated this year “would be mostly attributable to high investment in commercial and office buildings, hotels and IRS projects”.

The real risk to the Mauritian economy is that these excesses will unwind as building and real estate developers realize that their investment projects are overly ambitious. The latter have been financed by credit expansion when economic agents have been unwilling to sacrifice their consumption and raise their voluntary saving. Entrepreneurs act as if households had increased their saving when they have actually not done so.

Voluntary saving has not only failed to keep pace with economic growth, but it has also fallen to a negative rate in real terms. In 2008, gross national saving rose by only 3.3% against a nominal GDP growth of 12.2% and at a lower rate than the 6.3% inflation rate shown by the GDP deflator. More worrying is the fact that saving lags well behind investment for the fourth consecutive year.

The crux of the economic problem of Mauritius lies in its resource gap as a consequence of higher investment relative to saving. The resource gap, as measured by the difference between saving and investment, stood at 4% of GDP in 2005, exploded to 7.2% of GDP in 2006, narrowed to 3.8% of GDP in 2007 but widens again to 5.8% of GDP this year. Society’s investment cannot possibly exceed its voluntary saving for long periods.

The final amount of saving and investment must always be identical ex post. No society can durably force economic development by inflating investment through credit expansion unbacked by a parallel increase in voluntary saving. Any level of investment that exceeds that of saving results in wrong investments of the country’s saved resources and finally in an economic crisis.

Misallocation of resources has been encouraged by uncontrolled growth in the money supply as loans have been granted at below the natural rate of interest that balances voluntary saving and demand for capital. From 1991 to 2006, the money supply M2 in the form of bank notes and deposits grew at an average rate of 13% per year, thus increasing six times. Between March 2000 and January 2004, the savings interest rate was continuously cut from 9% to 4%.

The shock of monetary growth has distorted the productive structure and made it artificially capital intensive. The Austrian business cycle theory teaches us that recession is triggered by a shortage of saving, i.e. saving insufficient to complete capital intensive investments launched by error. Borrowers who have invested in long term capital projects will be called upon to improve their balance sheet.

In public pronouncements, our Finance minister regards recession as reflecting a fall in demand for products or labour, which can be corrected by ramping up spending. According to this view, common to Keynesians and monetarists alike, injecting more money in the economy would help avoid a recession. But such a policy could delay necessary liquidation of unwise investments. Instead, the government should reprioritise spending in favour of viable firms.

Our banks need to be extremely cautious about credit quality. They may suffer large losses on property lending as credit to construction has posted a 34% annual growth in August. The Bank of Mauritius may respond to the surge in property prices by using regulation, not monetary policy, with a tightening of mortgage lending standards.

When the cash reserve ratio (CRR) was raised to 6%, banks were supposed not to move up their prime lending rate, but they did not keep their word. Whereas they are not remunerated on their cash balances at the central bank, they are borrowing funds via repurchase transactions at 9.5%. A reversal in CRR would be a magnanimous gesture in return for a reduction in lending rates.