Mauritius: Staff Report for the 2001 Article IV Consultation

Mauritius experienced a rebound in economic activity, following a severe drought. Executive Directors welcomed the tightening of monetary policy, and noted the reversal of the real currency appreciation. They supported the initiatives to strengthen and modernize the financial sector and the institutional framework for the conduct of monetary and exchange rate policy. They emphasized the need to reduce unemployment, and suggested that the quality and timeliness of economic and financial statistics are satisfactory from the standpoint of conducting surveillance.

Abstract

Mauritius experienced a rebound in economic activity, following a severe drought. Executive Directors welcomed the tightening of monetary policy, and noted the reversal of the real currency appreciation. They supported the initiatives to strengthen and modernize the financial sector and the institutional framework for the conduct of monetary and exchange rate policy. They emphasized the need to reduce unemployment, and suggested that the quality and timeliness of economic and financial statistics are satisfactory from the standpoint of conducting surveillance.

I. Recent Economic Developments

1. Mauritian economic performance over the last two decades has been remarkable and among the best in sub-Saharan Africa. Real GDP growth has averaged 5.4 percent per year, while inflation has declined from over 10 percent to less than 5 percent. At the same time, social conditions have also improved, with life expectancy at birth having increased from 61 years in the 1960s to 71 in the 1990s, primary enrollment from 93 to 105 percent, and the Gini coefficient, a measure of inequality, having declined from 0.5 to 0.37.

2. In 2000/01 (July-June), Mauritius is enjoying an economic recovery, spurred by a rebound in agricultural production following the drought in 1999/2000 (Figure 1). Real GDP is projected to grow at 7.8 percent in 2000/01, up from 3.6 percent in the previous year (Table 1). Aided by the nominal appreciation of the Mauritian rupee and restrained monetary conditions, measured consumer price inflation (annual average) is on a downward trend, declining from 7.9 percent in 1998/99 to a projected level of less than 5 percent in 2000/01. However, inflation would have been higher had the government passed through in full the higher import prices for petroleum products to the consumer.

uA01fig1

Mauritius: Output, Employment, and Prices, 1990/91-2000/01 1/

(Annual percentage changes; percent)

Citation: IMF Staff Country Reports 2001, 077; 10.5089/9781451827729.002.A001

Sources: Central Statistical Office; and Fund staff estimates and projections.1/ Fiscal year from July to June.
Figure 1.
Figure 1.

Mauritius: Output and Demand, 1990-2000

Citation: IMF Staff Country Reports 2001, 077; 10.5089/9781451827729.002.A001

Sources: Mauritian authorities; and Fund staff estimates.
Table 1.

Mauritius: Selected Economic and Financial Indicators, 1996/97-2000/01 1/

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Sources: Bank of Mauritius; Central Statistical Office; Ministry of Finance; and Fund staff estimates and projections.

Fiscal year from July to June.

Sugar crops and milling included in fiscal year harvested; otherwise, averages of calendar-year data.

Excluding changes in stocks.

Excluding the acquisition of aircraft and ships.

Trade-weighted period averages (a negative sign signifies a depreciation). Data for 2000/01 are for July 2000 to January 2001.

From 1995/96 to 1997/98, net lending includes the on-lending of the proceeds from an international floating-rate note (FRN) issue of USS150 million. In 1998/99 and 2000/01, it includes the repayment of USS33 million and US$117 million of the FRN, respectively.

Changes in indicated aggregates as percent of broad money at the beginning of the period.

Maximum interest rate on fixed deposits with maturities of between six and twelve months. The rate for 2000/01 is for January 2001.

Including transfers.

The reserves of the Bank of Mauritius are not pledged as collateral for short-term liabilities, nor are they sold forward.

3. The trend rise in unemployment, evident since the early 1990s, has continued, with the unemployment rate climbing to 7.2 percent in 1999/2000, and close to 8 percent in 2000/01 (see figure above). Real wage growth in excess of productivity growth has accounted in part for this development.

4. Notwithstanding a decline in the terms of trade of about 4.4 percent (reflecting higher oil import prices) and a real effective appreciation of the Mauritian rupee of close to 6 percent in 1999/2000, the external current account balance shifted from a deficit of 1.6 percent of GDP in 19998/99 to a surplus of 0.5 percent of GDP in 1999/2000 (Table 2). A resilient tourism sector and buoyant exports to the United States, both reflecting the strength of the world economy, as well as significant sugar reinsurance receipts and strong productivity performance in the manufacturing sector, contributed to this strong external performance. As the effects of the currency appreciation are felt, and consistent with the global economic slowdown, the current account balance is projected to revert to a deficit of 1.2 percent of GDP in 2000/01.

Table 2.

Mauritius: Balance of Payments, 1996/97- 2000/01 1/

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Bank of Mauritius; Ministry of Finance; Mauritius Sugar Syndicate; and Fund staff estimates and projections.

Fiscal year from July to June.

In 1998/99, portfolio investment outflows include the partial repayment of US$33 million of the floating-rate note (FRN). In 2000/01, they include the repayment of the balance of the FRN of US$117 million.

Includes movements in international reserves of commercial banks.

Including valuation adjustments.

End of period.

Excluding the acquisition of aircraft and ships.

Market rate.

5. Fiscal policy was relaxed in 1999/2000. The ensuing deterioration in the public finances was mainly the result of a downward adjustment in domestic petroleum prices of about 10-20 percent (and only a marginal increase in electricity prices) in the wake of a sharp rise in international petroleum prices through 1999 and 2000. Large operating losses were accumulated at the state-owned enterprises responsible for oil imports (the State Trading Corporation, STC) and electricity generation and distribution (the Central Electricity Board, CEB). As a result, the overall fiscal deficit (including parastatal accounts) increased from 4.0 percent of GDP in 1998/99 to 5.5 percent of GDP in 1999/2000 (Table 3).

Table 3.

Mauritius: Summary of Government Finances, 1996/97-2000/01 1/

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Sources: Ministry of Finance; Bank of Mauritius; and Fund staff estimates and projections.

Budgetary central government. Government Finance Statistics basis, unless otherwise indicated; fiscal year from July to June.

In 1996/97 and 1997/98, net lending includes the on-lending of the proceeds from an international floating-rate note (FRN) issue of US$150 million. In 1998/99 and 2000/01, it includes the repayment of US$33 million and US$117 million of the FRN, respectively.

The consolidated state-owned enterprises comprise the State Trading Corporation, the Central Electricity Board, and the Central Water Authority.

Exceptional factors include the on-lending of the proceeds from the FRN equivalent to 2.2 percent of GDP in 1996/97 and 0.1 percent of GDP in 1997/98. They also include the repayment of the FRN on-lending equivalent to 0.8 percent of GDP in 1998/99, and 1.3 percent of GDP in 2000/01, as well as the proceeds from the sale of fixed assets equivalent to 0.5 percent of GDP in 1998/99 and 0.4 percent of GDP in 1999/2000.

Overall balance after grants, excluding interest payments.

6. In September 2000, the incoming government attempted to reverse the deterioration in the public finances. While raising domestic consumer prices of petroleum products by 50-90 percent and electricity by some 20 percent, it lowered excise taxes on petroleum products,2 zero-rated the value-added tax (VAT) for electricity and water, introduced a temporary subsidy for bus operators, and granted the electricity parastatal additional rebates on customs duty for the import of oil. The net fiscal improvement due to these measures was estimated at about 1.3 percent of GDP.

7. Notwithstanding the corrective actions taken, the overall fiscal deficit is likely to widen from 5.5 percent of GDP in 1999/2000 to 7.6 percent of GDP in 2000/01 (Table 3). This widening is attributable to lower revenue resulting from the tariff cuts introduced in June 2000 (1.3 percent of GDP) and to lower nontax revenue (0.9 percent of GDP), and it is being reined in by reduced expenditure of 0.9 percent of GDP (mainly owing to a large repayment to the budget of the previously on-lent floating rate note).3 Nevertheless, the government’s net borrowing needs were sharply reduced by the proceeds from the privatization of Mauritius Telecom (see below).

8. Monetary policy was also tightened in September 2000. To head off inflationary pressures at a time of recovering growth, the authorities raised the Lombard rate4 to 12.5 percent in two steps of 50 basis points each in late-September and November 2000. This action reversed a sequence of previous interest rate reductions, when the Lombard rate was cut from 14 percent in December 1999 to 13 percent in March 2000, and to 11.5 percent in June 2000.5

9. Starting in October 2000, the Mauritian rupee depreciated against the U.S. dollar, reflecting the adjustment to the accumulated financial imbalances. As the euro, in turn, stabilized against the U.S. dollar, the rupee eased in real effective terms by about 7.5 percent between October 2000 and January 2001, reversing almost entirely the appreciation during 1999 and 2000 (see figure below and Figure 2). In mid-2000, the Bank of Mauritius (BOM) reintroduced a 50 percent surrender requirement on the export proceeds of the Mauritius Sugar Syndicate. The BOM provided targeted assistance to firms in the export processing zone (EPZ) through much of 1999 and 2000.6 This assistance reflected the accommodation by the BOM of pressures from the export industry in the wake of the appreciation of the rupee in real effective terms through late 2000.

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Mauritius: Nominal Exchange Rates, January 1999-January 2001

(Monthly period averages)

Citation: IMF Staff Country Reports 2001, 077; 10.5089/9781451827729.002.A001

Source: IMF, International Financial Statistics.1/ Foreign currency per Mauritian rupee; index 1990=100; increase denotes appreciation.
Figure 2.
Figure 2.

Mauritius: External Sector, 1983-2000

Citation: IMF Staff Country Reports 2001, 077; 10.5089/9781451827729.002.A001

Sources: Mauritian authorities; and Fund staff estimates.

10. After long delays, the government’s privatization program got off the ground when in November 2000 it sold 40 percent of its shares in Mauritius Telecom for US$261 million (or 5.7 percent of GDP) to France Telecom. This large inflow of foreign direct investment more than offset the final repayment of US$117 million on the floating rate note (outflow of portfolio investment) that was borrowed in 1995/96.

11. The near-term outlook for growth remains generally encouraging, but the deterioration in the public finances and the continuing rise in unemployment pose downside risks. Following the recovery in 2000/01, real GDP growth is expected to converge to its trend level of 5.5-6 percent. Inflation is likely to remain largely unchanged at about 5 percent, and the current account deficit is expected to widen slightly to about 1.5 percent of GDP in 2001/02.

II. Report on the Discussions

A. Overall Framework

12. The discussions with the authorities focused on (1) the medium-term growth strategy, including the appropriate structural reforms, and (2) the appropriate short-term financial policies, which would not only address the emerging macroeconomic imbalances but also support the medium-term economic expansion.

13. The challenge facing the new government of Mauritius is to perpetuate the economic success of the past against the backdrop of a changing economic environment. A favorable external environment, overall stable macroeconomic policies, and a development strategy of targeted intervention, as reflected in the support of selected industries located in the EPZ, has contributed to sustained economic growth, averaging close to 6 percent annually (Box 1 and Figure 3).

Figure 3.
Figure 3.

Mauritius: Growth Accounting, 1985-97

Citation: IMF Staff Country Reports 2001, 077; 10.5089/9781451827729.002.A001

Sources: Mauritian authorities; and Fund staff estimates.

14. Two developments in the economic environment—demographics and external trade—were likely to warrant changes in the current strategy (Box 2). First, the decline in fertility and the aging of the population would decrease the available pool of labor for the economy, thus reducing the long-term growth potential. Second, changes in the World Trade Organization (WTO) rules would constrain export subsidization policies, while likely changes in the trading environment7 would weaken the profitability of the two main export sectors, sugar and clothing. The consequences for exports and private savings could be substantial.8 However, the U.S. African Growth and Opportunity Act (AGOA) could mitigate the impact of some of these adverse developments, particularly in relation to exports of clothing (Box 3). Nevertheless, the combined impact of population aging and loss in preferential access would likely reduce domestic savings by up to 4-5 percentage points of GDP in the medium to long term, placing limits on the amount of domestic investment.

Mauritius: Targeted Intervention and Preferential Market Access

Mauritius has followed an unorthodox development strategy. While incentives are broadly neutral between the import-competing and exporting sectors, neutrality was the result of heavy intervention in both sectors.

Imports were, and continue to be, restricted. Mauritius elicited a rating of 6 on the Fund’s restrictiveness index in 2000 (down from 10 in 1990). While tariffs have recently been reduced, particularly for intermediate goods and raw materials, they remain high and dispersed, and the tariff schedule riddled with exemptions. Nontariff barriers, in the form of state trading in selected commodities, are also present.

However, the anti-export bias stemming from import restrictions has been offset by extensive “export subsidization.” The latter has resulted from government policies, as well as those of partner countries:

  • Preferential treatment (on corporate income taxation and terms of credit and, until the late 1980s, in regard to labor laws) of companies based in the export processing zone (EPZ) has provided substantial export subsidization.

  • Externally, Mauritius has benefited from preferential access for its two main export products: on sugar exports mainly to die European Union (EU), it has a guaranteed quota and a guaranteed export price that is well above international market prices; on clothing, it has benefited from unrestricted access to the EU market, while competitors have faced quotas. These benefits have improved the terms of trade and increased the returns to exports. Thus, the arrangements in sugar have provided an implicit export subsidy that has averaged about 90 percent during the last 25 years. Crucially, from a macroeconomic perspective, the benefits have led to increased private savings and investment in the economy. It is estimated mat preferential access for sugar alone has resulted in a transfer from EU consumers to the Mauritian economy of about 5.4 percent of GDP a year between 1975 and 2000.

The successful elimination of the anti-export bias is reflected in the performance by firms in the EPZ, which has driven Mauritian growth.

Output in the EPZ (which accounts for about 12 percent of total value added) grew at an annual rate of 10.2 percent between 1982 and 1999. During this period, it accounted for about one-fourth of overall growth.

Moreover, EPZ growth performance, unlike aggregate growth, has been underpinned not just by rapid factor accumulation, but also by very high rates of total factor productivity (TFP) growth.

Mauritius: Growth Accounting for the Export Processing Zone, 1982-99

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Source: Fund staff estimates.

Mauritius: Changes in the Economic Environment

The Mauritian economy is likely to experience a number of economic changes over the medium to long term, with important consequences for policy.

On the domestic side, future demographic changes will reduce the long-term growth potential, strain the public finances, and depress aggregate savings:

  • As the figure below shows, as fertility rates decline and the population ages, labor force growth is likely to decline to less than 1 percent per annum over the next 10-15 years and to about 0.6 percent thereafter. In this context, the ratio of retirement age population to working-age population will increase from 14 percent to 46 percent and the overall dependency ratio from 51 percent to 80 percent.

  • These developments will have two key macroeconomic effects: the decline in labor force will, ceteris paribus, reduce the economy’s long-run growth potential; and increasing dependency rates will likely reduce both private and government savings rates.

uA01fig3

Mauritius: Projected Demographic Trends, 2000-45

Citation: IMF Staff Country Reports 2001, 077; 10.5089/9781451827729.002.A001

Sources: Mauritian authorities; and Fund staff estimates and projections.

On the external front, changes in the trading environment will constrain export policies, reduce the returns to exports, and decrease private savings.

The elimination of the global quotas on clothing under the Multifibre Arrangement (MFA) by the European Union (EU) and the United States by end-2004 will reduce the preferential access enjoyed by Mauritian exporters by exposing them to competition from other exporting countries, including those in Asia. Ongoing negotiations between the EU and sugar-exporting countries and future multilateral liberalization will likely reduce the profitability of the Mauritian sugar industry. However, the adverse effects of these developments in the apparel sector could be offset—at least in part—by the recently enacted U.S. African Growth and Opportunity Act, which provides preferential access for apparel exports to the U.S. market from sub-Saharan Africa, including Mauritius (see Box 3).

15. Future economic growth would, therefore, need to rely to a greater extent on productivity growth than previously. The staff outlined a growth accounting model that suggested that, in order to maintain past levels of economic growth rates against a background of declining contributions from labor and largely unchanged levels of investment, a significantly higher contribution from growth of total factor productivity (TFP) would be needed than in the past (see Figure 3 and table below). Reaping these efficiency gains would require exposing the economy to greater competition, particularly through trade liberalization. The constraints on growth could, however, be alleviated if Mauritius chose to augment its labor force through imports of foreign, particularly skilled, labor.

Mauritius: Sources of Growth

(Growth in percent)

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Source: Fund staff estimates.

Exogenously determined by demographic developments.

This would imply that the investment level remains at about 25-26 percent of GDP.

16. The authorities concurred with the staffs assessment of the medium- to long-term outlook and challenges ahead, particularly with the need to boost productivity growth. To this end, they had planned a number of actions. First, recognizing that the skills base of the population had to be enhanced commensurate with the needs of an economy that was moving up the value-added chain, the government was proposing to improve fundamentally basic education and move from a compulsory six-year to an eleven-year cycle. Concurrently, greater emphasis would be placed on information technology (IT) at all levels of education, and the IT base of the economy would be strengthened.9 Second, the government was planning to introduce greater competition in key services, notably the communications industry. Third, considerable effort was being devoted to upgrading the regulatory framework in the financial sector, including the proposed Financial Services Development Bill. Finally, mindful of the potential loss of preferential access for sugar, the authorities had started consultations with the social partners to make the sugar sector more competitive by reviewing laws that required labor to be employed even in the intercrop season and formulating plans for rationalizing labor under a voluntary retirement scheme.

Mauritius: The Impact of the African Growth and Opportunity Act

The African Growth and Opportunity Act (AGOA) enacted in 2000 by the United States could have a significant impact on Mauritius. The key provisions of the act mat will affect Mauritius will involve extending:

  • quota-free access in apparel from sub-Saharan Africa, including Mauritius, until 2008 (when AGOA expires);

  • duty-free access in apparel until 2008 subject to a rule-of-origin requirement, namely, that Mauritius source inputs (yarn/fabric) from the United States or other sub-Saharan African countries; however, for Madagascar and other least-developed countries in sub-Saharan Africa, duty-free access in apparel to the U. S. market will be exempt from the rule-of-origin requirement until end-2004; and

  • duty-free access for a number of items that are currently subject to tariffs under the U. S. Generalized System of Preferences.

A rough estimate of the impact of the AGOA on Mauritius would be as follows:

  • Until the elimination of quotas under the Multifibre Arrangement (MFA) at end-2004, the AGOA will lift constraints affecting 70 percent of Mauritius’s current textile and apparel exports to the U.S. market, which amounted to US$172 million in 1998 (20 percent of its total textile and clothing exports). This could increase exports by about US$30 million (17 percent).

  • Beyond 2005, the impact will depend crucially on the rule-of-origin requirement. Without it, Mauritius could be expected to obtain a terms of trade gain of about 17 percent, which could translate into increased exports of about 33 percent. The rule-of-origin requirement would reduce this by about 50 percent (assuming that U.S. or African fabric is about 30-50 percent more expensive than that from the cheapest source), reducing the gain by half.

  • When the impact of the MFA elimination, which is likely to be negative for Mauritius, is superimposed on the AGOA, the net effect on Mauritius would be either a small gain or none at all. Thus, the AGOA will serve to mitigate the likely negative effect of the elimination of the MFA.

  • Finally, an important channel by which Mauritius would benefit from the AGOA could be the higher income from Mauritian foreign direct investment (FDI) in neighboring African countries, such as Madagascar. As a result of rising unit labor costs at home, and in view of the benefits under the AGOA flowing to least-developed countries, including Madagascar, Mauritian clothing firms have been investing in neighboring countries. Mauritian FDI is likely to experience a boost consistent with increased exports from Madagascar to the United States (estimated at about 45 percent of current exports), resulting in higher income for Mauritius.

17. The staff welcomed these initiatives, which demonstrated the authorities’ ability to anticipate, and their resolve to respond to, emerging challenges. The emphasis on upgrading human capital was necessary, particularly since Mauritius seemed to have fallen behind some of the fast-growing Asian economies in educational attainment (see table below). The staff cautioned, however, that the success of the authorities’ medium-term strategy would require maintaining short-term macroeconomic stability and achieving savings-investment balances that would underpin the growth effort.

Mauritius: Comparative Educational Attainment, 1965-2000

(Average years of schooling in population above 15 years of age)

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Source: Robert J. Barro and Jong-Wha Lee, “International Data on Education Attainment - Updates and Implications,” NBER Working Paper No. 7911, (Cambridge, Massachusetts: National Bureau of Economic Research, 2000).

B. Financial Policies

Fiscal policy

18. The staff argued that the current state of the public finances threatened short-term stability by undermining external competitiveness and crowding out private sector activity. It also raised doubts about fiscal sustain ability in the medium term. Under current policies, including the measures that the authorities were contemplating (increased spending on education and IT), and taking into account the rising pension expenditures because of demographic changes, the public sector’s debt-to-GDP ratio was expected to increase sharply over the medium term to about 71 percent by 2005/06 and 92 percent by 2010/11 (see figure below). While recognizing the need for these measures and their contribution to sustaining higher productivity growth in the future, the staff cautioned, that unless corrective actions were taken elsewhere, the ensuing macroeconomic instability could jeopardize growth prospects.

uA01fig4

Mauritius: Medium-Term Fiscal Projections, 2000/01-2010/11 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2001, 077; 10.5089/9781451827729.002.A001

Sources: Ministry of Finance; and Fund staff estimates and projections.1/ Fiscal year from July to June.

19. Corrective fiscal measures of about 5-6 percentage points of GDP (cumulative over the medium term) were necessary to place the public finances on a sound medium-term footing. In the illustrative adjustment scenario prepared by the staff (see figure above and Appendix V), the fiscal deficit would be reduced from about 6 percent of GDP in 2000/01 to about 1.5-2 percent of GDP in 2005/06 and beyond, allowing the debt-to-GDP ratio to gradually fall to 54 percent of GDP in 2005/06 and 47 percent of GDP by 2010/11.10 This reduction would ensure that the ratio of public debt (internal and external) to GDP remained at sustainable levels.11 Moreover, targeting a debt-to-GDP ratio that was on a declining trajectory would accommodate the buildup of pension-related fiscal pressures in the longer term.

20. Consistent with this profile of medium-term adjustment, fiscal policy in the immediate future needed to be tightened considerably. While the authorities had taken some corrective fiscal actions in September 2000, these were insufficient in view of the deteriorating situation. The staff considered that the next budget should begin the medium-term adjustment with an ambitious corrective action of about 1.5 percent of GDP. Fiscal consolidation would also help monetary policy to maintain low inflation, without crowding out the private sector.

21. For the next budget, the staff proposed a number of revenue-enhancing measures. These included (1) raising the VAT rate from 10 percent to 12 percent and broadening its base by applying the standard rate to the currently zero-rated goods (except for the socially most sensitive items and for exports); (2) increasing the excise duty on diesel from 25 percent to 50 percent; and (3) eliminating certain import duty exemptions. The staff also advised the authorities to adopt a revised system for pricing petroleum products. The experience of the past two years had demonstrated that it was important for domestic petroleum prices to be more responsive to movements in international prices. Ideally, the distribution and marketing of petroleum products should be in the domain of the private sector (see below). In the interim, however, the government needed to consider instituting an automatic price-setting mechanism for all petroleum products, based on transparent rules.12

22. For the medium term, the authorities should consider a comprehensive reform of the tax system, accompanied by institutional changes that would improve the transparency and predictability of the budgetary process and help the fiscal consolidation effort (Box 4). Fiscal adjustment over the medium term would also need to aim at rationalizing expenditures, including the reform of the welfare state and, in particular, the pension system.

23. The authorities recognized the need for fiscal adjustment. For the forthcoming budget, they indicated their willingness to consider some of the staff’s proposals but had yet to decide on the magnitude of the adjustment. They concurred with the staff’s assessment on the need for medium-term tax and institutional reform, the broad outlines of which they planned to announce in the next budget. To help design and implement this reform, they were requesting technical assistance from the Fund. The authorities were consulting closely with their social partners and the World Bank on the parameters of pension reform, which would also constitute an essential plank of medium-term fiscal consolidation.

Monetary and exchange rate policies

24. The staff welcomed the tightening of the monetary policy stance following the elections in September 2000 and the declining trend of measured inflation (Figure 4). Macro-economic stability had underpinned the strong growth performance in Mauritius. For 2001/02, the authorities had targeted money growth consistent with trend GDP growth of 5.5-6 percent and inflation of about 4.5-5 percent. Over the medium term, the aim was to achieve an inflation target consistent with that in trading partners.

Figure 4.
Figure 4.

Mauritius: Prices, Money, and Interest Rates, 1990-2001

Citation: IMF Staff Country Reports 2001, 077; 10.5089/9781451827729.002.A001

Sources: Mauritian authorities; and Fund staff estimates.

Mauritius: Fiscal Policy—Structure, Outlook, and Reform Agenda

Mauritius’s current tax structure is characterized by the following:

  • The corporate tax base is narrow and the system is highly discretionary. There are a variety of exemptions, preferential rates, and varying treatments of dividends, investment allowances, etc. Corporate income taxes represent 5.7 percent of total revenue and 1.2 percent of GDP. Distinctions made under the various incentives schemes are highly subjective (e.g., pioneer status enterprises, strategic local enterprises, etc.).

  • The personal income tax has a narrow base, and is possibly inequitable, and its administration is inefficient. A variety of exemptions, allowances, and deductions lead to a taxpaying population of 58,000 out of a population of 1.2 million. Personal income taxes represent 6.6 percent of total revenue and 1.4 percent of GDP. Salaried employees pay the bulk of this tax (85 percent) while higher-income groups pay little, owing to generous exemptions and deductions, particularly on financial savings, and inadequate enforcement.

  • The tariff structure is inefficient. The average import-weighted tariff is 12 percent (2000), dispersion is great (the top rate is 80 percent), and the system is riddled with exemptions. Customs duties account for a high (30 percent) but declining share of total revenue.

  • The indirect tax rate is low and the base is narrow. The standard value-added tax (VAT) rate is 10 percent and the base now excludes most services. Nevertheless, VAT collections amount to about 5 percent of GDP.

The medium-term fiscal outlook for Mauritius is based on the following assumptions:

  • Demographic changes will lead to sharply rising social expenditures. The number of pensioners—including from the civil service—is expected to increase substantially over the next 20 years and will entail higher expenditures of about 1 percent of GDP a year.

  • Trade reform will lead to declining revenues. Further tariff reform will likely reduce customs revenues by about 1.5 percent of GDP.

  • Expenditures on education may have to rise. Commensurate with the need to upgrade the skills of the workforce as Mauritius moves up the value-added chain, the government may have to devote greater resources to secondary, tertiary, and vocational education.

  • Other government expenditures will add to fiscal pressures. The government is planning to invest over the medium term in infrastructure for information technology and a new transport system, as well as develop social programs to support the unemployed.

Based on these assumptions, projections indicate threats to medium-term fiscal sustainability. On current policies, the debt-to-GDP ratio would rise from about 56 percent to 92 percent in 2010. Any assessment of sustainability over this period should factor in the strains likely to persist beyond the ten-year horizon.

The reform agenda, as proposed by Fund staff, is as follows:

  • Tariffs. Rates, especially top ones, and exemptions (which should be limited to duty drawback schemes) need to be reduced.

  • VAT. It would be important to extend the tax to goods and services that are presently zero rated and increase the rate to at least 12 percent.

  • Direct taxes. Corporate tax incentives need be reduced and rationalized. On personal income taxes, exemptions and allowances should be reduced.

  • Pensions. Options could include raising the retirement age, targeting the basic pension, and reducing pension benefits for civil servants and old-age pensioners.

  • Institutional reform. Adopting a medium-term fiscal framework, tax expenditure budgeting, and consolidated fiscal accounting could be important in themselves for increasing transparency and also for facilitating other fiscal reforms. Adoption of rules that link more fully and automatically domestic prices of fuels, electricity, and other essential items to cost is needed.

25. The staff expressed concern about the conduct of monetary and exchange rate policy in 1999 and 2000. It recognized that the real currency appreciation that had occurred during 1999 and much of 2000 had since been largely reversed (Figure 2), and the value of the Mauritian rupee did not appear to be significantly misaligned.13 However, the staff noted that, during 1999 and 2000, the exchange rate had not been adequately sensitive to market pressures, leading to a larger appreciation of the rupee than might have been appropriate. Furthermore, the staff emphasized that, by providing targeted subsidies on at least two occasions in 2000 in response to the demands from the export industries, and by reimposing the 50 percent surrender requirement on sugar exports, the central bank risked undermining its own credibility. Furthermore, market participants had perceived the interest rate reduction in June 2000 (announced by the Minister of Finance) as having been motivated by political considerations in anticipation of the general elections.

26. The authorities responded that they did not have a target for the exchange rate. Nevertheless, they considered that the real appreciation in 1999 and 2000 might have had the advantage of dampening entrenched expectations of currency depreciation and, hence, of forcing the tradable sector to improve competitiveness through cost reductions and productivity gains. The reimposition of the surrender requirement was necessitated by the structure of the foreign exchange market—its thinness and seasonality, as well as the concentration of foreign exchange suppliers—that made it vulnerable to disruptive movements, which the BOM wished to avoid.

27. In the staffs view, disruptive movements were best avoided by maintaining sound monetary and fiscal policies, thereby reducing uncertainty and engendering confidence. In this context, it was important that the monetary authorities’ primary objective be the maintenance of price stability, with the exchange rate allowed to respond to market conditions and intervention in the foreign exchange market confined to smoothing short-term volatility. In the event that undue pressures did arise, a tightening of monetary policy was a more appropriate response than the use of nonmarket means, such as the surrender requirement, especially since Mauritius was committed to maintaining a liberal exchange regime with an open capital account. At the same time, measures needed to be taken to deepen the foreign exchange market and improve its efficiency, so that greater reliance could be placed on market forces to determine the exchange rate.

28. The authorities concurred with the staffs assessment that the experience of the last two years supported the case for strengthening the institutional framework for the conduct of monetary and exchange rate policy. Such a strengthening would include conferring greater independence on the BOM in conducting monetary policy and mandating that price stability be its primary objective, while increasing its transparency and accountability. To this end, they have requested technical assistance from the Fund so that the necessary revisions to the Bank of Mauritius Act could be submitted to the National Assembly during the current legislative session.

C. Financial Sector and Bank Supervision

29. The authorities highlighted a number of initiatives to strengthen and modernize Mauritius’s financial sector, with a view to positioning Mauritius as an international center for financial intermediation. A Financial Services Development Bill had been submitted to the National Assembly that would rationalize, strengthen, and bring under one umbrella the regulation and supervision of the nonbank financial sector. The bill proposed to eliminate the distinction between onshore and offshore activities. It also envisaged, at a later stage, integrated supervision of the nonbank and banking sector. In June 2000, the National Assembly passed the Economic Crime and Anti-Money Laundering (ECAML) Act,14 which established an Economic Crime Office (ECO) with the authority to investigate suspicious transactions and economic offenses. Mauritius also made an advance commitment to the OECD to eliminate harmful tax practices and has cooperated with the Financial Action Task Force (FATF). The BOM (with Fund technical assistance) continued to strengthen banking supervision by clarifying the legal framework, as well as by increasing on-site inspection. It has also introduced (with World Bank technical assistance) a real-time gross settlement system.

30. The staff welcomed these initiatives, as they would strengthen the domestic institutional framework while responding to the concerns of the international community.15 Key indicators of financial system health suggested that the banking sector remained essentially sound (Box 5). Furthermore, banking supervision had been strengthened recently with the help of Fund technical assistance. The large increase in credit in recent years, which held the potential for a decline in credit quality, combined with the structure of Mauritius’s banking sector (which had a high concentration of banking activities and high degree of connectedness between firms), warranted heightened attention by the authorities, including in the area of banking supervision. Steps to improve off-site monitoring would usefully complement the BOM’s on-site inspection.

Mauritius: Banking Soundness and Supervision

The ten onshore commercial banks operating in Mauritius (two of which account for about three-fourths of the market) are profitable, benefiting from healthy interest rate spreads that average about 4 percent. Interest income remains the principal source of their profitability, accounting for about 85 percent of their net income. Although the average return on equity of banks has fluctuated in recent years, it has remained above 20 percent. The banks are well capitalized, with an average risk-weighted capital adequacy ratio in the range of 12-13 percent in the past three years, above the Basel requirement of 8 percent. At end-June 2000, one-half of the banks had capital adequacy ratios greater than 16 percent, while the others were between 10 percent and 14 percent. Nonperforming loans amounted to about 8 percent of total loans, having declined from the previous year’s level of 9 percent. Three small banks, however, had ratios higher than 10 percent.

Mauritius: Indicators of the Banking Sector, 1998-2000

(In percent, unless otherwise indicated)

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Source: Bank of Mauritius.

Aggregate large exposure is the sum of all exposures that individually exceed 15 percent of a bank’s capital base.

Private sector credit has increased at a brisk pace in recent years, which raises the potential for a decline in credit quality. This situation highlights the need for constant monitoring. On average, large credit exposure ratios have been in the range of 255-278 percent for the last three years. However, three banks have exceeded the overall threshold of 600 percent prescribed by the Bank of Mauritius (BOM), and they have submitted plans to achieve compliance with BOM guidelines within the transition period allowed. The concentrated nature of the banking sector and the high degree of connectedness between firms warrant close monitoring of large exposure ratios by the BOM.

The BOM has enhanced its supervision capacity. It developed and implemented a supervision framework for banks covering on-site inspections, off-site monitoring methodology, special purpose guides for the staff, and inspection modules. It issued four guidelines to the industry on liquidity, credit classification for provisioning purposes and income recognition, credit concentration limits, and internet banking. A guideline on corporate governance has been completed and is awaiting release to the industry. The BOM has made significant efforts in providing on-the-job training to the supervision staff in conducting on-site inspections. The legal framework for banking supervision has been improved, and further changes are contemplated with the help of Fund technical assistance.

31. The staff stressed the need to further strengthen the framework for banking supervision, consistent with the efforts being taken with respect to the nonbank financial institutions. One particular area would be to establish full regulatory oversight by the BOM over nonbank deposit-taking institutions that were currently not adequately supervised. Concurring with the staffs assessment, the authorities have requested Fund technical assistance to revise their banking legislation, with a view to submitting it to the National Assembly before the end of the current legislative session.16

D. Structural Issues

Trade liberalization

32. The staff noted that Mauritius had made progress in liberalizing its trade regime. Most quantitative restrictions had been eliminated, and in June 2000 significant tariff cuts had been implemented. Effective June 2001, the favorable treatment of firms located in the EPZ, which could have violated WTO rules on export subsidization, will be eliminated. The authorities viewed regional integration as affording an important vehicle for Mauritius to further its economic prospects. Outward investment in, and possible sourcing of inputs from, countries in the region—for which the AGOA had created opportunities—would be an important part of Mauritius’s strategy to sustain high levels of growth.

33. The staff stressed that trade liberalization, in the context of the changing external environment) would be critical for accelerating productivity and, hence, future economic growth. With export subsidization no longer an option, maintaining neutrality of incentives required significant import liberalization. Moreover, recent tariff cuts had been concentrated on inputs and as such had increased effective protection for domestic producers of final goods. A medium-term preannounced tariff reform, including reduction of the levels and numbers of tariff rates and a curtailment of exemptions, should be a high priority and part of the medium-term tax reform being contemplated by the government. The government also needed to eliminate state trading in cement and petroleum products, as well as the discrimination against certain (“nonpreferential”) countries in its external trading regime.

34. While broadly agreeing with the staffs assessment, the authorities argued that trade liberalization would have to be gradual and afford time for domestic industry to become competitive. They concurred with the staffs view on the need to rationalize the multiplicity of regional initiatives in eastern and southern Africa.

35. The staff welcomed the privatization of Mauritius Telecom. It was encouraged by the authorities’ determination to lift Mauritius Telecom’s monopoly as the international gateway for voice and data communications by end-December 2003. It stressed that establishing and strengthening the regulatory framework governing key sectors, such as telecommunications, water, and power, would be essential to promoting competition and reaping efficiency gains. These actions would also pave the way for commercialization and eventual privatization of other state utilities.

Unemployment

36. Addressing the rising trend of unemployment was a big challenge for the authorities. The staff drew attention to the impact on unemployment of contrasting developments of wage and productivity growth between the 1980s and 1990s (see figure below and Figure 5). It noted that some aspects of the labor market, in particular the tripartite wage setting system and the automatic application of annual wage increases that were announced by the Minister of Finance to the whole economy, may have prevented wages in the 1990s from growing in line with productivity.

uA01fig5

Mauritius: Labor and Productivity Indicators, 1982-2000

Citation: IMF Staff Country Reports 2001, 077; 10.5089/9781451827729.002.A001

Sources: Central Statistical Office; and staff estimates.
Figure 5.
Figure 5.

Mauritius: Labor Market, 1982-2000

Citation: IMF Staff Country Reports 2001, 077; 10.5089/9781451827729.002.A001

Sources: Mauritian authorities; and Fund staff estimates.

37. The authorities argued in favor of a multipronged approach to remedying the unemployment problem. Introducing greater flexibility in the labor market, while ultimately desirable, could not be the sole or even the priority objective. In their view, unemployment increasingly reflected a mismatch between the skills of the unemployed workforce and the demands of the workplace. Despite the large pool of unemployed, growth industries (particularly the EPZ sector) were finding it difficult to fill vacancies with local staff and were forced to employ foreign workers, whose numbers were limited. The government was seeking to improve the skills levels of the labor force consistent with the needs of the economy, including through retraining and vocational programs. Furthermore, anecdotal evidence supported the view that, to some extent, high unemployment also reflected high and rising reservation wages.17 While acknowledging that the present tripartite wage determination process needed reforming, the authorities considered that the political costs of effecting changes in the immediate future would be very high, particularly since the process had contributed significantly to the industrial peace and social stability that Mauritius had enjoyed for several decades.

E. Statistical Issues

38. Mauritius started participating in the Fund’s General Data Dissemination System (GDDS) in September 2000, but improvements are required before it can subscribe to the Special Data Dissemination Standard (SDDS). The quality and timeliness of Mauritius’s reporting to the Fund of core minimum and other economic and financial statistics are, in general, satisfactory from the standpoint of conducting surveillance. However, more complete information on the overall public accounts (including government off-budget accounts and the parastatal sector) would be helpful, particularly for policy formulation and monitoring. For this, the authorities have requested technical assistance from the Fund. The authorities have recently started to compile quarterly national accounts and balance of payments statistics, and are working on improving coverage of external transactions of offshore banks and nonbank financial entities in the balance of payments. Mauritius has agreed to the preparation of a Report on the Observance of Standards and Codes (ROSC) for data dissemination during 2001/02.

III. Staff Appraisal

39. Mauritius is experiencing a rebound in economic activity, following a severe drought that affected the key sugar sector, while inflation is on a declining trend. The near-term outlook for growth is encouraging. Real GDP growth is expected to recover to 7.8 percent in 2000/01 before reverting to its trend level of 5.5-6 percent in the medium term.

40. Near- and medium-term prospects are, however, marred by the deterioration in the public finances in recent years. While the new government has taken some corrective actions in the form of long-overdue adjustments of petroleum and electricity prices, these have been insufficient. Moreover, new expenditure initiatives, while contributing to higher productivity growth in the future, will nevertheless add to fiscal pressures. Hence, the current fiscal stance would likely burden monetary policy, crowd out private investment, and undermine international competitiveness. It is also likely to give rise to an unsustainable debt burden that could further jeopardize growth prospects in the medium term.

41. The staff encourages the authorities to take the opportunity afforded by the forthcoming budget to initiate the process of medium-term deficit reduction with up-front actions. Complementary institutional reforms, such as tax expenditure budgeting, the establishment of a medium-term framework, and the undertaking of fiscal responsibility commitments, will help consolidate the policy reforms. The staff welcomes the authorities’ request for Fund technical assistance to design and implement these reforms.

42. The staff endorses the recent tightening of the monetary policy stance. The real currency appreciation that occurred during 1999 and much of 2000 has since been largely reversed, and the value of the Mauritian rupee does not appear to be seriously misaligned.

43. Nevertheless, the staff considers that the experience of the last two years supports the case for strengthening the institutional framework for the conduct of monetary and exchange rate policy. Inadequate flexibility of the exchange rate during 1999 and 2000, the perception that monetary policy is sensitive to the election cycle, and the reintroduction of the surrender requirement on exports of sugar, as well as the episodic subsidization of the export sector by the BOM, underpin this view. Strengthening the institutional framework would include conferring greater independence on the central bank in conducting monetary policy, mandating that price stability be its primary objective—with the exchange rate allowed to be determined by market conditions—and increasing the BOM’s transparency and accountability. The staff welcomes the government’s request for technical assistance aimed at achieving this strengthening and its intention to implement these changes expeditiously.

44. The staff supports the authorities’ recent initiatives to strengthen and modernize Mauritius’s financial sector. The proposed Financial Services Development Bill would rationalize the legal framework and strengthen the supervision of the nonbank sector. The banking sector remains essentially sound, and its supervision is being substantially improved. The staff welcomes the government’s desire to enhance the legal framework for the supervision of banks, as reflected in its request for Fund technical assistance. These actions along with the recent passage of the Economic Crime and Anti-Money Laundering Act, demonstrate the authorities’ commitment to strengthening domestic institutions while also responding to the concerns of the international community.

45. With remedial fiscal actions in place, the prospects for sustaining long-run growth at current levels are encouraging. Changes in the economic environment will entail a shift in the sources of growth, requiring greater reliance on growth of productivity rather than of inputs. Demographic changes will likely reduce the available supply of labor, while changes in the external economic environment will mean that Mauritius’s privileged market access for its exports will come under threat, thereby reducing savings and limiting capital accumulation.

46. The staff is confident that the authorities will rise to the challenges posed by the changing economic environment. A number of initiatives demonstrate that they are anticipating these changes and taking the appropriate actions. Thus, proposals to fundamentally improve basic education by moving from a compulsory six-year to an eleven-year education cycle, strengthen the IT base of the economy, inject greater competition into the key services sectors, and bolster domestic institutions, particularly in the financial sector, will serve to enhance the economy’s skills base while also raising productivity growth. The staff endorses these initiatives. However, given the scarcity of skilled labor, the authorities may wish to consider relaxing restrictions on imports of skilled foreign workers as a way of alleviating the constraints on medium-term growth.

47. Trade liberalization and the exposure to foreign competition will be key to accelerating productivity growth. As export subsidization policies are constrained by WTO rules, the restoration of neutrality of incentives between import-competing and export sectors will require a medium-term preannounced liberalization of the import regime, including the elimination of state trading. Strengthening the appropriate regulatory framework in the services sector while injecting greater competition, including through the privatization of state utilities, will provide a further fillip to productivity growth.

48. The rising trend in unemployment poses another serious challenge. The government’s initiatives to address the growing mismatch between demands of the workplace and the skills of the labor force, while creating social safety nets for the unemployed, are commendable. The government is urged to consider efforts to inject greater flexibility into the current centralized tripartite wage negotiating system as a way of usefully complementing these initiatives.

49. The quality and timeliness of Mauritius’s reporting to the Fund of core minimum and other economic and financial statistics, are, in general, satisfactory from the standpoint of conducting surveillance. However, more complete information on the overall public accounts (including government off-budget accounts and the parastatal sector) would be helpful. Mauritius has agreed to the preparation in the coming year of a Report on the Observance of Standards and Codes (ROSC) for data dissemination.

50. The staff recommends that the next Article IV consultation with Mauritius be held on the standard 12-month cycle.

Table 4.

Mauritius: Monetary Survey, 1996-2000

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Sources: Bank of Mauritius; and Fund staff estimates.

Including claims on public enterprises.

Table 5.

Mauritius: Indicators of External Vulnerability, 1996/97-2000/01 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Mauritian authorities; and Fund staff estimates and projections.

Fiscal year from July to June.

End of period; maximum interest rate on fixed deposits with maturities of between six and twelve months. The rate for 2000/01 is for end-January 2001.

Excluding the acquisition of aircraft and ships.

The reserves of the Bank of Mauritius are not pledged as collateral for short-term liabilities, nor are they sold forward.

End of period. Data for 2000/01 are as of April 19,2001.

Bonds rated “Baa2” by Moody’s are considered as medium-grade obligations.

Table 6.

Mauritius: Medium-Term Projections, 1999/2000 - 2005/06 (Nonadjustment Scenario) 1/

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Sources: Bank of Mauritius; Central Statistical Office; Ministry of Finance; and Fund staff estimates and projections.

Fiscal year from July to June.

Sugar crops and milling included in fiscal year harvested; otherwise, averages of calendar-year data.

Excluding changes in stocks.

Excluding the acquisition of aircraft and ships.

Trade-weighted period averages (a negative sign signifies a depreciation). Data for 2000/01 are for July 2000 to January 2001.

In 2000/01, net lending includes the repayment of US$117 million of the international floating-rate note.

Including transfers.

Table 7.

Mauritius: Medium-Term Projections, 1999/2000 - 2005/06 (Adjustment Scenario) 1/

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Sources: Bank of Mauritius; Central Statistical Office; Ministry of Finance; and Fund staff estimates and projections.

Fiscal year from July to June.

Sugar crops and milling included in fiscal year harvested; otherwise, averages of calendar-year data.

Excluding changes in stocks.

Excluding the acquisition of aircraft and ships.

Trade-weighted period averages (a negative sign signifies a depreciation). Data for 2000/01 are for July 2000 to January 2001.

In 2000/01, net lending includes the repayment of US$117 million of the international floating-rate note.