Mauritius: 2005 Article IV Consultation—Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Mauritius
Author: International Monetary Fund
Publication Date:
14 Jun 2006
eISBN:
9781451827828
Language:
English
Keywords:
ISCR; CR; bottom; government; inflation-targeting regime; product; price; debt service; textile prices high; retail price; textile export; Imports
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Mauritius showed slow economic growth owing to the deteriorating external economic environment, particularly of the sugar and textile sectors. Executive Directors urged the authorities to develop a comprehensive economic strategy that combines structural reform measures and policies geared toward macroeconomic stability. They commended the financial sector reform and the implementation of Financial Sector Assessment Program recommendations, welcomed the financial sector monitoring and tax reforms plans and emphasized the need for strong exchange rate and monetary policies for securing external competitiveness.

Abstract

Mauritius showed slow economic growth owing to the deteriorating external economic environment, particularly of the sugar and textile sectors. Executive Directors urged the authorities to develop a comprehensive economic strategy that combines structural reform measures and policies geared toward macroeconomic stability. They commended the financial sector reform and the implementation of Financial Sector Assessment Program recommendations, welcomed the financial sector monitoring and tax reforms plans and emphasized the need for strong exchange rate and monetary policies for securing external competitiveness.

I. Recent Economic and Political Developments

1. The economy has been increasingly affected by the phasing out of textile quotas (Box 1) and, more recently, by higher prices for imports of petroleum products. Growth has fallen during the past few years, reflecting a marked contraction of activities in the export processing zone (EPZ), dominated by textile manufacturing, and unemployment has risen (Figure 1). The surplus of the external current account has recently turned into a deficit, owing to a decline in exports and a price-related surge in imports of petroleum products.

Figure 1.
Figure 1.

Recent Economic Developments

Citation: IMF Staff Country Reports 2006, 209; 10.5089/9781451827828.002.A001

2. The real effective exchange rate has depreciated, and net official foreign reserves have dropped (although they remain at a relatively comfortable level), owing to the deterioration of the current account as a rising merchandise trade deficit is no longer offset by tourism receipts. The exchange rate depreciation was in part also related to the ample liquidity (see below). Mauritius continues to have a managed floating exchange rate regime, with the exchange rate being freely determined in the interbank market, and the Bank of Mauritius’s (BoM) interventions in the foreign exchange market aimed only at mitigating excess short-term volatility.

uA01fig01

Mauritius: Real and Nominal Exchange Rate Indexes

Citation: IMF Staff Country Reports 2006, 209; 10.5089/9781451827828.002.A001

Source: BoM and IMF staff estimates.

Selected Economic and Financial Indicators, 2000/01-2004/05 1/

article image

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

Fiscal year (July-June).

Trade-weighted period averages (a negative sign signifies depreciation). Based on the consumer price index.

Mauritius: Impact of Elimination of Trade Preferences

The textile and clothing industry in Mauritius benefited from the Multi-Fiber Agreement, which restricted exports from countries with lower production costs. Because of its higher labor cost, Mauritius is expected to lose market share to more competitive suppliers such as China and India, whose textile exports were restricted by the quota system.

The EPZ sector has already started to feel the impact of the quota phaseout. The EPZ sector, which grew on average, by more than 6 percent a year during 1995–2000, contracted by 18 percent during 2001–04. Following the expiration of textile quotas at end-2004, EPZ exports fell by 12 percent in the first quarter of 2005, compared with the same quarter of 2004, and employment fell by 13 percent during the same period as enterprises shut down. In comparison, most other major textile-exporting African countries (Kenya, Lesotho, Madagascar, and Swaziland) have suffered much smaller declines or just a slowdown of textile exports.

Mauritius: Contribution of the Export Processing Zone (EPZ) and sugar sector to GDP, Employment, and Exports

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Sources: Central Statistics Office; and IMF staff estimates.

Textile and Apparel: Hourly Compensation for Selected Countries, 2002 1/

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Source: U.S. International Trade Commission.

Including wages and fringe benefits.

The sugar sector will also experience difficulties because of the planned reduction in EU sugar prices in the European Union (EU). Mauritius’s sugar export price to the EU (its main market) has been guaranteed at more than three times world market levels for a given quota during the past decade.1

Simulations show that the economy will continue to be adversely affected during the next few years. The negative impact on real GDP growth is projected to average 1.2 percentage points over the next five years (assuming that some of the textile and sugar sectors’ competitiveness is restored). By end-2009/10, the external current account balance is expected to decline by 4.1 percent of GDP because of the shock, and net international reserves are expected to be 3.4 months of imports lower.

1

The European Commission has proposed a liberalization of the EU sugar market, including a reduction of guaranteed import prices by 39 percent over the next few years.

3. The 2004/05 (July–June) cash budget deficit of the central government was maintained at 5 percent of GDP, as targeted, but a broader definition of the public sector deficit shows a worsening overall situation. This is also worrisome as public sector debt levels are already high. Specifically, the suspension of an automatic price adjustment mechanism for petroleum products in early 2005 during the run-up to general elections, coupled with rapidly rising import costs, resulted in an operational deficit of the State Trading Company (STC) that amounted to 0.6 percent of GDP.1 In addition, a sizable amount of government debt was converted from short-term obligations to longer-term debt (with interest payable upon maturity), significantly reducing interest payments on a cash basis.2 Fully accounting for the STC deficit and for cash interest payments on an accrual basis would have increased the overall fiscal balance to about 6½ percent of GDP.

4. Prior to the July 2005 elections, the outgoing government approved a budget for 2005/06 that was based on an optimistic growth outlook. It envisaged a cash deficit of the central government of just below 5 percent of GDP and began to implement wide-ranging reductions of import duties on consumer goods. Plans were announced to eliminate all import duties over the next few years.

5. The opposition Social Alliance coalition won the elections with a clear majority. In light of the adverse external developments, it had stressed the need to identify new sources of growth, mitigate the social impact of the economy’s needed transformation, and reduce unemployment, including through the promotion of small and medium enterprises and a focus on attracting foreign direct investment.

6. Inflation has picked up since mid-2004, reflecting ample liquidity and higher import prices for petroleum products. More recently, price developments have moderated owing to the suspension of the adjustment of domestic oil prices in response to international prices and slower growth in monetary aggregates associated with the loss of foreign reserves. On financial sector issues, new central bank and banking laws were passed in 2004, and the BoM issued several prudential regulations to strengthen supervision, in line with the recommendations of the Financial Sector Assessment Program. The decline of textile production caused a temporary increase in nonperforming loans, but strengthened provisioning requirements and closer supervision have led to a gradual improvement in overall financial soundness indicators.

uA01fig02

Mauritius: Inflation Rate and Broad Money Growth, Jan. 1999 - May 2005

Citation: IMF Staff Country Reports 2006, 209; 10.5089/9781451827828.002.A001

Source: BoM

II. Report on Policy Discussions

7. The policy discussions focused on the short- and medium-term risks to sustained growth posed by the phasing out of trade preferences for textiles and sugar. They also covered the recent surge of world oil prices. To maintain high growth rates and to reverse the recent rise in unemployment, the authorities recognized the need for comprehensive structural reforms to diversify the economy and enhance competitiveness. Macroeconomic stability would also need to be safeguarded to help preserve social cohesion and create a favorable investment climate.

A. Medium-Term Outlook and Challenges

8. The new authorities are hopeful that, with appropriate macroeconomic and structural policies, a number of sectors could significantly increase their contribution to growth over the next few years. They recognize the need to attract significant foreign direct investment to these activities; to this end, they are taking steps to improve the overall business climate by streamlining business permits and the current investment incentives scheme. These sectors are tourism, financial services, information and communications technology (ICT), and products and services related to fishing activities (Box 2).

Mauritius: Sources of Growth

In light of the decline in textile and sugar activities, a number of industries with significant growth potential have been identified which could enable Mauritius to resume a pattern of high and job-creating growth in the medium term.

  • Tourism: In the short term, the authorities expect to increase overall hotel occupancy by admitting additional airlines during the high season and tapping into new markets, including in the region, during the low season. In the medium term, they expect benefits from adding conference and shopping activities to the traditional holiday tourism concept. The sector may create significant job opportunities, including for lower-skilled workers.

  • Financial services: Efforts are under way to negotiate bilateral tax agreements with emerging economies in Africa and Asia to enhance the attractiveness of offshore activities. Focused training efforts are needed to meet the sector’s human resource requirements.

  • Information and communication technology: While still limited in its contribution to GDP, the sector is developing rapidly, focusing on business process outsourcing, software development, and call centers that benefit from Mauritius’s ethnic and linguistic diversity. The sector is not expected to provide significant employment opportunities but will likely boost the economy’s overall productivity.

  • Seafood hub: Efforts are under way to develop Mauritius into a regional platform for the storage, processing, and distribution of seafood and to offer repairs and maintenance services to fishing boats. The employment effects are potentially significant.

9. In welcoming these initiatives, the staff stressed the need to take early and decisive action, particularly in structural reforms, so as to remove impediments to growth and boost overall competitiveness. Such efforts need to be underpinned by macroeconomic policies geared toward maintaining stability and moving toward a sustainable fiscal position. In the structural area, measures are required to increase labor market flexibility so as to facilitate the movement of workers currently hampered by cumbersome firing rules. Such efforts should be accompanied by well-targeted training programs for the largely unskilled jobless and school graduates to create the competencies needed in the expanding sectors. The authorities should also explore the extent to which the current centralized wage-setting mechanism (with its focus on using inflation as a floor for wage increases) is compatible with allowing wage adjustments to reflect productivity changes at the plant level (see below). The withdrawal of the public sector from commercial activities over the medium term could also provide opportunities for growth and job creation.

10. In the fiscal area, the staff pointed out that there is ample room to reduce the fiscal deficit through steps to boost the revenue base and curb expenditures, particularly on transfers and subsidies. In this regard, particular attention needs to be paid to ensuring full cost recovery by public enterprises that are providing public utilities or commercializing certain commodities (such as petroleum products), so as to avoid indirect budgetary pressures.

11. The authorities recognized the need to develop a comprehensive policy agenda early on in order to bolster investor confidence. They agreed that the stakeholders needed to examine thoroughly the key elements of the reform agenda. They were confident that concrete steps in the main areas would be identified in early 2006 to guide the preparation of the 2006/07 budget.

12. To illustrate the benefits of early and decisive reforms, two medium-term scenarios were discussed. Under the “baseline” scenario, with the existing policy agenda, real GDP growth would remain at about 3 percent, insufficient to create significant employment opportunities. A slow recovery of exports would be unable to reverse the current account deficit and the associated loss of reserves. The fiscal deficit would worsen over time, and public sector debt would become unsustainable.

13. The “strong reform scenario” assumes that the fiscal deficit is gradually reduced to sustainable levels, creating, in conjunction with early labor market reform, renewed momentum for private sector activity. Real GDP growth would return to about 5 percent following the period of adjustment to the reduction of trade preferences. The current account would recover over time from the deterioration of the terms of trade, driven mainly by strengthening exports, following a modest real depreciation of the currency.

Mauritius. Medium-Term Scenarios, 2005/06-2010/11

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Source: IMF staff projections.

14. In the strong reform scenario, fiscal adjustment would be achieved as follows. Revenue would stabilize at about 20 percent of GDP, as the already announced gradual elimination of import tariffs is offset by a broadening of the base for income and consumption taxes (see below), and the implementation of a modern unified tax authority. Overall expenditure would gradually decline, owing largely to lower transfers and subsidies (particularly to public enterprises), thus freeing up resources for priority areas (education and infrastructure) to foster competitiveness while ensuring that public debt declines over time (Box 3). The authorities concurred with the main elements of this reform agenda.

Central Government Finances under the Strong Reform Scenario

(In percent of GDP)

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Source: IMF staff projections.

Mauritius: Fiscal Sustainability

Mauritius’s domestic public debt has increased rapidly over the past decade, raising concerns about debt sustainability in the medium term. The debt-to-GDP ratio stood at 72 percent at the end of June 2005, up from 55 percent in 1995, reflecting persistent budget deficits over the period 1996-2005 (averaging about 5 percent of GDP a year).

uA01bx03fig01

Mauritius: Ratio of Public Sector Debt to GDP

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 209; 10.5089/9781451827828.002.A001

Source: IMF staff projections.

To return public debt to a more sustainable path, the central government would have to reduce its overall budget deficit gradually to about 3 percent of GDP through a combination of revenue-enhancing and expenditure-reducing measures. Under this assumption, the debt-to-GDP ratio would be reduced to about 60 percent by the end of the decade, keeping public debt on a sustainable path under virtually all standard stress tests (see Appendix I). However, should growth not pick up as envisaged, debt levels would remain virtually unchanged—if growth were 1½ percentage points lower than projected, the debt-to-GDP ratio would not fall significantly below 70 percent of GDP, stressing the need for further fiscal consolidation.

B. Fiscal Issues

15. Regarding the 2005/06 budget, the authorities were concerned that less buoyant economic activity would lower revenue collections below original projections. They also recognized that the emergence of a sizable and widening deficit of the STC, while not directly affecting the central government balance, would jeopardize Mauritius’s overall fiscal position.

16. They proposed to offset the shortfall in revenue collections by reducing capital outlays while carrying out a broader review of their medium-term spending needs and priorities. On the STC deficit, they recognized the need to adjust to petroleum retail prices periodically; owing to the mechanism’s suspension for about six months in 2005, they considered that the initial retail price adjustments would need to be substantial.

17. The staff encouraged the authorities to move on both fronts without delay. On the quarterly automatic adjustment of petroleum prices, it recommended that they consider more frequent adjustments or adopt a formula using a moving average of import prices, so as to smooth the impact of price adjustments.

18. The staff also recommended using the review of the 2005/06 budget to take the first steps toward fiscal sustainability. While the authorities recognized the need to begin moving toward a sustainable fiscal deficit, they stressed that they needed time to define a comprehensive strategy. They expect to have a medium-term plan in place by early 2006, when preparations for the 2006/07 budget begin.

19. Overall, the authorities agreed that they had significant scope to reduce the fiscal deficit by broadening the revenue base and streamlining outlays for transfers and subsidies. The staff advised the authorities on concrete steps (already identified by FAD technical assistance) to strengthen tax administration, and urged them to conduct a thorough review of current transfers and subsidies, with a view to better targeting individuals with identified needs and realizing budgetary savings (Box 4). The staff also recommended improving debt management, including through a further diversification of debt instruments so as to tailor them better to investors’ needs; this step could result in some budgetary savings. The authorities agreed to explore all proposals.

20. The authorities also reported that they intended to review efforts to implement a medium-term expenditure framework. Earlier efforts to develop medium-term spending plans had lost momentum, and only limited progress has been made in some ministries (such as education). The staff welcomed this initiative, emphasizing that it would help to prioritize outlays in a coherent manner, and encouraged the authorities to seek technical assistance in this area (including from the World Bank).

21. The staff encouraged the authorities to review the current pension system. Although not an immediate issue, Mauritius’s aging population could lead to a significant rise of fiscal liabilities over the medium term. The authorities noted that they were already examining various reform options, with assistance from the World Bank.

Mauritius: Fiscal Measures to Ensure Sustainability

There is ample scope to reduce the fiscal deficit to sustainable levels through steps to broaden the tax base and streamline expenditure. The authorities should consider the following concrete actions.

Broadening the revenue base

  • Reduce the value-added tax threshold to annual sales of MUR 2 million

  • Lower the threshold for large tax-payers to an annual turnover of MUR 100 million

  • Streamline current income tax breaks and credits

  • Update taxpayer register and enforce filing by all registered taxpayers

  • Introduce advance tax payments for all businesses

  • Establish the Mauritius Revenue Authority in line with international best practices; strengthen the audit function and clear accountability of all services to its Director General make its Director General accountable for all services

Streamlining expenditure

  • Strengthen the financial health of public enterprises to reduce their reliance on budgetary transfers

  • Review a large number of untargeted subsidies and transfers and limit budgetary support to well-defined low-income or other needy segments of the population

C. Exchange Rate, Money, and Banking Issues

22. The BoM agreed that the exchange rate needed to play a central role in facilitating the country’s adjustment to a less favorable external environment. Although not ruling out the need for intermittent intervention—given the openness of capital markets—to smooth possible excessive short-term pressures on the rupee, they concurred with the staff’s advice to allow the exchange rate to move to a level that was in line with the country’s deteriorated external environment and to shield foreign reserves. This would help bolster the economy’s competitiveness (Box 5).

23. In light of the ample liquidity situation, the staff recommended tightening monetary conditions so as to help reduce inflationary pressures (Box 6). This would also help to increase the effectiveness of monetary policy (see below). In concurring with this recommendation, the authorities noted that fiscal adjustment would be required to make sufficient credit available to the private sector.

Mauritius: The Real Effective Exchange Rate and Preferential Trade Arrangements

Despite rising unit labor costs and other input prices over the past 25 years, textile and clothing and sugar producers have remained competitive because of preferential trade arrangements. Global textile quotas favored Mauritius and kept textile prices high, and sugar trade arrangements with the EU and the United States guaranteed high sugar export prices. These implicit subsidies on Mauritius’s export prices have positively affected the terms of trade and the external account balance.

Against the background of this favorable terms of trade position, an empirical study compared the real effective exchange rate that is consistent with the long-run trends of the domestic and external balances with the observed real effective exchange rate.1 The study reveals that the actual exchange rate has been close to its equilibrium value, indicating the appropriateness of exchange rate policies given the fundamentals. This said, the study shows that domestic factors, particularly persistent fiscal deficits and rising labor costs, necessitated a depreciation of the real effective exchange rate over time.

The end of the preferential trade agreements has a permanent, adverse effect on Mauritius’s terms of trade. The restoration of external balance would require a depreciation of the real effective exchange rate. If the exchange rate is not allowed to depreciate sufficiently, the country’s external and savings-investment balances will deteriorate. Reforms implemented to bolster competitiveness would reduce the required extent of the exchange rate’s depreciation.

uA01bx05fig01

Real effective exchange rate

Citation: IMF Staff Country Reports 2006, 209; 10.5089/9781451827828.002.A001

1

See the companion Selected Issues paper for a detailed analysis of Mauritius’s real effective exchange rate

Mauritius: Determinants of Inflation

A study examined data between 1977 and 2004 to identify the key domestic and external determinants of inflation.1 It found that changes in broad money had a strong impact on inflation, whenever supply exceeded money demand (the latter has grown strongly during the period under consideration, largely reflecting rapid financial deepening). By contrast, and in line with earlier findings by the BoM, the pass-through of exchange rate changes to domestic prices was found to be limited.

The results confirm the need to keep the increase of the money supply in line with changes in demand to avoid inflationary pressures. Regarding the limited impact of the exchange rate, the result may underestimate the current pass-through because domestic price controls were more common in the past. This said, the remaining administered prices only delay the needed adjustments.

1

See the companion Selected Issues paper for a more comprehensive analysis.

24. Accordingly, the staff encouraged the authorities to manage liquidity more actively. Noting the authorities’ concern that the BoM had so far relied on its own securities for its open market operations, which entailed significant costs to the BoM, the staff stressed that the use of these instruments was indispensable as long as alternatives had not been fully developed and accepted by the market. It also noted that the BoM’s financial position had so far not been jeopardized by the use of these instruments.3 The authorities are looking forward to IMF technical assistance to diversify their range of instruments.

25. More active liquidity management would also strengthen the BoM’s efforts to use interest rates to signal the desired stance of its monetary policy. At present, the BoM uses the Lombard rate for signaling purposes, but it has been unable to influence other key market interest rates. The staff suggested that the BoM move toward short-term rates as the operational target while underpinning its signaling through interest rates by managing liquidity more actively. The authorities concurred with the thrust of this recommendation.

26. The authorities are monitoring closely the effects of the deteriorating external environment on the financial sector. The exposure of Mauritian banks to the textile and sugar sectors has declined steadily over the past few years, to around 14 percent of bank loans. Provisioning requirements have been strengthened, resulting in a reduction of the ratio of nonperforming loans to capital and reserves. The authorities expect that possible further provisioning needs would be met from profits (which are comfortable), without affecting capital.4 Nevertheless, the BoM is considering heightened collateral requirements for new lending, and is closely monitoring a comprehensive set of financial indicators.

27. Regarding the potential effect of an exchange rate depreciation on the banking system, the staff agreed that the small net open position in foreign exchange suggests a limited degree of vulnerability.5 That said, the authorities were encouraged to begin collecting information on corporate debt-to-equity ratios and the currency composition of corporate debt, so as to assess the indirect credit risk that could arise from the credit worthiness of firms borrowing in foreign currency.

28. Overall, the financial system is liquid and well-capitalized. The authorities have recently begun to publish key financial soundness indicators on a consolidated basis.

29. The monetary authorities indicated that they did not intend to adopt a formal inflation-targeting scheme until they had addressed institutional issues, external conditions had improved, and fiscal consolidation was well under way. They welcomed the forthcoming technical assistance from MFD to help them meet the preconditions for such a step, including inflation forecasting and modeling capabilities, more effective monetary policy instruments, and sufficiently deep and diversified capital markets.

30. The BoM has made progress in implementing the Banking Act and the BoM Act (both approved in 2004). Both Acts reflect recommendations by the FSAP conducted in 2002 and subsequent technical assistance. Specifically, the autonomy of the central bank was strengthened; rules for an orderly resolution of failed banks were introduced; and provisions were made to enable the BoM to apply sanctions against cases of noncompliance with AML/CFT (anti-money laundering and combating the financing of terrorism) regulations.6 The new banking regulations include guidance on credit classification for provisioning, credit concentration limits, credit risk management, and related-party transactions. The authorities intend to establish a deposit insurance.

31. Regarding offshore financial activities, the authorities have moved toward a single license for domestic and offshore banks and intend to harmonize the tax treatment of both activities shortly. The unified treatment of all banking activities is expected to enhance the overall attractiveness of Mauritius’s financial system.

D. Structural Issues

32. Discussions focused on labor market issues and the role of the public sector in commercial activities, with an emphasis on their role in fostering economic growth. The outlook for the textile and sugar sectors and the authorities’ plans to restructure them were also reviewed.

33. On labor market issues, the need to increase labor flexibility and the effects of the centralized wage-bargaining system on labor costs were reviewed. The authorities concurred with the staff’s view that labor flexibility would facilitate the deployment of workers from declining to expanding sectors. In that regard, the staff urged the authorities to carefully review current hiring and firing rules. In recognizing the need for such a review, the authorities stressed that more flexible rules had already been applied to the EPZ and that similar arrangements were envisaged for the ICT sector.

34. Regarding the centralized wage-settlement mechanism, the authorities emphasized that it was geared toward offsetting some loss of purchasing power, while additional decentralized negotiations would allow wages to better reflect sectoral differences in productivity. The World Bank is analyzing the impact of the wage-settlement mechanism on labor costs in the whole economy and at the sectoral level. The staff encouraged the authorities to quickly advance the policy actions in this area, taking into account the rising trend of labor costs over the past few years, as well as private sector concerns about the impact of the current wage-settlement arrangements on employment and investment.

35. The staff agreed with the authorities that the current unemployment benefit system did not discourage job searches because there were no recurrent unemployment benefits. The current system consists largely of lump-sum payments to individuals when their job terminates; the payments increase with the years of employment, but the amounts are not large enough to discourage the unemployed from searching new jobs. The authorities underscored that overall benefits were insufficient to sustain extended periods of unemployment.

36. The role of the public sector in commercial activities was also discussed. The authorities explained that the country’s small market size and lack of competition in certain activities called for the involvement of public enterprises to ensure a steady supply of key commodities at a reasonable cost. The staff encouraged them to consider measures that could attract additional private sector interest in these areas, with a view to strengthening growth and investment. Generally, the authorities agreed that the financial soundness of public enterprises needed to be monitored carefully so as to avoid costs to the budget.

37. On textile and sugar activities, the authorities explained their restructuring plans and accompanying measures aimed at mitigating the impact of the phasing out of trade preferences. On textiles, they were encouraging firms to cooperate in business planning, market development, and financial restructuring to strengthen their operations; some had already succeeded in moving to higher-quality products and had secured long-term contracts with international high-end retailers. In the context of bilateral trade negotiations with a number of emerging markets, the authorities were seeking access for Mauritian textile products to certain high-quality segments of these markets.

38. Efforts are also under way to restructure the sugar sector. The authorities have encouraged firms to move toward the production of goods with higher value added (such as refined sugar) and to explore fully the scope for side products that could be used for energy generation (such as ethanol).7 To reduce costs, the authorities intend to implement a program to combine plantations into larger, more efficient units and to support investment in irrigation. They were also hopeful that negotiations with the EU could result in more gradual price reductions and some financial support for their restructuring efforts.

39. The staff recognized the need for a sectoral strategy that would take into account the potential loss of employment and livelihoods for a large number of smallholder households. However, the staff urged the authorities to use great care in designing sectoral measures to avoid creating any disincentives for existing sugar activities. In the current difficult fiscal situation, the authorities need to minimize their recourse to fiscal incentives.

E. External Sector Issues

40. The authorities have begun to phase out all import tariffs to bolster external competitiveness. Furthermore, they have embarked on bilateral trade negotiations with major Asian economies (India, Pakistan) to secure market access for their textile sector. They are aware of the need to coordinate these steps with the Southern African Development Community (SADC) and Common Market for Eastern and Southern Africa (COMESA) to avoid conflicts with regional trade arrangements. There have been no other changes to Mauritius’s trade and exchange system since the last Article IV consultation.

41. Mauritius is not very vulnerable to shocks to its external debt-servicing capacity because its external public debt is low (14½ percent of GDP). Nonetheless, the authorities were encouraged to strengthen their collection of detailed data on private external debt so as to make future vulnerability assessments more comprehensive.

42. Despite the deterioration of Mauritius’s external environment, largely as a result of the erosion of trade preferences, the authorities saw no need to consider financial support from the Fund, including under the IMF’s Trade Integration Mechanism (TIM), at this stage. They pointed at the comfortable reserve level, equivalent to 6 months of imports, and expressed their confidence that a strong reform package would prevent a further significant worsening of their external and reserve positions. However, they asked for closer IMF involvement in designing and implementing reform measures.

F. Statistical Issues

43. Mauritius’s data availability is adequate for surveillance purposes. Recent discrepancies between monetary and fiscal statistics and the emergence of significant errors and omissions in the balance of payments data has been addressed. The authorities have also begun to publish quarterly national accounts data. On the staff’s suggestion to move the fiscal accounts to an accrual basis, they considered that further technical work was needed, particularly on the valuation of public sector assets and liabilities. Regarding external debt data, the authorities should explore discrepancies between official and external data (which indicate that the total stock of external debt could be higher than officially recorded).

III. Staff Appraisal

44. Economic conditions in Mauritius and its outlook have deteriorated markedly since the last Article IV consultation as a result of adverse external developments. The effects of the phasing out of trade preferences for textiles and sugar and the recent surge in world oil prices pose significant policy challenges in the short and medium term. Economic management is further complicated by the country’s high domestic public debt, which severely limits the scope for using fiscal policy to reenergize the economy.

45. The new government’s recognition of the need for fundamental reforms to boost competitiveness and ensure fiscal sustainability is welcome. A comprehensive policy response, combining appropriate macroeconomic and structural reforms, will be required. It would also help to restore investor confidence early on. As the authorities recognize, they need to redouble their efforts to attract foreign direct investment to the sectors that could help rekindle growth and job creation.

46. A more flexible labor market will be key to facilitating the transition of workers from declining sectors to growing ones. Hiring and firing rules for the entire economy need to be adjusted to the more flexible standards applied to some sectors, and the impact of the current centralized wage-settlement mechanism on labor cost and competitiveness must be examined without delay. These efforts need to be underpinned by well-targeted training programs so as to provide growing sectors with skilled workers.

47. A medium-term fiscal strategy needs to be formulated as soon as possible to move the public sector deficit toward sustainable levels. The authorities are encouraged to follow through with their plan to gradually phase out all import tariffs, also to bolster competitiveness, but need to implement measures to offset the associated revenue loss. There is ample scope to broaden the tax base and streamline expenditure while protecting the needs of disadvantaged groups more effectively through well-targeted transfers and subsidies. The financial soundness of public enterprises needs to be monitored carefully to avoid any cost to the budget.

48. Immediate measures need to be put in place to avoid a further deterioration of Mauritius’s overall fiscal position in 2005/06. The authorities need to reinstate the automatic price adjustment mechanism for domestic retail prices of petroleum products without delay and should begin implementing revenue-enhancing measures that have already been identified. The schemes to support the textile and sugar sectors that are under consideration should not lead to additional budgetary outlays.

49. Over the short term, monetary and exchange rate policies will play a crucial role in supporting external competitiveness while maintaining macroeconomic stability. The exchange rate needs to be allowed to move to a level commensurate with the worsened external environment and to protect international reserves. In parallel, liquidity conditions should be tightened to keep inflation low.

50. The risks to the banking sector from the deteriorating external environment require constant monitoring. While the authorities have stepped up efforts in this area, further actions, including the collection and monitoring of corporate debt information, are required.

51. The staff agrees that the current conditions are not favorable for moving to a formal inflation-targeting regime. Before such a step should be seriously considered, monetary policy instruments have to be sharpened, the external environment needs to become more predictable, and fiscal consolidation should be advanced. Meanwhile, the authorities are encouraged to work with forthcoming technical assistance from the IMF to meet the technical preconditions for such a step.

52. The staff stands ready to support the authorities’ reform efforts through stepped-up policy and technical advice, including, as requested, in formulating of the macroeconomic framework and budget for 2006/07.

53. It is proposed that the next Article IV consultation be held on the standard 12- month cycle.

Table 1.

Mauritius: Selected Economic and Financial Indicators, 2000/01-2010/011 1/

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Sources: Bank of Mauritius; Central Statistics Office; Ministry of Finance; and IMF staff estimates and projections.

Fiscal year (July-June).

Excluding changes in stocks.

Excluding the acquisition of aircraft and ships.

Trade-weighted period averages (a negative sign signifies a depreciation).

Including transfers, aircraft, and ships.

Table 2.

Mauritius: Balance of Payments, 2000/01-2010/11 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 IMF staff estimates and projections.

Fiscal year (July-June).

Including movements in international reserves of commercial banks.

Including valuation adjustments.

End of period.

Excluding the acquisition of aircraft and ships.

Market rate.

Table 3.

Mauritius: Summary of Public Sector Finances, 2001/02-2010/11 1/

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

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

Deferred interest payments on treasury bills during 2004/05-2006/07 are due in 2007/08.

In 2000/01 and 2001/02, net lending includes the repayment of US$33 million, US$111 million, and US$6 million of the international floating rate note of US$150 million, respectively.

Overall balance after grants, excluding interest payments.

Table 4.

Mauritius: Monetary Survey, 2003-2011

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Sources: Bank of Mauritius; and IMF staff estimates.

Including claims on public enterprises.

Central bank bills held by nonbanking financial institutions.