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.
December 2, 2005
1. I would like to express my Mauritian authorities’ appreciation to the staff for the constructive discussions on issues pertaining to the Mauritian economy during the last Article IV consultation exercise. My authorities are in broad agreement with staff’s analysis and policy recommendations regarding the main challenges facing the economy, and they thank staff for the informative set of papers. My authorities also appreciate the excellent and timely technical assistance provided by the Fund. In this context, the authorities valued the two seminars presented by staff on the topic of Inflation and Exchange Rate during the mission.
2. As has been noted by the Board, during past Article IV Consultation discussions, Mauritius, over the past two decades, has made impressive social and economic progress. Real GDP growth was among the highest in the world, with real per capita income more than doubled. The external account remained strong and the level of international reserves increased significantly. These achievements have been underpinned by large private and public investments which relied mainly on the high rate of domestic savings, strong public institutions, and importantly by taking full advantage of existing international trade agreements.
3. The changes in trade agreements, namely the phasing out of trade preferences for textiles at end-2004, and that for sugar starting in 2007, two sectors on which the growth of the Mauritian economy had been built, are posing severe challenges to the authorities and are creating an uncertain medium-term outlook. As I explained in my last Buff statement on Mauritius, the authorities have recognized the challenges facing the country and the need to restructure the economy. In this context, they have embarked on an ambitious program to find new drivers for economic growth. The country is reengineering itself to move up the value chain and build a knowledge economy based on financial services, and information and communication technologies. Measures are also being taken to modernize the sugar and textile sectors through higher productivity, better technology, and greater capitalization.
Recent Developments
4. Macroeconomic performance in 2004/2005 has been adversely affected by the retrenchment in the textile and garments sector with the coming to expiration of the Multi fiber Agreement, and the sharp increase in the import price of petroleum products. Sugar production will also be lower than earlier forecast due to heavy rains early in the year. Although the tourism sector is expected to show robust growth, the authorities now project real GDP to grow by about 3.5 percent this fiscal year. Inflation has been revised upwards and is projected at 5 percent for 2005, compared to 4.7 percent in 2004. The increase is due mostly to higher costs of imports. Unemployment continued to increase, due to retrenchment in the textile and sugar sectors, and was estimated at about 10 percent at end -2004. The decline in exports of textile and garments and the higher import price of petroleum products caused the external current account which has been in surplus in the recent past to turn into a deficit. The fiscal deficit for 2004/05 is expected to be about 6 percent of GDP.
5. In July 2005, elections for the National Assembly were held and were won by the Labor Party and a coalition of smaller parties. The new Government issued from the elections has recognized the major macroeconomic and structural challenges facing the country and has indicated its determination to address them. In presenting its economic program, the government has announced that its efforts will focus on reducing the fiscal deficit and implementing comprehensive structural reforms to diversify the economy and enhance competitiveness.
Macroeconomic Policies
6. The authorities agree that macroeconomic policies need to be tightened. It is their intention to take measures that will gradually reduce the fiscal deficit over the medium term, and to tighten monetary policy. However, with GDP growth slowing down, the authorities feel that they need to proceed carefully in their approach. At a time of slow growth and rising unemployment, policies have to be carefully balanced so that they do not make the situation worse by creating more unemployment.
7. Moreover, the new development strategy that is being put in place may also not help to reduce unemployment significantly, at least in the beginning. Indeed, diversification may create a period of jobless growth, as more emphasis is placed on the development of more capital- and knowledge-intensive sectors that demand high skills and create fewer jobs.
8. In the fiscal area, for the short term, the authorities are focusing their efforts on containing expenditure, especially through cuts in capital outlays, at least for the remainder of this fiscal year. Cuts in transfers and subsidies will be difficult in this period of increasing unemployment, but will be looked at as the economy improves. However, the authorities did raise petroleum prices by the full 15 percent in October, in accordance with the automatic price adjustment mechanism. Further price adjustments will be made quarterly following the mechanism in place. It is to be noted that this increase followed the increase in September in the price of natural gas for commercial users.
9. The authorities are in the process of developing a comprehensive medium-term strategy to return the economy toward fiscal sustainability, and also address the public debt problem. They expect to announce new revenue-enhancing and expenditure-reducing measures in the next Budget. As a first step the authorities intend to tighten tax loopholes and broaden the tax base.
10. The objectives of monetary and exchange rate policies are to support external competitiveness and maintain macroeconomic stability. As inflationary pressures have increased, the Bank of Mauritius has already raised interest rates. However, the monetary authorities feel that they need to move carefully as regards interest rate so as not to discourage investment, and also to pay close attention to the financial health of the banking sector at a time when many factories are closing down. In any case, policies will remain prudent. In their efforts to better manage liquidity, the authorities are considering diversifying their monetary instruments, and have requested technical assistance from the Fund.
11. The Bank of Mauritius has made good progress in the adoption of an informal inflation-targeting framework for monetary policy. However, they do not feel that all the conditions exist to adopt a formal inflation targeting framework. Box 2 of the Selected Issues paper outlines well the conditions that Mauritius has to meet before it can move to a formal inflation-targeting regime. In this regard, the authorities look forward to the next T/A mission from MFD to help them develop the necessary instruments and meet the preconditions for such a move.
12. The financial sector remains in sound health. In anticipation of the shocks to the textile and sugar sectors, provision requirements had been strengthened, and the exposure of the Mauritian banks to these two sectors have declined significantly over the past few years. The authorities are confident that further provisioning needs could be met from profits which remain strong. Nevertheless, the Bank of Mauritius continues to monitor the situation closely. It is also to be noted that there is now a single license for domestic and offshore banks, and the authorities intend to harmonize the tax treatment of both activities shortly.
Structural Issues
13. As noted above, changes in the international environment are adversely affecting the Mauritian economy. To maintain the growth momentum, and take full opportunity of the globalization process, fundamental structural changes are being implemented. Comprehensive restructuring plans for the sugar and textile sectors have been developed through close cooperation between the private sector and the government, and broad consultation with stakeholders, and have relied entirely on domestic financing. The restructuring plans aimed at bolstering competitiveness in both the textile and sugar sectors and to encourage diversification within those sectors. At the same time the government has put in place a retraining program to enable displaced workers both in the sugar and textiles sectors to acquire new skills that could help them find employment in other sectors.
14. In the sugar sector, the measures being implemented have already helped to reduce production costs, but the social costs are high, with the loss of more than 10,000 jobs, since 2000. The number of sugar mills which stood at 20 have now been reduced to 11 and will be reduced further to 5 within 5 years. The mechanization process will continue and more layoffs will occur. At the same time, a process of diversification is underway within the sugar sector, with the production of ethanol, rum, specialty sugar, and greater use of the residue from sugar cane in the production of energy. As an example of the diversification process, Mauritius now exports over 60,000 tons of specialty sugar which has a high market value and is not subject to any quota.
15. In the textile sector, the loss of employment is estimated at about 15,000 since 2000. However, the authorities expect the situation to start stabilizing by year-end. Already some of the more efficient factories have started to hire employees. The restructuring strategy has also focused on upgrading technology, diversifying products and markets such as taking better advantage of preferential access to the U.S. market under the AGOA, developing skills and human resources, and attracting foreign direct investment. Large investments have been made, often with foreign partners, in spinning technology which will enable vertical integration and lower costs. Already, the industry is regaining some competitiveness as regards upscale products.
16. Together with the restructuring of the these two sectors, the authorities are continuing their efforts to deepen the tourism sector which has done very well. The strategy put in place and which has relied on the development of an upscale tourist industry has been successful. The authorities are building on the this success to expand this sector further. New hotels are being built and air-link networks are being developed with other countries. This sector is expected to make significant contribution towards employment creation. Concurrently, the authorities are also working closely with the private sector in developing a new strategy aimed at making the island a “shopping paradise” through the gradual elimination of all import tariffs, and through a policy of attracting regional tourists.
17. As regards other growth sectors, good progress is being achieved in the development of the Information and Communications Technology (ICT) sector, with the assistance of foreign partners. This sector is absorbing much of the more educated workers, and is expected to grow further over the medium term. The seafood sector is fully operational and has large potential. The financial services sector aslo continues to make positive contribution to growth. This sector employs about 7,000 highly skilled workers.
18. On the labor market, while more flexibility could help to reduce some unemployment, the authorities are of the view that the market is not as rigid as one might think. In the EPZ, for example, where most of the textile and garments factories are located, labor laws are flexible and firms can hire and fire at any time. Similarly, in the new ICT sector which has many outcall centers and which needs to be opened 24/7, labor laws are flexible, and wages are determined by supply and demand. In the tourism and in particular in the hotel sector where there is union activity, the hiring of workers has not been a constraint. The Tripartite Negotiations (Labor, Management and Government) has generally not been a source of rigidity. In fact, it has contributed to peaceful industrial relations in Mauritius, an important factor in attracting foreign investors. As regards the inflation-biased argument of the wage negotiation system, my authorities would point out that the implementation of the salary increase recommended has been generally tapered, such that the average salary increase has been overall half the inflation rate. Over the years, different governments have looked at the many proposals with a view to changing the system, but none has gathered a consensus. Moreover, none of the other system is as transparent and easy to understand as the inflation-related wage increase. In cases where there have been large wage increases, it has come on top of what the Tripartite Negotiations had proposed and was the result of direct sectoral negotiations. Nevertheless, the authorities will continue to work closely with all stakeholders with a view to make the present system less rigid. My authorities would also like to point out that the unemployment issue is more a problem of a lack of employment opportunities rather than one of rigidities in the labor market.
19. Overall, while the economic situation in the short term is difficult, the outlook for the medium to longer term seems brighter as Mauritius continues to adapt and re-engineer its economy to the new realities. In designing their development strategies, the authorities remain in close consultation with the World Bank. The authorities also look for closer relation with the Fund, in assisting them in the analysis of the economic and financial situation, and in helping them design the appropriate policies to meet the ongoing challenges.