Mauritius
2007 Article IV Consultation: Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; Statement by the Staff Representatives; and Statement by the Executive Director for Mauritius

The loss of trade preferences in textiles in 2005, the reform to the European Union’s sugar protocol for 2006–10, and higher international oil prices have brought about a permanent deterioration in Mauritius’s terms of trade. This 2007 Article IV Consultation highlights that the authorities have initiated broad-based reforms to address recent economic setbacks and to raise growth to levels of the previous two decades. Executive Directors have welcomed the authorities’ efforts to tighten monetary policy. This should help to reduce inflation and avoid entrenching inflation expectations.

Abstract

The loss of trade preferences in textiles in 2005, the reform to the European Union’s sugar protocol for 2006–10, and higher international oil prices have brought about a permanent deterioration in Mauritius’s terms of trade. This 2007 Article IV Consultation highlights that the authorities have initiated broad-based reforms to address recent economic setbacks and to raise growth to levels of the previous two decades. Executive Directors have welcomed the authorities’ efforts to tighten monetary policy. This should help to reduce inflation and avoid entrenching inflation expectations.

I. The Challenges: Reducing Fiscal Vulnerability and Revitalizing Growth

1. Mauritius’s economy has suffered setbacks after two decades of remarkable growth. The loss of trade preferences in textiles in 2005, reform to the European Union’s sugar protocol for 2006–10, and higher international oil prices have worsened Mauritius’s terms of trade. Low growth and high fiscal deficits have fueled growth in public debt, and with slow adjustment in consumption behavior, the current account deficit and external vulnerability have increased.

Mauritius: Selected Economic Indicators, 1994/95-2005/06

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Sources: CSO, BOM, and IMF staff estimates.

In percentage points.

Includes sugar growing and sugar milling.

Employment by sugar estates and large sugar cane planters, data available from 2002.

2. The authorities have advanced several reforms initiated with the 2006/07 budget. They have improved the business environment, moved towards fiscal consolidation, simplified the tax system, eliminated some subsidies, liberalized trade, opened air access, and advanced the restructuring of the economy and the development of new sectors. The Bank of Mauritius (BoM) has replaced the Lombard rate with the repo rate as key policy rate. Planned labor market reforms focus on more wage flexibility and reducing the cost of releasing labor, supported by the empowerment program, which includes a workfare program emphasizing training and reskilling.

3. While there are signs of economic recovery, macroeconomic imbalances persist (Figure 1). Strong growth in the service sector and slowing job losses in the textile sector have helped revive real GDP growth. However, headline inflation surged largely reflecting budgetary measures. Public debt remains high, and the current account deficit has widened further, owing to weak export performance, higher oil prices, and lower import tariffs.1 The BoM has continued intervening in the interbank foreign exchange market and has gradually raised its signaling rate in response to higher inflation.

Figure 1:
Figure 1:

Mauritius: Selected Economic Indicators, 1994/95–2006/07

Citation: IMF Staff Country Reports 2007, 192; 10.5089/9781451827842.002.A001

Sources: Central Statistics Office, Bank of Mauritius, Ministry of Finance, and IMF staff estimates.1 In 2006/07, the import of one aircraft will account for 3 percent of GDP.

II. Policy Discussions

4. The authorities’ commitment to reform remains strong, but there is some resistance within the governing coalition and among the general public. Trade-offs in reform implementation arise between faster reform implementation and public acceptability, and the sequencing of measures would need to be kept under review. Some early successes, for example progress with the implementation of the empowerment program, would be conducive to political acceptance. Staff acknowledged the importance of wide stakeholder support but encouraged the authorities to put priority on (i) stepping up the fiscal effort in the medium term, (ii) reforming the labor market, (iii) further liberalizing trade, and (iv) pursuing additional structural reforms to promote growth.

5. The streamlined Article IV consultations followed up on the findings in the recent staff Letter of Assessment.2 The mission focused on macroeconomic prospects, fiscal consolidation and public expenditure management, and selected structural reforms to spur private sector development. Mauritius has been receptive to Fund advice, in particular in fiscal and monetary policies.

A. Boosting Macroeconomic Prospects

6. The growth recovery may prove short-lived, if reform efforts lose their momentum. The staff’s baseline scenario projects real GDP growth of more than 4 percent this fiscal year and in 2007/08, supported by strong growth in the service sector. In the medium term, high public debt would crowd out private investment, pulling average real GDP growth back to 3.5–4 percent. External adjustment would be slow. Assuming continuing foreign exchange intervention and capital inflows near current levels, reserves would dip to below three months of imports.

7. The risks to the baseline outlook are balanced. A further decline in oil prices and sustained growth in the service sector could restore external balance faster than projected, boosting growth. Higher-than-expected fiscal deficits or a renewed surge in oil prices could increase external vulnerability, leading to a larger current account deficit together with a lower level of reserves, or requiring additional macroeconomic adjustment.

8. Additional reforms would boost productivity and stimulate growth (Figure 2). The mission’s accelerated reform scenario is in line with the experience of other emerging markets (Figure 3). While it is difficult to identify specific policies that have caused growth accelerations, in general, they have been export-led, supported by strong private sector development and a reduction of infrastructure bottlenecks that hamper trade activities.

Figure 2.
Figure 2.

Mauritius: Baseline and Accelerated Reform Scenario, 2005/06–2011/12

Citation: IMF Staff Country Reports 2007, 192; 10.5089/9781451827842.002.A001

Source: IMF staff estimates.
Figure 3.
Figure 3.

Growth Accelerations in Emerging Markets: Some Stylized Facts1

Citation: IMF Staff Country Reports 2007, 192; 10.5089/9781451827842.002.A001

Sources: Central Statistics Office, Bank of Mauritius, Ministry of Finance, and IMF staff estimates.1 A growth acceleration is defined as a period in which the six-year trend growth rate of GDP per capita exceeded 3.5 percent, was at least 2 percentage points above the previous six-year period average, and real GDP per capita exceeded the pre-acceleration peak. From a list of 25 emerging markets (excluding transition economies) from the JP Morgan Emerging Market Bond Index, the staff identified 14 growth accelerations. For the methodology and further references, see Funke, Harjes, and Leelapornchai (2006), South Africa: Selected Issues Paper, IMF.

Baseline versus Reform Scenario: Main Assumptions

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B. Monetary and Exchange Rate Policies

9. Inflationary risks need to be monitored carefully (Figure 4). The staff and the authorities agreed that it is important to reduce high headline inflation quickly to the medium-term target of 4.5–5 percent, given the risk of entrenched inflation expectations. The staff argued that the BoM should consider raising the repo rate, if signs emerge that headline inflation would not decline as the one-time effects of budgetary measures start dropping out in mid-2007. Staff emphasized the need to develop the institutional framework (including research on transmission mechanisms of monetary policy and improving communication with the public) in order to establish the repo rate as an effective policy rate.

Figure 4.
Figure 4.

Mauritius: Recent Monetary and Exchange Rate Developments, 2002–2006

Citation: IMF Staff Country Reports 2007, 192; 10.5089/9781451827842.002.A001

Sources: IFS, BOM, CSO, and IMF staff estimates.1 Update of Bergljot Barkbu, Preferential Trade Agreements and the Equilibrium Real Exchange Rate of the Rupee, (2005), Selected Issues Paper, IMF.

10. The staff argued that sustaining competitiveness may require further adjustment in the exchange rate, in addition to wage restraint and productivity gains. According to staff estimates, fundamental factors, most notably the decline in the terms of trade, have lowered the equilibrium real effective exchange rate. Staff noted that the real effective exchange rate may be somewhat above its estimated long-run equilibrium value, and further adjustment may be required if the additional expected terms of trade decline materializes. Intervention should be limited to smoothing excess volatility to avoid postponing adjustment. In this context, staff also noted the sharp interest rate increase in treasury bills at primary auctions. The authorities raised concerns about the pass-through of exchange rate depreciations on inflation and suggested that the economic reforms could in time promote stronger capital inflows, causing the exchange rate to appreciate. They attributed the rise in treasury bill rates to institutional weaknesses, including the small number of market participants.

C. Fiscal Policy

11. The fiscal deficit (on a cash basis) is estimated to be close to the budgeted target for 2006/07, but the adjustment mix is unfavorable.3 Staff estimates that sweeping tax changes, together with reduced import tariffs, will have a slightly negative effect on revenues (0.5 percent of GDP less than in 2005/06). Compared to the budget, delays in filling vacancies have curbed expenditure on wages and salaries, but higher-than-expected inflation has increased spending on other goods and services. Subsidies and transfers are also expected to be above target (0.2 percent of GDP). The budget arithmetic was only squared by a cut in capital expenditure (0.4 percent of GDP).

Mauritius: Fiscal Position

(percent of GDP)

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Sources: Mauritian authorities; IMF staff estimates and projections.

Based on authorities’ nominal GDP projection.

12. Additional fiscal efforts are needed to reduce the budget deficit in the medium term and to improve the expenditure mix (Figure 5, Figure 6, Box 1). Around 4-5 percent of GDP are needed to achieve the medium-term budget deficit target of 3 percent of GDP, while increasing capital expenditure by 1 percent of GDP, and compensating for revenue loss from further trade reform. While the authorities agreed on the need for further fiscal consolidation, they have not committed to specific options as some measures, including eliminating VAT exemptions and pension targeting, are politically sensitive. The authorities pointed to the political trade-off between reorienting productive expenditure to improve the quality of the budget and further deficit reductions. Their plans to strengthen debt management will reduce fiscal vulnerability stemming from high interest payments and refinancing risks. Under staff’s reform scenario, public debt sustainability would improve (Appendix Table 9, Figure 10).

Figure 5.
Figure 5.

Mauritius: Recent Fiscal Developments 1994/95–2006/07

Citation: IMF Staff Country Reports 2007, 192; 10.5089/9781451827842.002.A001

Sources: CSO, Ministry of Finance, and IMF staff estimates.
Figure 6.
Figure 6.

Mauritius: Public Debt Sustainability: Bound Tests 1/

(Public debt, percent of GDP)

Citation: IMF Staff Country Reports 2007, 192; 10.5089/9781451827842.002.A001

Sources: International Monetary Fund, country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent one quarter standard deviation shocks applied to real interest rate, growth rate, and primary balance.3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2006/07, with real depreciation defined as nominal depreciation (measured by the percentage decline in dollar value of local currency) minus domestic inflation (based on GDP deflator).

Selected Options for Budgetary Savings1

Revenue-enhancing measures

  • Eliminate exemptions and zero VAT rates, including for food items (0.8-1.1 percent of GDP)

  • Phase out import exemptions on import duties (0.3 percent of GDP)

  • Remove exemptions on excise duties (0.2 percent of GDP)

  • Stop reducing corporate income tax rates (0.1 percent of GDP)

  • Eliminate remaining exemptions and allowances in the income tax (0.1 percent of GDP)

  • Reduce tax credit for offshore banking activity.

Reducing expenditure

(i) Recurrent expenditure

  • Implement a partial hiring freeze in the public sector by replacing only 25 percent of the new job vacancies (0.1 percent of GDP)

  • Adjust wage review mechanisms (incl. for parastatals) as of 2008/09 (0-1.6 percent of GDP)

(ii) Price subsidies, user fees, and transfers

  • Eliminate remaining price subsidies and replace them with unconditional transfers to low-income households (0.3 percent of GDP)

  • Introduce user fees for tertiary education and hospital services (0.1 percent of GDP)

  • Link government transfers to parastatals and local governments to rule-based formulas

(iii) Pensions

  • Accelerate schedule for raising retirement age to 65 for the Basic Retirement Pension (BRP) (0.1 percent of GDP)

  • Retain the BRP only for the elderly living in households in the bottom four income deciles (1 percent of GDP)

  • Introduce a defined contribution benefit formula for the civil service pension scheme and increase the retirement age

(iv) Capital expenditure

  • Public private partnerships

1/ Based on a 2006 technical assistance mission and updated policy discussions.
Table 9.

Mauritius: Public Sector Debt Sustainability Framework, Reform Scenario,2002/03-2011/12

(In percent of GDP, unless otherwise indicated)

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General government and parastatals’ gross debt.

Derived as [(r - p(1 + g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1 + g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1 +r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure 10.
Figure 10.

Mauritius: Public Debt Sustainability: Reform Scenario Bound Tests 1/

(Public debt in percent of GDP)

Citation: IMF Staff Country Reports 2007, 192; 10.5089/9781451827842.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance.3/ One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2006/7, with real depreciation defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

13. The mission encouraged the authorities to reduce the financial risks of Mauritius’s largest public enterprises, improve their efficiency, and review opportunities to involve the private sector. Most parastatals have borrowed in foreign currency, largely unhedged. These contingent liabilities could be reduced with improved monitoring and clear policy guidance from the debt unit of the Ministry of Finance.

14. The authorities and the mission agreed that further prioritizing spending (including reorientation to social functions) and enhancing expenditure management are key to improving the quality of expenditure. The mission supported the authorities’ intention to extend the three-year rolling Medium Term Expenditure Framework (MTEF) to all ministries in the 2007/08 budget and to improve budget monitoring, and macromodelling capacity within the MTEF. The mission emphasized the importance of reallocating fiscal resources (e.g., to education, well-targeted social programs, and infrastructure) within the context of the overall reform agenda. The authorities highlighted the need to advance the training and reskilling initiatives.

D. Private Sector Development

Trade Reform

15. Recent progress in liberalizing trade is commendable and should foster Mauritius’s growth prospects (Figure 7). The authorities stressed that progress has also been made in reducing tariffs in sectors considered sensitive. However, as a small island economy, it would be relatively difficult to establish the necessary trade infrastructure (e.g., antidumping laws) and competition policies needed to liberalize trade in all sectors. The mission encouraged the authorities to aim for a simple and transparent tariff framework with low, uniform rates instead of a duty free island with multiple exceptions. In promoting Aid for Trade, the authorities argued that the phasing of tariff reductions would depend on the capacity to define, finance, and implement accompanying measures. The mission supported the authorities’ efforts in encouraging the Common Market for Eastern and Southern Africa (COMESA) and the Southern African Development Community (SADC) to harmonize their integration timetables.

Mauritius: Selected Import Tariffs and Employment

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Sources: Mauritian authorities, World Bank.

Includes employment in export industry.

Figure 7.
Figure 7.

Mauritius: Recent Developments in Trade and Competitiveness

Citation: IMF Staff Country Reports 2007, 192; 10.5089/9781451827842.002.A001

Sources: CSO, Bank of Mauritius, World Economic Forum, and IMF staff estimates.

Financial Sector

16. The financial system appears generally sound, however, more institutional improvements could help lower borrowing costs and make more financing available to small and medium-sized enterprises (Figure 8). Private sector credit as a share of GDP has started recovering with recent reforms: the authorities unified banking licenses in 2004; established a Credit Bureau in 2005; and developed a range of financing schemes with preferential interest rates under the empowerment program. The authorities reaffirmed their commitment to follow up on the proposals of the FSAP update (Box 2).4

Figure 8.
Figure 8.

Mauritius: Recent Financial Sector Developments

Citation: IMF Staff Country Reports 2007, 192; 10.5089/9781451827842.002.A001

Sources: Bank of Mauritius, Bankscope, World Bank, and IMF staff estimates.1 Structural break in series in 2005/06 because of the unification of offshore and onshore bank licenses.2 SBM: Standard Bank of Mauritius. MCB: Mauritius Commercial Bank.

Summary of Selected FSAP-Update Recommendations

Regulatory Agencies
  • Improve cooperation between BoM and Financial Services Commission by activating the December 2002 memorandum of understanding.*

  • Strengthen the effectiveness of regulatory agencies by filling vacant positions.*

  • Adopt manpower plans for both BoM and Financial Services Commission, emphasize training and capacity building.

Insurance and Pensions
  • Complete implementing regulations, including risk-based solvency rules, and proclaim the Insurance Act 2005.*

  • Finalize new private occupational pension bill and take steps to enact it.*

  • Activate National Pension Fund Investment Committee.

Securities Markets
  • Complete implementing regulations and proclaim the Securities Act 2005.*

  • Adopt measures to develop more efficient money and government debt markets, focusing explicitly on enhancing the efficiency of the primary market.

Money and Public Debt Markets
  • Constitute Monetary Policy Committee (envisaged for April).

  • Review money market operations and consider potential refinements.

  • Finalize public debt management strategy and take measures to enhance the transparency and efficiency of the primary market.*

* To be implemented in the near-term.

The mission recommended that the authorities:

  • consider the benefits and costs of the differential tax treatment for non-resident and domestic lending, taking into account the impact on borrowing costs, economic activity, the financial sector, and tax revenue;

  • explore opportunities for more closely involving market intermediaries in selecting and monitoring the risk of projects financed by the Mauritius Development Bank;

  • address institutional constraints by expanding the scope of the Credit Bureau to reduce asymmetric information between banks and potential borrowers, and by strengthening creditors’ rights.

Price Controls

17. Still widespread administered prices are likely to hinder private sector development. The staff suggested the authorities systematically review the rationale for using administered prices, with a view to deregulate prices. This review should include an assessment of the largest public enterprises, such as the State Trading Corporation. The authorities explained that historically prices were administered to protect vulnerable groups, limit monopoly power, and to protect local production. They shared staff’s assessment that some price controls could be liberalized quickly (e.g., fertilizers, timber, iron bars). Any phasing-out in other areas would require strengthening the system of social transfers or competition framework at the same time.

Mauritius: Administered Prices

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Source: Mauritian authorities.

The markup ranges between 14 and 45 percent.

Under the Automatic Price Mechanism (APM).

III. Staff Appraisal

18. Ambitious, broad-based reforms initiated with the 2006/07 budget are starting to bear fruit, though macroeconomic challenges persist. Recent reforms have revived GDP growth and boosted short-term growth prospects. The fiscal deficit (on a cash basis) is projected to fall to near the budget target of 4 percent of GDP. However, headline inflation has risen, largely reflecting budgetary measures and could raise the risk of entrenched inflation expectations. External vulnerability remains high.

19. The restoration of external balance will need to be supported by gains in competitiveness. Success in reducing headline inflation (supported by improvements in the monetary policy framework), wage restraint, and gains in productivity will be key. The depreciation of the exchange rate has helped Mauritius adjust to the permanent terms of trade shock. It should be allowed to move more freely to a level commensurate with the external environment and to stabilize international reserves.

20. Fiscal pressures in the medium term will require more decisive fiscal consolidation and full implementation of reform projects under way. Budgetary savings of about 4-5 percent of GDP would be needed to reach the medium-term budget deficit target of about 3 percent of GDP, create more space for capital and social spending, compensate for the loss in revenue from further trade liberalization, and improve debt sustainability. The MTEF being rolled out to selected line ministries and the debt management unit being established—important institutional improvements—will need to be extended and deepened. To further reduce financial risks, parastatals’ borrowing activities should be monitored by the Ministry of Finance’s debt unit.

21. Additional structural reforms, along with progress in instituting trade and financial sector reforms, would boost Mauritius’s chances of spurring private sector development and raising growth. Most importantly, labor market reforms must unfold as planned, with a view to increase wage flexibility. To enhance trade, a transparent tariff framework with low and uniform rates would be preferable to a regime with multiple exceptions. Reforms that further improve the institutional environment, including extending the reach of the credit bureau and improving contract enforcement, could help lower borrowing costs and make financing available to more small and medium-sized enterprises. A close review of price controls—taking into account social implications and the need for accompanying policies—should guide reforms in this area.

22. Staff proposes that Mauritius continues on the standard 12-month consultation cycle.

Table 1.

Mauritius: Selected Economic and Financial Indicators, 2004/05–2011/12 1

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

Fiscal year (July-June).

Excluding changes in stocks.

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

Percent of beginning of period M2.

Includes credit to parastatals.

Projections excluding external debt related to unidentified capital flows.

Downgrade in June 2006.

Table 2.

Mauritius: Balance of Payments, 2004/05-2011/12 1

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

Fiscal year (July-June), analytical presentation.

The 2006/07 budget announced the integration of EPZ and non-EPZ sectors.

Including unidentified capital flows. Projections maintain the average of the past two years.

Positive sign indicates reserves loss.

Table 3.

Mauritius: Summary of Public Sector Finances. 2005/06-2011/12 1

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

Fiscal year: July/June.

Includes central and local government and parastatals.

Table 4.

Mauritius: Monetary Survey. 2004-12

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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.

Table 5.

Mauritius: Financial Soundness Indicators for the Banking Sector, 2002-2006 1

(Percent, unless otherwise indicated)

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Source: Mauritian authorities.

Banking sector refers to former Category 1 banks up to December 2004 and to all banks thereafter.

Total of Tier I and Tier 2 less investments in subsidiaries and associates.

Prior to June 2006, data refer to Category 1 banks only.