Mauritius
Selected Issues
Author: International Monetary Fund
Publication Date:
21 Jul 2008
eISBN:
9781451827859
Language:
English
Keywords:
ISCR; CR; price; nominal exchange rate; interest rate; CPI inflation; forecasting exercise; inflation distribution; Mauritian rupee; liberalization inflation development; Inflation; Price controls; Exchange rates; Consumer price indexes; Real effective exchange rates; Global; interest rate differential; equilibrium exchange rate approach; REER index; policy of Mauritius; Exchange rate arrangements
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1. Mauritius, a relatively undiversified but very open small island economy dependent on the external sector, has been facing a triple negative terms of trade shock due to (1) the phasing out of the Multi-Fiber Agreement starting in 2004, (2) the reduction in sugar price guarantees from the European Union starting in 2006, and (3) higher world commodity prices, especially for food and petroleum. As export growth dwindled and the economy began adjusting to the new external environment, the current account (CA) deficit has worsened (to an average of 4 percent of GDP for 2004–07). Growth has been low by historic standards (averaging 3.6 percent of GDP between 2001 and 2007 compared to 4 percent in the 1990s and 5 percent in the 1980s).

Abstract

1. Mauritius, a relatively undiversified but very open small island economy dependent on the external sector, has been facing a triple negative terms of trade shock due to (1) the phasing out of the Multi-Fiber Agreement starting in 2004, (2) the reduction in sugar price guarantees from the European Union starting in 2006, and (3) higher world commodity prices, especially for food and petroleum. As export growth dwindled and the economy began adjusting to the new external environment, the current account (CA) deficit has worsened (to an average of 4 percent of GDP for 2004–07). Growth has been low by historic standards (averaging 3.6 percent of GDP between 2001 and 2007 compared to 4 percent in the 1990s and 5 percent in the 1980s).

I. Assessing the External Competitiveness of Mauritius 1

A. Introduction

1. Mauritius, a relatively undiversified but very open small island economy dependent on the external sector, has been facing a triple negative terms of trade shock due to (1) the phasing out of the Multi-Fiber Agreement starting in 2004, (2) the reduction in sugar price guarantees from the European Union starting in 2006, and (3) higher world commodity prices, especially for food and petroleum. As export growth dwindled and the economy began adjusting to the new external environment, the current account (CA) deficit has worsened (to an average of 4 percent of GDP for 2004–07). Growth has been low by historic standards (averaging 3.6 percent of GDP between 2001 and 2007 compared to 4 percent in the 1990s and 5 percent in the 1980s).

2. Recent performance raises questions about the competitiveness of the Mauritian economy and what needs to be done to ensure external stability and reduce vulnerabilities. One key measure of competitiveness is the extent to which the real exchange rate (RER) is aligned with its equilibrium value. Assessment of the equilibrium real exchange rate (ERER) is important because there is evidence that misalignment can undermine growth (Cottani, Cavallo, and Khan, 1990; Razin and Collins, 1997; Fosu, 2000). RER misalignment can affect growth by altering domestic and foreign investment decisions, thereby affecting capital formation and the tradable sector. Furthermore, an RER misalignment, if allowed to worsen, could lead to a disruptive adjustment. Competitiveness assessments also look at external sector outcomes, business climate indicators, and production costs.

3. This paper assesses the external competitiveness of Mauritius over the period 1980–2007, with particular attention to the most recent years. 2 We estimate the ERER using the macroeconomic balance approach, the single-equation equilibrium exchange rate approach, and the capital-enhanced equilibrium exchange rate approach. A wealth of structural competitiveness indicators are also analyzed.

4. Our findings indicate that the real exchange rate at the end of 2007 was broadly in line with its equilibrium value (as determined by economic fundamentals). We also find that Mauritius fares better than comparator countries in terms of structural competitiveness, especially in terms of the business climate.

5. In what follows, Section B describes the evolution of Mauritius’ exchange rate regimes going back to its colonial past. In Section C three econometric methods are applied to estimate the equilibrium value of the RER. Section D surveys the country's competitiveness using various structural indicators, and Section E concludes.

B. The Evolution of the Mauritius Exchange Rate

6. Mauritius has adopted a variety of exchange rate regimes over time. 3 As part of the British Empire it did not initially have its own currency, but the government established a currency–board–like system in 1848. Until 1870 Mauritius switched between the pound sterling (gold) and the Indian rupee (silver). Between 1878 and 1934, Mauritius was part of a common monetary union with India, so the legal tender was the Indian rupee. This reflected the inflow of Indian rupees with Indian immigrants to Mauritius. During that period the currencies of British colonies were almost all linked to the pound sterling through currency boards. When the United Kingdom abandoned the gold standard in September 1931, most British colonies did likewise. In 1934, Mauritius followed the lead of several other British colonies by introducing its own currency, but still under a currency board pegged to the pound sterling. This regime lasted until November 1967 (Figure 1).

Figure 1
Figure 1

Exchange Regimes and the Nominal Exchange Rate, 1948–2007

Citation: IMF Staff Country Reports 2008, 237; 10.5089/9781451827859.002.A001

Source: Reinhard and Rogoff (2004) and AREAER.

7. In preparation for independence, the Mauritian rupee moved from a currency board to a peg to the pound sterling in November 1967. A dual market co-existed, however, separating foreign exchange markets for capital transactions from CA transactions. Capital transfers were subject to a stamp duty initially set at 15 percent. With gold convertibility ending when the dollar standard was abandoned in 1971, trade diversifying away from Britain, and the weakness of the pound sterling, Mauritius left the sterling area in June 1972 and established a central exchange rate with Special Drawing Rights (SDRs). It maintained a second exchange rate for the stamp duty rate for capital transfers. In January 1976 Mauritius officially pegged the rupee to the SDR, with a 2 percent band. In practice, the exchange rate for official purposes was a crawling band around the U.S. dollar. Following a period of overvaluation, the rupee was devalued in 1979 and 1981. The stamp duty on transfer of capital was raised in July 1981 from 36 percent to 45 percent.

8. In June 1982 the Mauritian rupee was officially de-linked from the SDR and pegged to a trade-weighted basket of the currencies of its major trading partners, but the composition of the basket was not disclosed. The change was part of the broad liberalization launched under an IMF program. The exchange rate remained pegged de facto to the U.S. dollar, with a 5 percent band. The limit on the sale of foreign exchange for travel was administered as a capital control. Until the early 1990s Mauritius maintained a multiple currency practice in the form of a 15 percent tax on some capital remittances.

9. Exchange rate restrictions were lifted in 1992 and transactions involving foreign currencies were fully liberalized in July 1994. Beginning in 1992, the crawling band was de facto maintained around the U.S. dollar but narrowed to 2 percent. The capital transfer tax was abolished. Since the mid-1990s Mauritius has maintained a managed float, and the Bank of Mauritius intervenes solely to smooth exchange rate fluctuations rather than alter the trend.

10. Post-Bretton Woods the nominal exchange rate (NER) continuously depreciated against the U.S. dollar (Figure 2). This reflected higher inflation in Mauritius than in its trading partners. Monetary policy accommodated the higher inflation differentials by letting the NER depreciate to achieve a stationary REER.

Figure 2
Figure 2

Nominal and Real Effective Exchange Rates, 1980–2007

Citation: IMF Staff Country Reports 2008, 237; 10.5089/9781451827859.002.A001

Source: INS

11. An examination of various price-based REER indices relative to its main trading partners indicates that Mauritius's competitiveness has improved markedly since 2002 (Figure 3).4 The real exchange rates are computed relative to an aggregate of trading partners 5 and are adjusted for inflation of consumer prices, GDP deflator, unit labor costs, and export prices. Figure 3 shows that the various price-based REER indices move closely together over time. After staying relatively flat throughout the 1990s they suggest sharp depreciation since 2002. This path is a consequence of negative terms of trade shocks, which required it so as to restore the economy to sustained growth (Funke, Granziera, and Imam, 2008).

Figure 3.
Figure 3.

Price–based REER indices

(2000=100)

Citation: IMF Staff Country Reports 2008, 237; 10.5089/9781451827859.002.A001

Source: Mauritius Central Statistics Office, INS, and Staff estimates.

C. Empirical Analysis of the Equilibrium Exchange Rate

12. Assessing the departure of the actual level of the REER from its equilibrium value is key to identifying external imbalances. The desired level of competitiveness is attained when the REER is consistent with both internal balance—low unemployment and low inflation—and external balance—a sustainable long–term CA position. If a country faces persistently high unemployment or a persistently high CA deficit, the REER must be adjusted—through NER depreciation or subdued wage growth—to restore equilibrium. 6 In this section we present the results of three econometric approaches to identifying equilibrium value and assessing external competitiveness: the macroeconomic balance approach (FEERMB), which assesses a country's deviation from equilibrium by observing by how much the CA is projected to deviate from its sustainable norm implied by the fundamental determinants of saving and investment; the single–equation equilibrium exchange rate approach (FEER–SE), which assesses the equilibrium exchange rate based on a country's macroeconomic fundamentals; and the capital–enhanced equilibrium exchange rate approach (CHEER), which adds the uncovered interest parity (UIP) condition to analyzing deviations from equilibrium. These methodologies assess the exchange rate misalignment from different angles, but in the case of Mauritius (see below), they lead to the same conclusions.

Macroeconomic Balance Approach (FEER–MB)

13. The FEER permits the calculation of the ERER as implied by medium-term macroeconomic fundamentals (Edwards, 1989; Williamson, 1994; Isard and Faruqee, 1998; Faruqee, Isard, and Mason, 1999; Driver and Westaway, 2005). The FEER abstracts from the influence of transitory factors. We focus on the REER that secures external balance for Mauritius in the sense of CA sustainability.

14. The analysis consists of three steps. First, we estimate a model of the determinants of the CA balance using panel data for 140 countries between 1980 and 2005. Second, we project the CA norm for Mauritius over the medium term (2008–13) using coefficient estimates from the model and staff's forecast for economic fundamentals. In the last step, we determine the exchange rate adjustment that would be needed to close the gap between the CA norm and the underlying CA (measured using WEO projections for the medium-term) based on estimated trade elasticities.

15. To project the CA norm, coefficient estimates based on three panel estimators are considered: pooled OLS, random effects, and fixed effects (Appendix Table 1).7 The results are reassuring: the coefficients do not vary much across methods. Note, nevertheless, that the purpose of the model is not to identify the causal effect of macroeconomic variables on the CA balance. Rather, it is to obtain strong statistical covariates of the CA balance so as to interpret the predicted values as reflecting the country's economic fundamentals.

16. Coefficient estimates from the panel analysis accord with economic theory and intuition in terms of signs and magnitude. 8 An increase in the overall fiscal balance-to-GDP ratio predicts a CA balance higher by one third of a percentage point of GDP; and a higher NFA/GDP position is also associated with a higher CA balance but the coefficient size is much lower. While higher income (relative to the U.S.) improves the CA balance, higher per capita growth causes it to deteriorate. The demographic control variable shows that an increase in the population growth rate by 1 percentage point is associated with a CA balance that is lower by ½ percentage point of GDP. Finally, countries that export fuel, have been affected by the East Asian crisis, or are global financial centers have substantially higher CA surpluses over the period; the reverse is true of offshore financial centers (such as Mauritius), whose CA balances are 5–6 percentage points lower than in onshore centers.

17. It appears that the REER has been close to its equilibrium value for much of the period (1980–2005) and that the exchange rate policy of Mauritius has been appropriate given the economic fundamentals. Figure 4 plots the actual CA balance against that fitted from the fixed effects model. Over the period analyzed, the average fitted CA balance is slightly below the average realized CA balance. This implies that for the two to have been aligned historically, a slight real exchange rate appreciation would have been required.

Figure 4.
Figure 4.

Macroeconomic Balance Approach: Actual and Fitted CA/GDP

Citation: IMF Staff Country Reports 2008, 237; 10.5089/9781451827859.002.A001

Source: Staff estimates.Note: the actual CA/GDP is expressed as a three–year moving average.

18. Looking ahead, the macroeconomic balance approach suggests that the level of the REER is broadly appropriate as the projected CA deficit is close to the underlying CA norm(Figure 5). Over the medium term (2008–13), the CA norm (determined by medium-term fundamentals and coefficient estimates from panel regressions) is close to the underlying CA (based on medium-term WEO projections). Therefore, the method predicts that little or no RER adjustment will be necessary. 9

Figure 5.
Figure 5.

Macroeconomic Balance Approach: CA norm and underlying CA

Citation: IMF Staff Country Reports 2008, 237; 10.5089/9781451827859.002.A001

Source: Staff estimates.Note: the underlying CA is expressed as a three–year moving average and is stripped of temporary factors such as purchases of aircraft and ships.

Single-Equation Equilibrium Exchange Rate Approach (FEER-SE)

19. Here we analyze the ERER by estimating a reduced-form structural relationship between the REER and a vector of economic fundamentals. 10 The concept of equilibrium used is again medium-term. We assess whether the level of the exchange rate reflects the value of the fundamentals. The data consist of time series for the period 1960–2007. For purposes of estimation, we use the autoregressive distributed lag (ARDL) approach to cointegration developed by Pesaran and Shin (1999) and Pesaran, Shin, and Smith (2001). 11

20. The starting point is a general model comprising the following variables: terms of trade, government consumption, openness, relative productivity, interest rate differential, NFA position, and a capital controls dummy for post-1994 liberalization. Using a general-to-specific methodology, we eliminate those variables that do not appear to have a cointegrating relationship with the REER. Notably, data paucity over the period analyzed precludes a reliable analysis of the interest rate differential, notwithstanding its importance. We also find that the NFA/GDP ratio, the capital account liberalization dummy, and relative productivity do not yield statistically significant or meaningful results in the long-run model.

21. We identify long-run cointegrating relationships between the REER and three variables: terms of trade, openness, and government consumption. 12 We report only one parsimonious specification (which preserves degrees of freedom), as follows:

ln(REER)t[t−stat]=0.53×ln(TOT)t[2.22]***−0.97×ln(OPEN)t[−3.51]***−0.92×ln(GCONS)t[−2.19]***(1)

First, as expected, the terms of trade of goods have a positive coefficient, since a positive shock improves the trade balance and the resulting higher domestic demand pushes up the prices of nontradables, leading the real exchange rate to appreciate. Second, an increase in openness (which can be seen as a proxy for the easing of trade restrictions) is associated with lower domestic prices, hence a real depreciation. Third, a rise in government consumption (about 15 percent of GDP) is associated with real depreciation (suggesting that the government spends primarily in the tradable sector).

22. The single-equation equilibrium exchange rate analysis suggests that the Mauritian rupee has been close to its equilibrium value since 2003 (Figure 6). This implies that exchange rate policy has been appropriate for the past several years. To qualify our findings, let us mention that ensuring alignment between the actual and equilibrium value of the real exchange rate should not be viewed as a policy goal in itself. Temporary deviations of the exchange rate from the level implied by fundamentals can be beneficial, as illustrated by the finding that an appreciating currency can put a brake on GDP growth or make it difficult to sustain periods of growth acceleration (Hausman, Pritchett, and Rodrik, 2005), and a depreciating currency can relaunch growth (Rodrik, 2007).

Figure 6.
Figure 6.

Single Equation Approach: Actual vs. Equilibrium REER

Citation: IMF Staff Country Reports 2008, 237; 10.5089/9781451827859.002.A001

Source: Staff estimates.Note: The price measure is the GDP deflator.

Capital-Enhanced Equilibrium Exchange Rate Approach (CHEER)

23. To better assess the recent evolution of the Mauritian rupee, we apply the CHEER approach to monthly data between July 1995 and December 2007. The CHEER approach is based on the idea that CA imbalances generated by real shocks must be financed through the capital account (Johansen and Juselius, 1992; Juselius, 1995; Juselius and MacDonald, 2004; MacDonald, 2000). It has the advantage of accounting for the interplay between the two components of the balance of payments by combining two parity conditions: purchasing power parity (PPP) and uncovered interest parity (UIP). Therefore, the extent of over- or undervaluation is defined as the variation in the exchange rate which is unexplained by interest rate differentials. Mauritius having opened up its capital account, the CHEER approach, unlike the others, captures capital flows as a factor affecting the ERER.

24. In the CHEER approach, departures from PPP are explained with real interest rate differentials. First, note that the UIP condition equalizes nominal rates of return on domestic and foreign currency assets. Therefore, the expected change in the nominal exchange rate is determined by the interest rate differential and any risk premium (e.g., for country risk) as follows:

st=Etst+1+(it−it*)+Σt(2)

where st is the (log) nominal exchange rate (MUR/US$);(it–it*) is the interest rate differential for T–bills; σt is the risk premium; andEt is the expectations operator. Assuming σt = 0, it follows that if domestic interest rates are above foreign rates, the domestic currency must be expected to depreciate to equalize rates of return. Imposing σt = 0 and subtracting the expected inflation differential from both sides of the equation, we have

et=Etet+1+(rt−rt*)(3)

where et is the real exchange rate and (rt–rt*) is the real interest rate differential. (For a visual interpretation of the two parities relative to the U.S., see Appendix Figure 1.)

25. We estimate a vector autoregressive model (VAR) of the nominal exchange rate, the inflation differential, and the interest rate differential. The vector of monthly variables is given by

[st,Δpt,Δpt*,it,it*]∼I(1)(4)

where Δpt and Δpt * represent inflation in Mauritius and the U.S. (measured by the consumer price index). The interest rates are yields on the 90–day T–bill. All variables considered (nominal exchange rate, prices, and interest rates) have unit roots in the level series (Appendix Table 3). We use the Hodrik–Prescott filter to obtain the equilibrium nominal exchange rate.13

26. The CHEER approach suggests that the MUR/US$ spot exchange rate has been in line with economic fundamentals since July 1995 (Figure 7). 14 Our findings based on the CHEER approach therefore confirm those from the previous methods, underlining the result that exchange rate policy in Mauritius has been appropriate in recent years. The nominal exchange rate has, however, been volatile around the estimated equilibrium, depreciating above the trend in mid-2006 because of a large real interest rate differential with the U.S. dollar. The rupee started to appreciate again at the end of 2006 as monetary policy became more credible once an independent Monetary Policy Committee was established. The cuts in U.S. interest rates since August 2007—the beginning of the rupee's deviation from long-run equilibrium—was not followed by commensurate reductions in Mauritian interest rates, leading to a rising positive interest rate differential. This explains the continued appreciation of the rupee against the U.S. dollar and its slight deviation from trend toward the end of 2007.

Figure 7.
Figure 7.

CHEER Approach

Actual and Equilibrium nominal exchange rate

Citation: IMF Staff Country Reports 2008, 237; 10.5089/9781451827859.002.A001

Source: Staff estimates.Note: Last data point is December 2007.

D. Structural Indicators of Competitiveness

27. In addition to equilibrium exchange rate methods, a comparative analysis of nonprice indicators may be essential in portraying a country's relative competitiveness. Indicators such as institutional quality (reflecting labor market flexibility, access to finance, or rule of law) can offer valuable insights on where bottlenecks lie and may help policy-makers to identify potential policy reforms. Caution is required in interpreting this section's results: Structural indicators of competitiveness can be useful in identifying binding constraints on growth but often conceal problems because economic agents often adapt to the environment by addressing binding constraints themselves. For example, power outages are known to be a problem in Mauritius, but surveys fail to show this as a problem because most firms have bought expensive power generators, thus bypassing the constraint (Clarke et al, 2006). While typical surveys (and indicators based on them) would thus suggest that power outages are not an issue for normal business functioning, in reality an upgrade of the power system is desirable to bring down input costs.

28. In analyzing several composite competitiveness indicators we find that Mauritius is one of the best performers in sub-Saharan Africa and often outranks comparator economies. We look at four indicators: (i) the Global Competitiveness Index developed by the World Economic Forum; (ii) the World Governance Indicators of the World Bank; (iii) the Doing Business Report indicators of the World Bank; and (iv) the Corruption Perception Index of Transparency International.

29. Mauritius fares well on structural competitiveness. Figure 8 plots standardized scores for Mauritius and three comparator groups. Mauritius ranks in the top third of most competitive countries in the world according to the Global Competitiveness Index. It is ahead of comparator small-island economies for which data are available but lags behind high-growth Asian economies (South Korea, Hong Kong, Singapore, Taiwan, Malaysia, Thailand, and Indonesia). The World Governance Indicators summarize survey opinions on several dimensions of institutional quality: voice and accountability, political stability, government effectiveness, regulatory quality, rule of law, and control of corruption. Again, Mauritius ranks high by international standards, outperforming high-growth economies as well as small island states. The Doing Business Report 2008 named Mauritius the best-performing country in sub–Saharan Africa and ranked it 27th in the world. Compared to other nations, the country fares particularly well on institutional variables related to commerce and entrepreneurship, such as starting a business and dealing with licenses.

30. The analysis of structural competitiveness indicators helps identify areas for improvement in Mauritius. According to the 2007/08 Global Competitiveness Report, the main challenges are relatively inefficient government bureaucracy, limited labor flexibility, and an inadequately skilled workforce. The 2008 Doing Business Report flags a need for progress in registering property and the cost of closing businesses. The same report highlights relatively limited access to credit.

31. Looking at relative performance in trade and the information, communications, and technology (ICT) sector we conclude that Mauritius again fares well compared to both high-income countries and regional averages. We consider a sub-index of the Global Competitiveness Index—the trading across borders measure—to determine how Mauritius stands in terms of exporter and importer costs of doing business. Djankov, Freund, and Pham (2006) have documented the trade cost of delays in shipments and highlighted the importance of reducing them (not just reducing tariff barriers) to stimulate exports. In the number of documents required for a transaction, the cost (in US$ per container), and the time to export, Mauritius is outperformed only by the OECD countries (Figure 9 and Appendix Table 4).

Figure 8.
Figure 8.

Composite Indicators of Structural Competitiveness

Citation: IMF Staff Country Reports 2008, 237; 10.5089/9781451827859.002.A001

Source: World Economic Forum, World Bank World Governance Indicators, World Bank Doing Business Indicators, and Transparency International.

32. In what concerns access, quality, affordability, and institutional efficiency and sustainability, ICT sector services fare relatively well (Table 1). Mauritius seems to be outperformed (though by a large margin) only by high-income countries; it has clearly outpaced other income-based country groupings (including the upper-middle-income group). Still, progress is needed in the area of quality, notably in broadband Internet access and fewer telephone faults.

Figure 9.
Figure 9.

Trade Costs

Citation: IMF Staff Country Reports 2008, 237; 10.5089/9781451827859.002.A001

Source: World Economic Forum.
Table 1.

The Relative Performance of the Mauritius ICT Sector

article image
Source: World Bank ICT at a Glance Tables.

E. Conclusions

33. With the phasing out of the European Union sugar protocol, the elimination of the Multi-Fiber Agreement, and rising world commodity prices, Mauritius faces a triple terms of trade shock. To identify vulnerabilities to the country's external position, this study analyzed its equilibrium exchange rate using three econometric approaches—the macroeconomic balance, the single-equation, and the capital-enhanced approach—and also analyzed the business climate, trade, and ICT costs in comparative terms.

34. The Mauritian rupee appears to be close to its equilibrium value. The macroeconomic balance approach employed parameters from a model estimated on panel data for 140 countries and staff projections of economic fundamentals to project the Mauritius CA norm over the medium term (2008–13). It found that the CA norm is close to the underlying CA stripped of temporary factors, suggesting that little or no REER adjustment is needed. The single-equation approach used time series methods to explain the variation in the REER using fundamentals such as openness to trade, terms of trade shocks, and government consumption as a share of GDP. It concluded that the real exchange rate has been in line with the equilibrium level since 2003. The capital-enhanced approach brought the uncovered interest parity condition into the analysis; it investigated the relationship between monthly exchange rate variations and the interest rate differential with the U.S. Despite some volatility around the trend, the nominal exchange rate was close to equilibrium over the period, but appreciation pressures were noticeable at the end of 2007.

35. Given that the exchange rate regime is a managed float, the government should continue its policy of intervening in the foreign exchange market only to reduce volatility, not affect the trend. This policy should keep the RER at its equilibrium level consistent with economic fundamentals. Desired levels of the CA balance (and the net foreign asset position) over the medium term may require small exchange rate corrections, but these can be limited if accompanied by measures to address structural bottlenecks and bolster competitiveness.

36. Structural competitiveness indicators offer a glimpse into areas that require attention, such as labor market reforms, ICT, and certain dimensions of institutional quality. While the government’s reform program have had far-reaching effects in restoring competitiveness, actions may also be required to stimulate competition in goods markets, make labor markets more flexible, raise the average skill level, increase broadband access, and further reduce the cost of doing business. As Mauritius embarks on its ambitious plan to become a business and financial services hub, such measures are essential for improving its competitiveness profile.

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Appendix

Data Sources and Definitions

Econometric analysis: The data have been extracted from International Financial Statistics (IFS), Information Notice System (INS),World Economic Outlook (WEO),World Development Indicators (WDI), and Penn World Tables Mark 6.2. Data on the Mauritius 90-day average T-bill yield have been drawn from the Bank of Mauritius Monthly Statistical Bulletin (1994 to 2007).

Trading partners: Mauritius’s trading partners for purposes of calculating the REER are, in descending order of importance, France, Germany, the U.S., the UK, Japan, South Africa, Italy, Belgium, Singapore, the Netherlands, Taiwan Province of China, Hong Kong SAR, Spain, Switzerland, India, Korea, Canada, China, and Thailand. Trade weights have been obtained from the INS.

Comparator countries: Regional and income country groupings have been obtained from the WDI.

  • Small island economies: Comoros, Madagascar, Maldives, and Seychelles.

  • High-growth Asian economies: Hong Kong, SAR, Singapore, South Korea, Taiwan Province of China, Malaysia, Thailand, and Indonesia.

Structural competitiveness indicators:

Table 1.

Correlates of the Current Account Balance. Panel Estimates

(1980–2005)

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Robust standard errors in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%

Note: Old dependency ratio (defined as the ratio of population over 65 years of age to population between 15 and 64 years of age) as well as a measure of financial deepening (M2/GDP) are insignificant in most specifications and are excluded from the model. Financial centers are Belgium, Luxembourg, the Netherlands, Singapore, Switzerland, and Hong Kong. Offshore financial centers are St. Vincent & Grenadines, Dominica, St. Lucia, Grenada, St. Kitts & Nevis, Antigua and Barbuda, Barbados, the Bahamas, and Mauritius. To account for the large current account deficits up to the East Asian crisis and the surpluses thereafter, the East Asian crisis dummy takes value 1 for the following countries starting in 1998: Thailand, Indonesia, Korea, Malaysia, Laos, the Philippines, and Hong Kong. The euro zone dummy takes value 1 for the countries that have adopted the euro (in 1999 except for Greece, which adopted it in 2001). Fuel-exporting economies are Algeria, Angola, Bolivia, Cameroon, Ecuador, Egypt, Gabon, Indonesia, Iran, Iraq, Libya, Mexico, Oman, Syria, Trinidad & Tobago, and Venezuela, RB. To minimize the impact of outliers and measurement errors, outliers for the CA and overall government balance to GDP ratios are trimmed asymmetrically (around the 95th percentile). NFA/GDP is trimmed symmetrically at the 99th percentile. All variables are expressed as three-year moving averages to eliminate short-term fluctuations.Source: Staff estimates.
Table 2.

Unit Root Tests for Data used in the FEER-SE Approach

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Source: Staff estimates.Note: All variables in logs. Constant and trend included. Openness is defined as total trade to GDP. Government consumption is expressed in ratio to GDP. The null hypothesis for the Augmented Dickey-Fuller is of a unit root.
Table 3.

Unit Root Tests for Data used in the CHEER Approach

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Source: Staff estimates.Note: The null hypothesis for both tests is that of a unit root. The Augmented Dickey-Fuller uses 12 autoregressive lags. For the VAR, the likelihood-ratio test (not reported) indicates that the optimal lag length is 12. To secure valid statistical inference, we include in the VAR three dummy variables for large outlier observations identified as being higher in absolute value by a factor of 3.5 the sample standard deviation.
Table 4.

Granger Causality Wald Tests for the Nominal Exchange Rate Equation in the CHEER Approach

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Source: Staff estimates.Note: We could not reject that Mauritius inflation and U.S. T-bill rate causally affect the Mauritius T-bill rate.
Table 5.

Mauritius: Relative Performance on Trade Costs

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Source: World Bank Doing Business Indicators and Staff estimates.Note: Documents for export and import refer to filing documents, customs declaration, and clearance documents. Cost to export and import measures the fees levied on a 20-foot container in US$ (including costs for documents, administrative fees for customs clearance and technical control, terminal handling charges, and inland transport; it does not include tariffs or trade taxes).
Figure 1.
Figure 1.

Visual Interpretation of PPP and UIP (CHEER Approach)

Citation: IMF Staff Country Reports 2008, 237; 10.5089/9781451827859.002.A001

Source: Staff estimates.
1

Prepared by Patrick Imam and Camelia Minoiu.

2

The analysis uses annual data until 2007 and monthly data up to December 2007.

3

This section draws on Reinhard and Rogoff (2004); the Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER), and Mauritius Staff Reports going back to the late 1960s.

4

The terms “real depreciation” and competitiveness are often used interchangeably. However, as shown by the experience of Germany and Japan in the 1970s, it is possible for the REER to appreciate even when competitiveness is rising. This happens, for instance, when productivity growth outpaces the appreciation.

5

See list of trading partners in Data Sources and Definitions.

6

Success in explaining exchange rate behavior largely depends on the time horizon chosen. Ever since the seminal work of Meese and Rogoff (1983), economists generally agree that models incorporating economic fundamentals do not outperform random walks in predicting exchange rate behavior. This in turn implies that exchange rates are not expected to adjust in the short run to equilibrium levels determined by fundamentals.

7

We restrict the analysis to 1980–2005 to obtain as large a sample of countries as possible. The panel analysis helps improve the precision of coefficient estimates by using both within- and between-country variation. Earlier data are also omitted because for most countries they are sparse.

8

The coefficients are robust to estimation in different sub samples relevant for Mauritius, such as middle-income countries and small open island economies. Furthermore, a Hausman test yields no evidence of systematic differences between the random and fixed effects coefficient estimates.

9

For completeness, trade elasticities were estimated using single-equation error correction models for exports and imports. We obtained an export elasticity of 1.6 and an import elasticity of -1.1 over the longest period for which we have complete data (1977–2006). Using the formula (export elasticity)× (EXP/GDP)-(import elasticity) X (IMP/GDP) and average trade ratios over the same period (of 57 and 60 percent), we found that the CA elasticity with respect to the exchange rate is 1.6. An alternative set of estimates (3.5 and -0.8, respectively) was presented by Barkbu (2006).

10

The approach is similar to estimating a behavioral equation in which expected future movements in the real exchange rate are determined by fundamentals and short-run behavior by the risk premium and the interest rate differential (also known as the BEER). The focus of this section is on medium-term determination of the ERER rate rather than short-term.

11

This framework allows testing for cointegration when it is not known with certainty whether regressors are stationary, integrated of order 1, or mutually cointegrated.

12

Openness is defined as the ratio of total trade (exports + imports) to GDP. Government consumption is also defined as a ratio to GDP. The estimation was undertaken using the ARDL program developed by Chudik and Mongardini (2007) with a lag structure given by ARDL(1,0,0,0). The SBC (Swartz Bayesian Criterion) is the information criterion that helped select the model. Linear interpolation was used to fill in gaps in the data series. According to the bounds test for the existence of a level relationship, the null hypothesis of no such relationship is comfortably rejected at the 1 percent level for all models. Augmented Dickey-Fuller (ADF) tests for unit roots are shown in Appendix Table 2.

13

Our approach closely follows Juselius and MacDonald (2004) and Heerah-Pampusa and Hurree-Gobin (2006).

14

Granger causality Wald tests (Appendix Table 4.) indicate that the nominal exchange rate is Granger-causally affected by the T-bill differential.

References

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Appendix

Figure 1.
Figure 1.

Monetary Policy Variables: Interest Rates and Broad Money Growth, 2003–07

Citation: IMF Staff Country Reports 2008, 237; 10.5089/9781451827859.002.A001

Source: Bank of Mauritius Monthly Bulletin; Mauritius Central Statistics Office, IMFInternational Financial Statistics; and Staff estimates.
Table 1.

Unit root tests

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Source: Staff estimates.Note: Deterministic intercept and trend are included. Both tests’ null hypothesis is that of a unit root. In both cases, the MacKinnon approximate pvalue is reported.
Table 2.

Correlation matrix

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Note: * indicates significance at the 1 percent level. Interest rates and broad money growth are lagged 12 periods.

Source: Staff estimates.
Table 3.

The Determinants of Inflation: OLS Estimates (Robustness check)

(Dependent variable: Yearly end-of-period rate of change in the CPI)

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Notes: t statistics in parentheses; * significant at 10%; ** significant at 5%; *** significant at 1%. The standard errors are robust to heteroskedasticity of unknown form. Seasonal dummies are included.

Source: Staff estimates.
15

Prepared by Fabian Bornhorst and Camelia Minoiu.

16

For early contributions that use disaggregated goods data in this type of analysis, see Parks (1978), Lach and Tsiddon (1992), Parsely (1996), and Debelle and Lamont (1997).

17

In July 2007, the CSO revised its CPI methodology using weights for goods and services derived from the 2006/07 Household Budget Survey. For this reason our analysis ends in June 2007.

18

The relative merits of different policy responses to the current global conditions are not the object of this study. Rather, we seek to understand the role of administered prices and that of monetary policy and the nominal exchange rate in driving the inflation process in Mauritius.

19

All of Mauritius’ cement requirements are imported. In 2005, cement imports represented around 1 percent of total imports (CSO, 2006).

20

A partially offsetting measure was the reduction of customs duties for alcoholic beverages and cigarettes.

21

Neither of the two methods for computing the average rise in prices is without shortcomings. In the first case, we use actual price increases, but the weights may correspond to broader categories of goods. This is the case with PET bottles which are used in the soft drinks industry: while we observe the administered price increase (4.9 percent), the weight of PET bottles in the CPI is not known. Instead, we use the weight of soft drinks in the CPI. In the second case, neither the price increase nor the weight is “correct”, but they are good approximations. In our example, the weight and the CPI inflation rate for soft drinks is imputed to determine the contribution of PET bottle price increase to the overall inflation rate.

22

The contribution of the June 2006 price liberalizations to September inflation (yearly, end of period) was 45 percent. We do not extend the analysis beyond September 2006 because October witnessed another wave of price adjustments for petroleum products.

24

For exceptions and evidence consistent with a negative relation between relative price variability and inflation, see, e.g., Cecchetti (1985), Blinder (1991), and Lach and Tsiddon (1992).

25

See, e.g., Ghosh and Whalley (2004) for Vietnam, and Clements, Jung, and Gupta (2003) for Indonesia.

26

The 7 months over the sample period when the variation in administered prices exceeded that in free prices (and the main goods whose prices were subject to change) are: February 2004 (bread, flour, cooking gas), April 2004 (gasoline and Diesel oil), July 2004 (gasoline and Diesel oil); November 2005 (cooking gas, kerosene, and Motor oil); April (gasoline and Diesel oil); July 2006 (see Table 2); and January 2007 (kerosene, gasoline, Diesel oil, and Motor oil).

27

In our analysis, the variance and skewness are weighted by the CPI basket weights. For formulas, see, e.g., Appendix I in Coorey, Mecagni, and Offerdal (1996).

28

Our sample period starts in June 2003 to avoid the use of linking coefficients in deriving comparable end-period inflation figures prior to that date, as the CPI basket was changed in June 2002 based on the 2001/02 Household Budget Survey. The second sample period (June 2003 – June 2007) is also considered because it overlaps with a period of monetary policy transition, notably from the use of the Lombard rate and the repo rate for intervention.

29

The Lombard rate is a standing facility introduced in 1999 as a lender of last resort for commercial banks to meet unexpected liquidity shortfalls. Until 2002, the T-bill rates moved in tandem with the Lombard rate, suggesting that the latter was an effective signal of monetary policy. As this relationship gradually broke down, the Lombard rate was replaced in December 2006 by the repo rate, which targets the overnight interbank money market rate.

30

See Goodhart (2001) for a discussion of the expected length of monetary policy transmission lags.

31

We emply the Cochrane-Orcutt transformation to correct for serial correlation; the residuals therefore pass the serial correlation test. Similarly, the Jarque-Bera test indicates that there is no evidence against the null hypothesis of normality. Finally, the Philipps-Perron and the Augmented Dickey-Fuller (ADF) tests reject the hypothesis of unit roots in the residuals.

32

We have also considered models in which each measure of relative price variation has been included in the model alone, but the main result—i.e., that each variable is strongly and positively correlated with inflation—holds up despite the high correlation between the two.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Mauritius: Selected Issues
Author: International Monetary Fund
Volume/Issue:
Volume 2008: Issue 237
Publisher:
International Monetary Fund
ISBN:
9781451827859
ISSN:
1934-7685
Pages:
42
DOI:
https://doi.org/10.5089/9781451827859.002

Exchange Regimes and the Nominal Exchange Rate, 1948–2007