Former Minister of Financial Services and Economic Development Sushil Kushiram says that the proposed amendments to the Bank of Mauritius Act and the Public Debt Management Act will send wrong signals to international financial institutions and undermine the reputation of the country.
The proposed amendments in the Covid- 19 Bill to the Bank of Mauritius (BoM) Act and to the Public Debt Management (PDM) Act will ride roughshod on accepted principles of sound economic governance. The credibility and effectiveness of the central bank will be undermined, while the country's image and reputation for upholding fiscal responsibility will be weakened, with potentially disastrous economic consequences.
Even prior to the advent to the Covid-19 pandemic, Government was desperately seeking ways to finance its soaring deficits without increasing the public debt burden beyond unsustainable limits. Several financing choices were made to contain the mounting debt, from imaginary asset sales, to raiding the central bank's internal reserves, and even by deceptive debt accounting.
In the aftermath of Covid-19, Government financing needs to support affected persons and businesses have gone through the roof. Hefty financial resources will be required to bail out Air Mauritius. Government has recently created a special fund, the Covid-19 Projects Development Fund (CPDF), to finance a major investment programme to stimulate the economy. The CPDF's funding will come from Government, the BoM and other private and international contributors.
BoM Amendment - SRF Transfers
It is mainly with the CPDF in mind that the Covid-19 Bill proposes to amend the BoM Act to facilitate a greater and free utilization of central bank money for fiscal purposes. A highly contentious amendment provides that the Bank's Special Reserve Fund (SRF) can be used with Board approval to extend grants to Government to assist in measures to stabilize the economy, in view of the negative impact of Covid-19. A previous 2019 amendment was also controversial in authorizing the use of the SRF for repayment of Government external debt obligations.
Moreover, Covid-19 related Government financing under the proposed amendment is not subject to the existing provisions in the BoM Act to limit the use of the SRF. If applied to SRF transfers to Government, these restraining provisions would ensure that (i) the Bank must first provide for its internal capital and monetary policy needs, (ii) the SRF is used only in exceptional circumstances, and (iii) only if the efficient discharge of the Bank's functions is not adversely affected. The "exceptional circumstances" restriction would safeguard the SRF from becoming a recurring source of Government financing for several post-Covid-19 years.
The SRF derives its funds mainly from the net valuation gains on foreign exchange reserves. An amount of Rs 18 bn was thus drawn from the SRF for repayment of Government external debt in Dec 2019, after the Bank engineered a depreciation of the rupee in the first half of 2019, but only Rs 7 bn was prepaid to the African Development Bank in early 2020. The SRF balance currently stands at over Rs 7 bn, and can be continuously increased through further rupee depreciation.
Unfettered provision of central bank finance to Government is analogous to printing money, adding to liquidity, and putting pressure on prices and on the exchange rate, to ultimately end in excessive rupee depreciation and inflation. Central banks worldwide are thus prohibited from extending money freely to Government, and are also constrained in their lending to Government, in order to ensure the independence and effectiveness of monetary policy, as distinct from fiscal policy. The primary object of the Bank is to maintain price stability, and a key function is the conduct of monetary policy to focus on controlling inflation.
Should there be a compelling need for free central bank money, as a last resort, the case could be made for an amendment to the BoM Act for redirecting the already drawn SRF balance of Rs 11 bn to meet Government domestic financing requirements instead of external debt pre-payments.This will surely affect domestic liquidity and the effectiveness of monetary policy, but it is a smaller price to pay than legislating for the central bank to act as a printing press for Government.
BoM Amendment - Corporate investments
Another proposed amendment in the Covid- 19 Bill to an existing provision of the BoM Act broadens the power of the Bank, with the approval of the Minister, to provide financing, through a wider range of financial instruments, e.g., either by equity or debt, to any corporation or company, private or state owned, set up for facilitating economic development. The existing requirement for Ministerial approval is intended to restrain the Bank from assuming the functions of a development bank as well. Such direct corporate financing by the central bank is expected to be done only on a one-off and exceptional basis. If done on a large scale in the wake of the proposed amendment, the central bank would run the risk of compromising its role as a supervisor and regulator of financial institutions.
BoM Amendment - Reserves investment
A related proposed amendment to the BoM Act aims to diversify the Bank's portfolio of foreign exchange reserves to include the abovementioned financing instruments, namely, foreign currency-denominated shares or debt securities of companies set up for the purpose of facilitating economic development. The Bank will thus be authorized, in amounts determined by the Board, to hold its foreign exchange reserves in a new class of corporate financial assets, besides gold, bank deposits, and securities.
However, the inclusion of such a class of investments in the Bank's external reserves portfolio conflicts with the criteria governing the investment policy for managing the official foreign reserves of Mauritius, as laid down in the BoM Act. These investment criteria are in order of priority - security, liquidity and return. A central bank normally holds its foreign exchange reserves in highly safe and readily available financial assets that provide a reasonable return. It is unsound practice for of a central bank to assume an undue level of credit and liquidity risks in external reserves management. Investments in private or state-owned companies are more appropriate for sovereign wealth funds, or could be considered for central banks holding plenty of excess external reserves.
But, the latest International Monetary Fund (IMF) Staff Report on Mauritius concluded that the level of reserve adequacy was just adequate, and recommended more reserve accumulation to build buffers to strengthen resilience to shocks. In the aftermath of the Covid-19 crisis, the balance of payments position will become unfavourable, leading to pressures on foreign exchange reserves. In the first quarter of 2020, our gross international reserves have already shown a decline, albeit slightly, by USD 0.6 bn. Foreign exchange is scarce, and the BoM will need its reserves for active intervention to stabilise the forex market.
Consequently, even if provision were made to subject the new class of corporate investments to current investment policy criteria under the BoM Act, this is not the time to include potentially unsafe and illiquid investments in the foreign reserves portfolio of the central bank. If the likely candidate for investment of our foreign reserves turns out to be a restructured Air Mauritius, with Euro-denominated capital, the BoM would be dragged into a problematic bail-out of the national airline. We better not contemplate this shuddering prospect.
PDM Amendment - PSD Ceilings
The Covid-19 Bill proposes to repeal section 7 of the PDM Act relating to public sector debt (PSD) ceilings. The abolition of statutory PSD ceilings, expressed in terms of the ratio of PSD to GDP, does away with the very purpose and essence of PDM Act, which is to promote greater fiscal responsibility and discipline.
This emasculation of the PDM Act will weaken the country's compliance with accepted global standards of fiscal governance, undermine our standing vis-à-vis our development partners and international financial institutions, and unfavourably affect our credit standing. The IMF and rating agencies pay special attention to the importance of debt ceilings in maintaining fiscal credibility and achieving medium term debt sustainability. Moody's considers that a key feature of the institutional strength of our fiscal framework, is "a clearly defined debt ceiling, which is used as the main fiscal anchor".
Currently, the PSD debt ratio under the PDM Act should not exceed 65% of GDP at the end of any financial year, and should be reduced to less to 60% of GDP by end June 2021. Mauritius has missed its previous ceiling deadlines twice already in 2013 and 2018. Since the PSD ratio is presently in excess of 65% of GDP, and it is unlikely that the debt target can be reached by June 2021, Government has decided to eliminate the PSD debt ceiling altogether.
The Covid-19 pandemic cannot justify this extreme action since there is already an escape clause in the PDM Act for ceiling targets and deadlines in case of "natural disasters or other emergencies requiring exceptional expenditure". The PDMA provides Government with the leeway to postpone the attainment of the debt ceiling for 3 years, on the basis of a prepared plan which must be made public.
In ushering the PDM Act in 2008, an important clause was introduced in the Finance and Audit Act, under the heading "Fiscal rule", which reads "The public sector debt shall be governed by the ceiling referred to in section 7 of the Public Debt Management Act". This Fiscal Rule has been left unamended, so as not to draw attention to the scrapping of a legal provision for fiscal responsibility. The amended PDM Act will be reduced to a piece of legislation for statistical debt computation.
PDM Amendment - Guarantees
The PDM Act gives powers to the Minister to extend Government Guarantees on the debt of public sector entities, but also provides for a cautionary provision that the PSD level may effectively limit the amount of guarantees to be given in a fiscal year. This cautionary clause will be annulled through another proposed amendment in the Covid-19 Bill. Government guarantees represent contingent liabilities which, when exercised, can lead to spiralling public debt levels. Some form of restraint on the extension of Government debt guarantees should be maintained for the prudent management of fiscal risks.
PDM Amendment - Net Debt
The Covid-19 Bill also proposes to change the official definition of public sector debt in the PDM Act from a gross to a net basis. PSD was previously computed on a net basis until 2017, when its definition in the PDM Act was modified to a gross basis in conformity with international public debt standards. Indeed, the gross debt definition is privileged because it provides a standard basis for comparison of debt data between countries.
A reversal to the net debt definition is incomprehensible, except that Government may be seeking cosmetic gains in showing a lower PSD amount through doubtful netting adjustments. The proposed deductions from gross debt comprise the cash and cash equivalent holdings of Government and non-financial public sector bodies (NFPSB), as well as their equity investments in any private sector entity. A new proposed definition of cash equivalent balances would include all 1 year Treasury certificates issued by Government for investment by NFPSB, such as CEB, amounting to some Rs 5 bn in Mar 2020. This debt adjustment to PSD was already queried by the Director of Audit in his latest report. Moreover, the deduction for equity investments is also questionable.
CPDF was set up as a special fund by regulations under the Finance and Audit Act in April 2020. A managing Committee, consisting mainly of public officers, and chaired by the Financial Secretary, will be responsible for the implementation of the Fund's investment programme through the relevant Government entities, assisted by public officers and persons designated by the Minister. The Committee will provide the Director of Audit with the Fund's financial statements, and a Project Status Report, for audit purposes. These documents will be submitted to the Minister of Finance, who will lay a copy before the National Assembly.
Following a Covid-19 Bill amendment, Government can extend now Rs 15 bn as advances to the CPDF, instead of Rs 3.5 bn. Should the BoM contribute an equal amount of Rs 15 bn along with Government, it would mean that a total of Rs 30 bn of fiscal expenditures will be incurred by the CPDF outside parliamentary approval and accountability. The Covid-19 emergency spending, and "doing what it takes", should not be without ensuring fiscal transparency, and applying proper safeguards for public accountability and legitimacy.
An Alternative Strategy
The intention of Government to finance its expenditures by printing central bank money and to cancel statutory public debt ceilings is dangerous and unacceptable, although it may be understandable. Government is desperately trying to limit the increase in public debt, which is considered as elevated and raises affordability and sustainability concerns. Moody's has already downgraded the outlook for Mauritius to negative, while maintaining its rating. Moody's is obviously fearful of a likely downgrade as the debt burden balloons further with Covid- 19 related fiscal expenditures.
However, the Covid-19 crisis does not justify a jettisoning of our standards of good fiscal and financial governance, which can only lead us to economic bankruptcy and ruin. There are less perilous options. Government should temper its compulsive obsession on debt, and continue to borrow domestically for its fiscal needs.
But, Government must also propose a strong medium term fiscal reform plan to accompany the sizeable increase in Covid-19 spending. Implementing the reform plan will put public debt firmly back on a sustainable path as the pandemic winds down and growth recovers. Rich and poor countries are reforming their budgets to create headroom for higher spending. Saudi Arabia is tripling its value added tax to 15%. India has cut salary compensation of public servants. Tunisia too is reforming its civil service.
The discretionary fiscal response of countries to the Covid-19 pandemic has so far averaged around 5% of GDP. For Mauritius, this would represent an additional Government financing of 25 bn, which could well be mobilized from banks, pension funds, and other financial institutions. Recourse to IMF financing and policy assistance, like so many other African and middle income countries, could also help in instilling investor and market confidence. Emergency assistance from the IMF's Rapid Financing Instrument would represent an immediate Rs 7 bn. If needed, the BoM could extend added support by holding more Government debt on its balance sheet, for which an amendment to the BoM Act is required.