(This article is in 2 parts. Part I explains the distinction between the money printing measure of Rs60 bn announced by the Bank of Mauritius, and Quantitative Easing Policies as currently practised by other central banks. Part II discusses the risks of printing money, and the alternative options available.)
The Covid Crisis has wrought havoc to public finances the world over, as Government deficits and financing needs to be expanded greatly to fund wage support and unemployment schemes and provide for other relief measures aimed at affected persons and businesses.
Under its amended Act, the Bank of Mauritius (BOM) is granting an amount of Rs60 bn, equivalent to 12% of GDP, to Govt for its spending needs. This grant will not emanate from the BOM's Special Reserve Fund or its external reserves, but most probably come from an accounting gymnastic. Govt deposits on the liabilities side of the BOM's balance sheet would be credited by an amount of Rs60 bn, and a book-entry item for the same amount would be added on the liabilities side, called, say, Covid Grant to Govt.
The claims of the authorities that this measure to print paper money is no different from unconventional measures adopted by other countries elsewhere are patently untrue. In his intervention in the National Assembly on 14 May 2020, the Minister of Finance explained that the Bank of Mauritius amendments were part of a Quantitative Easing (QE) strategy, stating "C'est dans cette dynamique que nous nous engageons comme presque tous les pays à travers le monde".
The Prime Minister also observed in the National Assembly that "regarding the proposed amendments to the Bank of Mauritius Act,... .. what is being proposed in the Bill is not a novelty. Many countries, including the United States of America, United Kingdom, India, Japan, Seychelles and South Africa have also resorted to similar measures to support the recovery of their economy from the Covid-19 shock".
First, the BOM grant to Govt cannot be described as QE. It is an extreme form of money creation, which carries the highest inflation risks, as explained in Box 1. Secondly, other countries have not, in response to Covid, pursued money printing policies like Mauritius, as shown in Box 2.
No other central bank has adopted such an overt money financing measure. Govt is misleading Parliament and the public by drawing an improper analogy between the monetary actions of the BOM and of other central banks.
Box 1: QE and Money Printing
Since the onset of the 2008 global financial crisis, central banks in advanced countries, notably the U.S. Federal Reserve, the Bank of England, and the European Central Bank, have adopted both conventional accommodative monetary policies, such as lower interest rates, as well as unconventional policies, known as Quantitative Easing (QE). QE can be described simply as a large-scale purchase by central banks of Govt securities on secondary markets. Central banks are normally not allowed by law to acquire securities directly from Govt, or to give away money to Govt.
Criticisms of QE have grown in view of its lack of effectiveness in raising investment and growth. Instead, QE appears to have resulted mostly in asset inflation with booming property and stock markets and worsening economic inequality. For several years now, a new school of economic thinking, called Modern Monetary Theory (MMT), advocates central bank money creation to finance Govt directly so as to improve growth performance in advanced countries. These calls for money creation have gone unheeded until now, because of the perceived serious risks of inflation associated with it, contrary to the belief of MMT theorists.
However, with the advent of the Covid crisis, which is a combination of a supply and demand shock, the call for money creation has become more pronounced. The risks of price pressures in the current deflationary situation is seen as minimal. Even a Covid recovery may be drawn out over time, as output gradually recovers to its trend level, thus lessening the risks of inflation. When inflationary pressures eventually surface, central banks can apply the brakes by reversing QE and selling back Govt bonds to the market. Of capital importance, it is assumed that central banks will continue to enjoy the freedom to pursue restrictive monetary policy independently of Govt.
There is a good reason as to why central banks have not so far adopted more unconventional measures of money creation, but are still focused on expanding QE. When central banks inject money in the banking system by purchasing govt bonds, the private sector willingly holds the newly printed money instead of govt bonds in their portfolios as interest rates are close to or at the zero lower bound. The impact on spending and inflation is therefore muted. This can largely explain the absence of inflationary pressures despite the long period of QE pursued since so far.
MMT urges central banks to go beyond QE, for money creation by two methods of direct Govt financing, either (i) on a temporary basis, lending money to Govt, either by buying bonds directly from Govt and by making advances, or (ii) on a permanent basis, simply granting money to Govt.
Both temporary or permanent methods of financing Govt inject money into the financial system, without any equivalent disposal of govt securities by the private sector as in QE, and would, therefore, have a more direct impact on inflation. The direct grant of money to Govt is, however, a more extreme form of money creation, by activating the central bank's printing press without any restraint. Printing money is an apposite term to describe the central bank's generosity to Govt.
The widespread prohibition on central banks to buy bonds directly from Govt serves to ensure some measure of fiscal discipline. By forcing Govt to resort to public bond issues rather than selling bonds directly to the central bank, it is compelled to accept market borrowing terms, and thus face higher interest costs in case of excessive bond issuance.
Printing money by crediting the Govt's account at the central bank represents the worst type of money creation, without any check and discipline, and is known as seignorage. The central bank can print money for Govt by just adding an entry on the asset side of its balance sheet, or, by holding a zero-coupon non-repayable or perpetual bond issued by Govt. Spending by the Govt will inject this money in the financial system. However, because this is a permanent injection, there is less leeway for the central bank to reverse course and apply counter inflationary policies when prices start rising. Printing money represents the most inflationary means of deficit financing.
Box 2: Central Bank Policy Responses
Besides conventional responses to the Covid crisis, such as interest rate cuts and liquidity enhancements to banks for supporting businesses and households, many central banks have intensified their non-conventional Quantitative Easing (QE) policies through aggressive asset purchase programs. However, unlike the Bank of Mauritius, none of the following central banks has financed Govt by printing money.
The U.S. Federal Reserve is increasing QE, which has been extended to a wider purchase of corporate securities in addition to Treasury securities.
The Bank of England (BOE) is also strengthening QE with a greater purchase of Govt and corporate bonds. BOE has also extended some limited overdrafts to the Treasury, but these advances are temporary and refundable.
The Reserve Bank of India (RBI) is not authorized to purchase debt directly from Govt but has increased its purchases of Govt securities indirectly on the market, there is an ongoing debate for authorizing debt monetization, i.e., by amending legislation to allow for RBI to buy Govt securities directly from Govt. The RBI did agree last year to make a transfer to Govt from its internal reserves last year, only after a protracted and structured process to determine the level of its excess internal reserves.
Bank of Japan has boosted QE by increasing the purchase of Govt securities, and of riskier assets, such as commercial paper, corporate bonds, and exchange-traded funds, and by expanding the range of eligible counterparties and collateral to private debt, including household debt.
Central Bank of Seychelles (CBS) adopted a new QE policy "to buy back and resell Govt securities", with a statutory amendment for CBS to purchase Govt Treasury Bill and Govt-guaranteed securities up to prescribed limits. The National Assembly has allowed the Central Bank to provide a limited credit to the government up to SCR 500 million, or 2.5% of GDP, preferably through the purchase of securities. Seychelles has obtained IMF emergency assistance to meet its balance of payments and budgetary needs.
The South African Reserve Bank (SARB) is buying more Govt bonds on the secondary market, akin to QE operations, and is resisting calls to fund or purchase bonds directly from Govt. It is also supporting the private sector through repo facilities. In terms of SARB's legal framework, it is not permissible for SARB to lend directly to the government or to print money to finance the government deficit.
Printing Money for Government (Part II)
More money creation
Besides printed money, Govt is intent on grabbing hold of even more BOM money, notably from internal reserves held in the Special Reserve Fund. The BOM Act was also amended to allow for raiding the SRF, which currently holds about Rs 7bn of exchange valuation gains, to potentially increase with continued rupee depreciation. There is no limit on the amount that can be transferred, and "meeting the negative economic impact of COVID" could hold as a financing pretence for many years.
The utilization of the SRF has been made retroactive as from 23 March 2020. The balance of the previous transfer from the SRF of Rs18 bn initially meant only for external debt repayment, has probably already been used by Govt for domestic spending, which will be regularized by this retroactive amendment. Another BOM amendment will permit external reserves to be reallocated to domestic financing through the Mauritius Investment Corporation, probably to bail out Air Mauritius. BOM has turned into a money tree.
Depreciation and Inflation Risks
Money printing by the BOM is a wild option that offers Govt the easiest course of action, or rather of inaction. Because it means free money - not having to issue debt. |But, injecting a huge amount of money in the banking system intensifies pressures on a weakening rupee, which will aggravate inflation.
The view that money printing is required to stimulate the economy in the current crisis ignores the impact on the rupee and inflation. The belief that money creation will not have inflationary consequences in less advanced countries is a copy/paste argument that is not relevant to emerge markets.
For major advanced countries, fiscal and monetary policies operate without a balance of payments constraint, because they have reserve currencies - the USD, Euro, Pound, and Yen. But, small highly open economies like Mauritius cannot pursue fiscal and monetary policies independently of their external balance. Until the world accepts our external payments in rupees, or unless we hold a mountain of external reserves like China, the central bank cannot print money without ignoring the consequences for the rupee, or the level of our reserves.
The rupee has long been considered as overvalued because offshore and other capital inflows sustained the financing of a widening current account deficit and of reserves accumulation. Govt pursued generous social spending, encouraged consumption, and led us to live beyond our means, by ignoring the external accounts. Not any more.
Inflation, year on year, is running at 4%, the rupee is weakening significantly, and shortages on the foreign exchange markets are growing. The announced balance of payments deficit of Rs40 bn for 2020 is a conservative estimate that does not account for reduced foreign investment and other capital inflows. More is likely to come if the COVID pandemic drags on.
The current account deficit in 2020, as also announced, will double to reach a record level of 15% of 2019 GDP, or 21% of GDP, excluding GBC flows. The EU blacklisting of Mauritius on account of anti-money laundering deficiencies is an unmitigated disaster that bodes ill for investment and capital inflows. The adequacy of our external reserves is critically vulnerable to the volatility of capital flows, as discussed in a previous article.
There are less perilous alternatives to Govt's money creation policies. Mauritius could still implement more conventional monetary policy, by lowering interest rates even further and providing more interest-free liquidity to support bank lending to households and business. There is plenty of excess liquidity in the banking system, and Govt can raise funds by borrowing more from banks. Govt can also mobilize resources at exceptionally low-interest rates from the public through issues of long-dated bonds.
As bank liquidity grows tighter, the BOM can embark on QE and actively purchase Govt securities on the secondary market. Govt can borrow directly from the central bank too, by means of advances and issuing securities. The existing BOM restrictions on money creation, namely the ceiling on advances and the limit on holding Govt securities, can be appropriately lifted for COVID purposes.
In addition, Govt can raise external finance from international financial organizations, development partners and other friendly countries. The recourse to AfDB budget support for Rs 8bn is the right move and corrects the ludicrous decision to prepay Rs7bn to the AfDB a few months earlier. Tapping World Bank support and IMF emergency assistance under its Rapid Financing Instrument would also bring additional resources.
There is more than Govt can do. A crisis should not go waste, in terms of the opportunities it creates for change. Govt can generate fiscal space by restructuring public finances so that the higher debt burden from COVID spending is made sustainable in the medium term. A thorough reform of the welfare state is long overdue, after decades of political inertia. Fiscal policy reforms can be initiated now, to be fully implemented in the post-COVID years.
Instead of rushing to press the BOM print button to cope with COVID, Govt should have first turned to debt issuance, mobilized IMF and other international emergency assistance, and embarked on a deep but gradual fiscal reform programme.
A Reckless Wager
Access to printed money from the central bank is providing abundant fiscal resources for the continued pursuit of populist policies. The need for corrective adjustments to an already bloated budget deficit can thus be dodged. More Govt borrowings would raise debt to excessive levels, leading to a serious credit downgrade. Going to the IMF for financial and policy assistance would imply painful fiscal adjustment measures.
Govt is instead betting that COVID will be a short-term affair and that the adverse consequences of money printing can be contained. This is a wild and dangerous gamble that minimizes the risks of accelerated depreciation and inflation stemming from a longer Covid pandemic, and even the risks arising from the permanent economic scars of a shorter one.
Even in the unlikely scenario that inflationary pressures can remain suppressed during the current crisis despite money printing, there is little hope that BOM is independent enough to reverse course later and apply restrictive monetary policies. Fiscal dominance is evident. As an illustration, the BOM's Monetary Policy Committee was completely bypassed on the decision to grant Rs60 bn to Govt, making a total mockery of the conduct of monetary policy.
Jordi Gali, one of the few but most ardent advocates of printing money, underlines the importance of an independent central bank to quell resurging inflationary pressures. In a much-quoted article entitled "Helicopter Money: The time is now", dated March 2020, he cautions that "the reliance on money financing would be strictly restricted to the duration of the emergency measures linked to the health crisis. This is a commitment for which fulfilment can always be guaranteed by the central bank, which would put its reputation at stake". From past record, the independence of the BOM is a thought that can surely be entertained, but not so readily accepted.
The free printing of money for Govt is a watershed moment in the conduct of monetary policy in Mauritius. The safeguards to the independence of the central bank in determining monetary policy and the control of inflation have been swept away in the wake of the recent amendments to the BOM Act. Exceptional COVID circumstances call for exceptional measures, but this kind of money printing is nothing less than an aberration.
Mauritius, it seems, is determined to get on another blacklist.