Public Information Notice No. 03/97

Public Information Notice: IMF Concludes 2003 Article IV Consultation with Mauritius

August 6, 2003

On June 30, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mauritius.¹

Background

After expanding at a robust pace of 4 percent in 2001/02 (July-June), real GDP growth is expected to slow in 2002/03 to about 3½ percent. Following a record sugar crop in 2001/02, sugar output will decline substantially in the current fiscal year due to cyclone damage. The export processing zone (EPZ) and tourism sectors continue to be adversely affected by the weak global environment, and prospects remain uncertain in the aftermath of the war in Iraq. Economic growth in 2002/03 will rely mainly on the continuing robust performance of the construction, financial services and other services sectors.

Since the early 1990s, unemployment has risen steadily, despite continued robust economic growth, mainly as a result of an increasingly inadequate education and training system as well as significant labor market rigidities. At end-2002, the unemployment rate stood at nearly 10 percent, compared to 9.4 percent in 2001.

The overall fiscal deficit will remain at close to 6 percent of GDP for 2002/03. Public finances face further risks in the short term as a result of the worsening financial position of some state-owned enterprises. While the overall financial situation of public enterprises improved somewhat in 2001/02, the State Trading Corporation (STC) and the Central Electricity Board (CEB) accumulated significant losses in the current fiscal year due to the sharp rise in the international price of oil in 2002 and early 2003, which was not reflected in retail price adjustments for petroleum products and for electricity tariffs.

Monetary policy was tightened in 2002/03 compared to 2001/02. Nonetheless, in response to a widening interest rate differential between domestic and foreign interest rates, and the slowdown in economic activity, the Bank of Mauritius (BOM) has reduced the Lombard rate since the beginning of the fiscal year by a total of 125 basis points. Consumer price inflation has recently shown a declining trend and is estimated at about 5 percent (period average) at end-June 2003, compared with 6.4 percent a year earlier.

The external current account surplus has remained strong in 2002/03 and is estimated at about 4 percent of GDP. The coexistence of a significant fiscal deficit and a current account surplus in recent years reflect a decline in overall domestic absorption occasioned by a rise in private savings. Net receipts from services improved significantly due to a surge in gross tourism earnings, largely reflecting increases in average tourist expenditure, and imports experienced a pronounced fall in the EPZ sector. As a result of the intervention policy of the BOM, the net international reserves of the central bank increased to an estimated US$1.3 billion (7.3 months of import cover) at end-June 2003 compared with US$1 billion (6 months of import cover) at end-June 2002.

Mauritius participated in the Financial Sector Assessment Program (FSAP) during 2002. The FSAP concluded that Mauritius has a well developed financial system and that the banking system is highly profitable and sound. However, there are three main sources of potential risks and vulnerabilities: risks associated with external economic shocks and downturn in economic activity that reflect the limited diversification possibilities of a small island economy and the high concentration of credit among a few sectors; the rollover risks of growing short-term public debt; and potential reputation risk that could arise from money laundering or criminal activities of offshore funds and companies.

Executive Board Assessment

Executive Directors agreed with the thrust of the staff appraisal. They considered that generally sound macroeconomic policies have created the conditions for investment and growth and the overall strong performance of the Mauritian economy over the last two decades. Consistent real output growth made possible a more than doubling of per capita income, a narrowing of income disparities, and remarkable progress in improving social indicators, against the background of a stable political system. More recently, however, the fiscal deficit has been high, economic growth has slowed, and unemployment remains relatively high and persistent. Directors agreed that the recovery of growth to its historical level in the period immediately ahead will depend on the global economic recovery, continued good macroeconomic policies, the performance of the export processing zones and the tourism sector, and a rebound in sugar production from the cyclone-depressed level of 2002.

Directors observed that in the medium term, the authorities' key challenges will be to explore the scope for further economic diversification, address the problem of persistent unemployment despite a generally satisfactory rate of growth, and contain the budget deficit and the overall public debt level. Structural reforms to improve competitiveness, especially with respect to labor market flexibility, and to promote private sector investment, would also strengthen medium-term growth prospects.

Directors welcomed the authorities' efforts to restructure the sugar sector to reduce costs and improve competitiveness. They noted that the textile sector is positioning itself to take advantage of increased export opportunities. However, further restructuring is needed to improve overall competitiveness. High utility costs and increases in wage rates that exceed labor productivity growth, in particular, impede efforts to improve competitiveness. The current investments in information communications technology should also provide support for economic growth over the longer term, although some Directors noted that the high technology sector is especially sensitive to economic downturns.

Directors encouraged the authorities to reduce the involvement of government in commercial activities, and implement further structural reforms aimed at creating greater opportunities for private sector investment and employment. In that vein, Directors called on the authorities to eliminate remaining obstacles to foreign investment, in particular relating to permits and licensing processes.

Directors considered that the high rate of unemployment in Mauritius could be attributed to both rigidities in the wage determination process, and the mismatch between labor skills and job requirements. Directors urged the authorities to reform the pay setting mechanisms to allow for firm-level collective bargaining, and to encourage the arbitration tribunals and bodies responsible for public and private sector pay to take into account economic and competitiveness factors in handing down wage awards. They supported the government's efforts to improve the education system to eliminate the mismatch between jobs and skills.

Directors noted that Mauritius' public debt, although moderately high, is supported by the economy's track record of high growth. However, the current large fiscal deficit is not sustainable and risks compromising medium-term macroeconomic stability. Directors recommended that the authorities pursue a more ambitious fiscal deficit reduction target, with the objective of reducing the deficit to within a manageable range by 2006/07, and stabilizing public debt at a lower level.

Directors were concerned by the pressures on the public finances created by losses of the state-owned Central Electricity Board and the State Trading Corporation. To eliminate these losses, electricity tariffs should be adjusted in line with movements in the international price of fuel oil used for electricity generation. Directors also urged the authorities to implement the agreed automatic pricing mechanism for petroleum products.

Directors agreed that monetary policy in Mauritius is appropriately tight, but they cautioned that recent reductions in interest rates, in conjunction with an expansionary fiscal stance, risked a faster rate of inflation. The authorities should monitor liquidity conditions carefully before reducing interest rates further. Directors noted that the informal inflation targeting framework was working well, and encouraged the authorities to consider moving to formal inflation targeting, in the context of greater independence for the central bank. Directors considered that the exchange rate, which is market-determined, is broadly consistent with macroeconomic fundamentals. They encouraged the authorities to work to further deepen the interbank foreign exchange market.

Directors noted that the Mauritian financial system is well-developed, sound and profitable. They encouraged the authorities to further strengthen the system by implementing the key recommendations of the Financial System Stability Assessment. Directors welcomed the progress made in combating money-laundering and the financing of terrorism, including the enactment of the Financial Intelligence and Anti-Money Laundering Act of 2002. They encouraged the authorities to accept the United Nations conventions on money laundering and terrorism financing.

Directors commended the government for reducing tariff rates in the context of the regional trade agreements. They encouraged the authorities to simplify the customs tariff system over the medium term, and eliminate nontariff barriers.

Directors welcomed the staff's assessment of the effectiveness and efficiency of Fund-provided technical assistance to Mauritius. They concurred with the staff that technical assistance was well-targeted and generally effective. At the same time, they agreed that a more rigorous prioritization process could have resulted in more efficient technical assistance delivery in some areas.

It is expected that the next Article IV consultation with Mauritius will be held on the standard 12-month cycle.