Public Information Notice No. 04/98

Public Information Notice: IMF Concludes 2004 Article IV Consultation with Mauritius

August 25, 2004

On July 21, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mauritius.¹

Background

Real GDP growth is expected to rebound to around 4½ percent in 2003/04, following a disappointing 2¾ percent in 2002/03 (July-June). This largely reflects the recovery of tourism and sugar production, the latter due to favorable weather, and continued strong construction and transportation activity. However, high domestic production costs and increasing competition have continued to affect adversely the Export Processing Zone (EPZ) sector, which registered negative growth for the second consecutive year. The unemployment rate rose to 10.2 percent in 2003 from 9.7 percent in 2002.

The overall fiscal deficit in 2003/04 is estimated to be in line with the target of 5.5 percent of GDP, a reduction from 6.2 percent in 2002/03. This improvement reflects primarily higher tax and nontax revenue. The estimated overall balance of 30 nonfinancial public sector corporations shifted to a surplus of 0.9 percent in 2002/03 from a deficit of 0.6 percent of GDP in 2001/02. The Central Electricity Board (CEB) continues to face financial difficulties. The financial position of the State Trading Corporation (STC) is expected to improve following the introduction in early April 2004 of an automatic mechanism for adjusting the prices of petroleum products.

There is a danger that public debt could become unsustainable as a result of continuing central government fiscal deficits. The public debt, which was around 66 percent of GDP in 1999/00, rose to about 80 percent in 2002/03, and is projected at 73 percent of GDP by end-June 2004.

The Bank of Mauritius (BOM) has established credibility in achieving its inflation objective. Average annual inflation fell to around 4 percent in 2003, from 6.4 percent in 2002, reflecting in part slower growth in credit to the private sector. The outlook is for a further moderate fall in inflation over the near term, as demand pressures remain subdued. Given lower inflation expectations, the BOM lowered its Lombard rate in five steps by a total of 200 basis points, to 9½ percent in late January 2004. However, given the weaknesses in key sectors of the economy, banks have been cautious in advancing credit, which has led to a situation of excess liquidity in the banking system. The financial system in Mauritius is generally sound. The government has also taken a number of actions to strengthen its Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) framework.

The overall balance of payments surplus is projected to decline from 6½ percent of GDP in 2002/03 to below 2 percent in 2003/04. The current account is projected to remain in surplus with the recovery of the tourism sector offsetting a widening in the trade deficit. The capital and financial account is projected to register a small deficit of 0.8 percent of GDP in 2003/04 compared with a surplus in 2002/03. FDI flows are expected to weaken in 2003/04, however, portfolio investment inflows (primarily from U.S. and U.K. mutual funds) should register strong growth as a result of high interest rate differentials.

Executive Board Assessment

Directors noted Mauritius' impressive social and economic achievements during the last twenty-five years, in particular the strong GDP growth, high level of domestic savings, and improving living standards. These achievements have been underpinned by the strength of public institutions, good governance, respect for the rule of law, a stable democratic system, and a transparent regulatory environment—elements that will continue to serve the country well as it confronts future economic challenges. Nevertheless, Directors expressed concern about the high and growing level of unemployment, especially among the unskilled, the uncertain medium-term outlook for a number of key economic sectors, and the large stock of domestic public debt.

Directors considered that, to safeguard Mauritius's past achievements, prepare for a more competitive global environment, and strengthen medium-term fiscal sustainability, the authorities should focus in the period ahead on implementing structural adjustments and reforms, especially in the sugar and textile sectors and the labor market, and on reducing persistent budget deficits. It would be important to press ahead in these areas while the economy is still performing well, and the public debt is manageable.

Directors welcomed the reduction in the fiscal deficit achieved during 2003/04 and the fiscal efforts announced in the 2004/05 Budget Speech. At the same time, they urged the authorities to take further measures to reduce the deficit, with a view to returning the domestic public debt to a sustainable path and stabilizing the debt-to-GDP ratio over the medium term. They recommended, on the revenue side, a broadening of the income tax base and the extension of the VAT to additional items. On the spending side, they saw scope for more carefully prioritizing government expenditures, stretching out non-critical capital projects, and targeting the now-generalized subsidies for rice and flour to only the disadvantaged groups. The need to maintain fiscal discipline in the period leading to the general elections was underscored. Given the importance of improving the maturity structure of the debt, Directors considered that the creation of a debt management unit in the Ministry of Finance would be a step in the right direction.

Directors commended the authorities for their success in reducing inflation. Looking ahead, they urged the central bank to monitor closely the excess liquidity in the banking system to guard against a rapid expansion of credit to the private sector and increased inflation. Directors encouraged the Bank of Mauritius to review the effectiveness of its monetary policy instruments, in particular the signaling role of the Lombard rate. Directors noted that the current level of the real effective exchange rate appears to be broadly in line with macroeconomic fundamentals. They welcomed the central bank's policy of allowing the exchange rate to respond to market forces, and supported the central bank's view that external competitiveness should be fostered through real productivity gains.

Directors considered that the Mauritian financial system is well developed, sound, and profitable. They welcomed the authorities' positive response to the recommendations of the Financial Sector Assessment Program carried out in 2003. Directors noted that the development of an efficient corporate bond market would allow institutional investors to diversify their portfolios and help reduce credit concentration, and could strengthen the overall stability and soundness of the financial system. Directors welcomed the issuance of guidance notes to banks on anti-money laundering and countering the financing of terrorism, and the passage of the Convention on the Suppression of the Financing of Terrorism Act 2003.

Looking beyond the macroeconomic policy challenges to structural adjustments, Directors were encouraged by the steps being taken by the government to address the impending loss of trade preferences in the sugar and textile sectors, which risks a contraction of these sectors. They welcomed the planned review of the Sugar Sector Strategy, and urged the authorities to take further actions to strengthen the sector's competitiveness. Directors also welcomed the establishment of the Textile Emergency Support Team to assist in the rehabilitation and restructuring of those textile enterprises judged to be viable.

Directors called for a closer link between wage increases and productivity growth to facilitate the restructuring of the textile sector, stimulate job creation, and improve competitiveness. In particular, they urged the authorities to take steps to make the wage bargaining system more flexible and streamline labor regulations to stem the rise in unit labor costs. Directors welcomed the comprehensive measures that have been taken to improve access to the education system and strengthen the curriculum at all levels, which will help to alleviate the skills mismatch in the economy and raise employment over the medium term.

Directors commended the authorities for their efforts to diversify the economy and create new job opportunities by developing the financial services, tourism, and information and communications technology sectors. While the government must continue to play a leading role in providing infrastructure to support economic growth, Directors considered that greater opportunities could be provided for private sector participation in infrastructure development, in particular in the public utilities, transportation, and commercial areas. In this connection, they welcomed efforts to facilitate public-private sector partnerships in infrastructure investments, and also urged the authorities to take due note of the potential costs and risks of such arrangements.

Directors welcomed the authorities' commitment to trade liberalization and supported the reduction of custom duties in the 2004/05 budget. At the same time, they urged the authorities to announce a medium-term tariff reform program, including a lowering of the maximum and average tariff rates.