Long or Short Mauritius?

The process of creative destruction is the essential fact about capitalism - Joseph Alois Schumpeter.

To many foreign observers, Mauritius is portrayed as either a highly envied tourist destination or an
opaque tax haven. The latter is largely exaggerated as much effort has been done in order to make
Mauritius be a presentable and respected financial centre. Since the independence in 1968, the
country achieved a real transformational change of its economy, diversified its sources of revenue
and most importantly reached a fairly good redistribution of wealth. It is fair to admit that the
economic progress since the last 40 years is visible and for such a young democracy this change
demonstrate the capacity of its people to work together for a better future and also the ability of a
selected few political leaders to be forward looking. But is it right to say that Mauritius will
experience the same kind of economic prosperity for the next 20 years? Are the right economic and
political decisions been taken to enhance economic growth? Is the country at the mercy of dogmatic
fights and useless political moves? Some of the answers can be found in the global vision of political
leaders but the main reason for economic prosperity for a little economy as Mauritius remains
investment or a supply side framework.
To be able to attract investments at large, Mauritius will need to show a good track record of
economic performance. If Mauritius was an asset class, would a macro money manager view it as
potential investment opportunity as a whole?
Global Metrics
In 2013, the country grew by 3.2% in real terms with an inflation rate of 3.5 % along with a budget
deficit of 3.7%. By looking at these numbers, the question is the following; is the growth being
financed by a budget deficit? This assertion is only partially correct but it has the advantage to give a
quick overview of the situation and we can ask the following questions: Is Keynesian economics* still
adapted to the country? If this is the case, the efficiency of this policy can be doubted as there is a
barely multiplier effect by looking at these figures. So, what is the quality of growth generated by
Mauritius? Is this performance sustainable or its just a mere conjunction of factors? The following
analysis will explain and elaborate more on the aspects which affects the different components
which, in my opinion, is crucial to achieve economic prosperity.
Debt Analysis
Mauritius is, unfortunately, not blessed with immediate exploitable natural resources. The very basic
economic analysis shows that an economy will not be subject to economic cycles, only if its
consumption matches exactly its production. This is not the case, so to remedy to this issue,
borrowing and lending of capital help to consume or produce more is needed but in return this
economy will be impacted by booms and bursts. Credit, hence, debt becomes an important element
to judge a countrys room to manoeuvre.
The debt dynamics can be calculated as follows:
Dt= ((1 + It) / (1 +Gt)) Dt-1 Pt
Dt = Debt at time t.

It =Nominal interest rate paid at time t.

Pt = Primary Balance at time t.
Gt = Nominal Growth of GDP.
A primary balance is the difference between government revenues and spending before interest
payments.
Nominal Interest rate paid will be taken as the 1 year Treasury bill, which is yielding around
3.18%.The primary balance is around - 2.2 %, data retrieved from the IMF. The nominal growth is
around 6.7% last year. Finally, the Debt/GDP ratio is approximately 59.1% for 2013.
Computing all these figures, a debt dynamics figure of 59.35% is obtained, which is a bit higher than
the actual debt ratio. This shows that the level of debt in Mauritius is sustainable and as the nominal
growth is much higher than the 1 year interest rate means the government can allow a primary
deficit (see nature of the above equation). It is also important to point out that household debt
accounts for around 19% compared to 80% for the US, showing that private debt is not yet the major
issue. However, the level of corporate debt is around 22 % of the GDP, this is a worrisome figure
because most of this debt is concentrated in two sectors i.e tourism and construction which is
viewed at some extent as a siamese baby. This number has been increasing steadily since the last 5
years, and if a sound debt restructuring is not done in sectors linked to these two activities, there
could be a contagion through the banking sector. An asset quality review must be undertaken in the
banks by regulatory bodies to see if eventual bad loans can pose systemic risks (credit crunch) to the
real economy. Therefore, the level of debt/GDP (equity) ratio at large in Mauritius should be
monitored closely to avoid systemic contagion albeit the ratio is not at alarming highs.
It is also important to note that there is a current account deficit of nearly 9%. Mauritius has entered
the deficit zone since 2004. Since then, the deficit has been growing to stabilize itself around the
support line of 10%. This demonstrates that Mauritius is running over practically 10 years a deficit
which is becoming very difficult to overcome. During this period, there has been a global financial
crisis, some external shocks linked to sugar preferential protocols and other agreements which can
explain partially the deterioration of the current account.
However, it would be fair to state that Mauritius level of debt is high but under control. But
pinpointing the current account deficit as the main driver of the modest economic growth is a very
restrictive explanation.
Inflation Productivity dichotomy
On the long run, growth is determined by productivity gains, debt cycles and possible external
shocks. In order to increase productivity, one must be either work harder or smarter. The
consequence of that is that one gets to spend what one earns, and this is a function of that persons
productivity. In the short run however, one can spend an amount that is different one earns because
of borrowing and lending. An analysis of the Mauritian productivity shows that there has been a
steady decline since 2003. Productivity is an important element in the growth of a country as it
validates the increase in production and also acts as a buffer against inflation. A wage increase based
on productivity gains is beneficial to the economy whereas the contrary will be inflationary. There is

a negative relationship between inflation and productivity. The following diagram shows the spread
between productivity and inflation. In a virtuous environment, this spread should increase.
Figure 1

In Figure 1, it is showed that there has been a gradual deterioration of this spread. This can be
explained mainly by a fall of the productivity gains and an unstable rate of inflation. On average, the
productivity gain has been of 2.5 %( rough linear average) on the above period and the inflation rate
around 5.7%. Productivity gains are not acting as a buffer against inflation and/or some other
factors are fuelling prices. On the other side, the wage index has been decreasing since 2008 but at
an increasing rate (well above the productivity gains). This shows that inflation is mainly due to
demand pull factors. Notably, there has been commodity prices inflation and a major financial crisis
between 2008 and 2010. But this does not explain the frequent increases in salaries which are to put
on the back of unstable prices. If productivity gains are not acting as a buffer and if the rise in
commodity prices was just temporary, how the dynamics of the Mauritian economic growth are
explained?
A glimpse at the monetary policy
Mauritius is not self-sufficient and imports a large variety of core products for its consumption and
production. Thus, the country is impacted by external shocks which could increase the price of these
goods. However, external shocks are exceptional events their effects disappear in the long run. The
current monetary policy of the country showed that there have been constant cuts in the repo rate,
from 9.25% in 2006 to 4.65% today. The Central Bank of Mauritius, applying its open market
operations, has constantly pumped in money in the monetary system to stimulate the economy. The
transmission mechanism of monetary policy is a very subtle subject and in this case, the idea of the
Bank of Mauritius (BoM) was to act on bank rates for the domestic market and exchange rate to
favour exports. Unfortunately, it would presumptuous to say that market share was gained during
this period. Additionally, the situation is now aggravated by the excess liquidity in the system mainly
because of foreign loans contracted by local economic agents and this should normally lead the BoM
to a monetary sterilisation. A guided monetary policy is essential for a country to achieve a
sustainable economic prosperity. Inflation should be the main factor which should be monitored and
then special attention should be given to economic growth. The role of a Central Bank is not to

implement sound economic policies but its role should only to create the optimal financial
environment for the success of political and economic decisions. A closer look to some micro
economic figures shows that there has been a 72% increase in stock prices since 2006, the property
prices rose by 34 % when the economy has been growing since the last 6 years around 4%. Normally,
corporate profits rate of return should be equal to the economic growth more or less. Increased
profitability is due to either new market share gained and/or leverage, which most of the time is
beneficial to any company. However, there is a level which transforms traditional investment
vehicles into safe haven assets even if there are no such things today and thus lead to a
misallocation of resources.
Figure 2 below summarises the conjunction of factors which would eventually impact the future
growth if they are not being addressed.
Figure 2
Fall in Productivity
gains and
uncontrolled
Inflation rate.

Accommodative
Monetary Policy.

Encourage bubbles
on financial assets
and Real Estate.

Non
growth (or
one off)
producing
assets.

Excess capacity
environment,
Positive wealth effect
and poor credit
monitoring from
financial institutions.

Deterioration
of Debt/GDP
ratio, balance
Sheets and
quality of
collateral.*

Increase Income
inequality;reduce
savings and economy
relying on
consumption.

Competition for
loanable funds
with the private
sector for
Investment/Debt
service. Crowding
out Effect*.

Twin Deficits
(Budget and Balance
of Payments).

Loss of
Competitiveness,
misallocation of
resources and over
dependence on
preferential
agreements.

Exogenous and/or
Political/Lobby
pressures to
influence
Monetary Policy.
c

Social
Unrest.

A Mauritian economy a la franaise?

The above analysis showed that even if Mauritius is not in a serious economic downturn, it is
showing some signs of an anaemic growth generated mainly by returns of non-permanent growth
activities. A lot of countries would be very satisfied with a 3.5% economic growth but these nations
are well ahead in terms of development, technological innovation and society organisation.
Surprisingly, a deeper look at the welfare system in general, there is an impression that Mauritius
thinks itself (unconsciously) as a rich country and behaves likewise. Unfortunately, the country is not
yet rich because it has not achieved any requirements which categorises itself as an advanced
economy. Europe and the USA are declining due to their systemic problems linked to their economic
model and excess reliance on leverage. A country like France, which possesses a good capacity in
terms of innovation, human capital development, infrastructures is nowadays seen as a time bomb
for the European Union. The problem of this country lies in the way it finances its significant welfare
state, its rigid labour market, the inability of its companies to specialise on high value added
products and a series of bad economic policies. Mauritius is, of course, not in the same situation but
there are some similarities with the French economy, namely on its growing welfare state, its
gradual shift to a consumption based system and some signs of growing debts and deficits
accompanied by a gradual fall in productivity. Relying on the development of temporary trade
agreements or some effet de mode activities will not only damper structurally the ability to achieve
significant prosperity but will also provoke a permanent delay in the application of necessary
reforms. Not to mention that the natural course would be an increasing debt and inflation,
emergence of financial and real estate bubbles which de facto will inflate artificially credit rating
while reducing credit standards of financial institutions when giving loans. There will be also a
growing consumption dependence of imported goods accompanied by a decreasing savings rate
thanks to inappropriate deposit rates. This environment may eventually bring a misallocation of
resources, the emergence of shadow banking and if above that, there is no independent oversight of
institutions, this may lead to economic and/social unrest.
However, if, the right reforms are being undertaken, not only these risks can be mitigated but high
growth rate is possible with a policy mix i.e targeted fiscal policy with a tight monetary objectives.
Firstly, Mauritius being small country, a consumption based economy is not viable; reforms should
be made in order to increase investments in profit centre sectors (and infrastructures) where
comparative advantage can be achieved. All sectors should do whatever it takes to move upward the
value chain. Furthermore, the Central Bank should operate with a clear independent mandate. The
education system and public training institutions must try to work hand in hand with the local
companies, adapt their syllabus to the activities where Mauritius is specialised. A thorough analysis
must be undertaken to see what kind of jobs the Mauritian economy needs, quota must be
introduced for law and medical activities as they tend to be in the long run less growth generating.
Emphasis should be laid on fields like software development and engineering activities going from
marine to financial. There should be a constant front running of innovation which will be
transformational for the world. Most importantly, the mind-set must evolve, and to reach that goal,
personal responsibility at all levels should ultimately not be outsourced to some third party or to the
state. The agency relationship which exists between the people and the government should be
tested more often by stronger independent institutions but for this the country needs strict
legislation for the financing of political campaigns.

This article attempted to analyse if Mauritius would qualify as a macro investment opportunity.
Based on the findings, it would be fair to say that Mauritius has a lot of prospects ahead only if it
succeeds to identify its weak points and correct them. A Neutral recommendation would be given
to an investment manager as Mauritius can have a bright future for its economy and for its people in
general but right now there is a sentiment of slow and gradual decline.

Note :
Long - To Buy.
Short - To Sell.
Keynesian Economics Favouring fiscal policies over monetary policies.
Crowding out Effect Increased public spending driving down private initiatives.
Collateral A transferable/ guaranteed asset.

About the author.

Davin Appanah has been working as a Quant/Structurer/Trader on Interest Rate and Exotic Derivatives within
the investment banking sector for the last 10 years in Paris and New York. His areas of interests are financial
and mathematical modelling, quantitative hedge fund strategies, market microstructure and financial
microeconomics.