Public Information Notice No. 02/71

Public Information Notice: IMF Concludes 2002 Article IV Consultation with Mauritius

July 15, 2002

On May 24, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mauritius.¹

Background

The Mauritian economy has weathered the global economic slowdown relatively well. Economic output is expected to expand by about 5.3 percent in 2001/02 (July-June), only slightly below its trend rate of growth of the past 20 years. Tourism weakened somewhat in the second quarter of 2001 but picked up in the second half, partly reflecting Mauritius's reputation as a safe destination. Sugar output grew by 14 percent during the 2001/02 crop year reaching 645,000 tons, its highest level since 1987. Financial services also continued to expand robustly, as did other services, such as transport and communications. Output in the export processing zone (EPZ) is likely to increase by about 6 percent in 2001/02. However, recent political upheavals in neighboring Madagascar, and the resulting disruption in production and trade, have hurt the profitability of Mauritius's EPZ firms because of their sizable investments in, and vertical integration with, Madagascar's EPZ.

Notwithstanding the relatively robust economic growth over the past decade, unemployment has risen steadily and is projected to reach about 9 percent in 2001/02. This trend suggests a mismatch between the requirements of the workplace and either the job aspirations or skills of the unemployed workforce, as well as rigidities in the labor market and more general problems in education and training.

Government finances are expected to deteriorate further in 2001/02, following a sharp deterioration in 2000/01. The main cause is higher capital expenditure on education and environmental projects and an increase in net lending, although this will be partially offset by lower expenditures on interest payments and wages. Government revenue is likely to be broadly stable. Overall, the primary deficit is expected to widen from 1.3 percent of GDP in 2000/01 to 3 percent of GDP in 2001/02. While the financial situation of state-owned enterprises improved in 2000/01 and is expected to strengthen somewhat in 2001/02, it remains weak, as adjustment of utility and energy prices by the government continues to be infrequent, and based primarily on political rather than commercial considerations.

While inflation in 2000/01 (12-month average) fell to 4.4 percent from 5.3 percent in the previous year, it subsequently rose to 5.6 percent in February 2002, boosted by the depreciation of the rupee during 2001 and a number of transitory factors, including the rise in the value-added tax (VAT) rate, increases in electricity and other administered prices, and the impact of a cyclone in late February on food prices.

The Financial Services Development Act came into effect in December 2001 with the formal establishment of the Financial Services Commission (FSC) under the chairmanship of the Managing Director of the Bank of Mauritius (BOM). The FSC is responsible for regulating and supervising the nonbank financial sector, while the regulation and supervision of banks, both onshore and offshore, remain with the BOM. It is envisaged that after a transition period of three to four years the FSC and the Banking Supervision Department of the BOM will be merged into an integrated supervisory agency.

The external current account swung from a deficit of 1.6 percent of GDP in 1999/2000 to a surplus of 1.8 percent of GDP in 2000/01. There was a significant improvement in the trade balance, reflecting a strong recovery in sugar exports and lower imports of inputs for the EPZ. In the capital and financial accounts, net inflows of foreign direct investment of US$228 million more than offset the final repayment on the floating rate note of US$117 million. The real effective appreciation of the Mauritian rupee during 1999 and much of 2000 was partly reversed during 2001. In 2001/02, the current account is expected to remain in modest surplus.

Executive Board Assessment

Executive Directors noted that sound macroeconomic policies and structural reforms over the past two decades have firmly established Mauritius as one of the leading economic performers in Africa, with robust economic growth, high real per capita incomes, improving social conditions, and a diversified economic base. The economy's resilience has enabled it to weather the recent global economic slowdown relatively well, with growth expected to be only slightly below its trend of the past two decades, inflation pressures subdued, and the external position in broad balance. Nevertheless, concern was expressed at the large and growing fiscal deficit and at the steadily rising unemployment rate.

Directors welcomed the government's intention to lower the fiscal deficit over the medium term, stressing that this will require substantial fiscal measures beginning with the upcoming budget for 2002/03. It was noted that failure to take corrective measures, while going forward with the ambitious capital spending plans, could result in substantial increases in the deficit and potentially trigger unsustainable debt dynamics that could jeopardize medium-term growth prospects. There was broad support for increasing the VAT rate, broadening the income and customs tax bases by reducing exemptions and concessions, and strengthening tax administration. On the expenditure side, the need to review, prioritize, and check the pace of execution of the planned capital projects to guard against excessive demand pressures was emphasized.

It was also important to implement an automatic and transparent mechanism for the pricing of petroleum products. This would help reduce losses of the State Trading Corporation and therefore the potential need for budgetary support.

The stance of monetary policy was considered to be appropriately tight, and Directors viewed favorably the Bank of Mauritius's move to an informal inflation-targeting framework. They noted, however, that many of the conditions for the adoption of a formal inflation-targeting framework, including greater independence for the central bank and a mandate setting price stability as its primary objective, were not yet in place. Directors welcomed the authorities' intention to allow the exchange rate to be market determined, with only limited intervention to reduce short-term volatility.

Directors welcomed the authorities' expeditious passage of legislation on anti-money laundering and combating the financing of terrorism and encouraged its full implementation. They also welcomed other actions to strengthen financial market supervision, including the establishment of the Financial Services Commission and Mauritius's request to participate in the Financial Sector Assessment Program starting later this year.

Considerable emphasis was placed on the need for labor market reforms to reverse the trend rise in unemployment and sustain growth at the relatively high levels Mauritius has enjoyed during the past two decades. Education and training to reduce the mismatch between labor demand and skills availability, as well as revision of labor laws and regulations to engender increased labor market flexibility, were considered crucial. In this context, Directors looked forward to the upcoming comprehensive study on labor market reforms that will be financed by the World Bank. A few Directors considered that the proposed prioritization and rescheduling of capital spending should not affect such spending on education.

Directors commended the authorities for recent measures to liberalize trade and to encourage regional economic integration. They encouraged the authorities to further liberalize trade and to bring Mauritius fully in line with World Trade Organization rules.

Directors noted that the quality and timeliness of Mauritius's reporting to the IMF of core minimum and other economic and financial statistics were in general satisfactory for surveillance purposes.