Public Information Notice No. 06/01

Public Information Notice: IMF Executive Board Concludes 2005 Article IV Consultation with Mauritius

January 3, 2006

On December 2, 2005, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Mauritius.¹

Background

Mauritius has been increasingly affected by the phasing out of external trade preferences for its textile exports and, more recently, by higher prices for petroleum product imports. Growth has slowed to 3.5 percent in 2004/05 and is expected to remain subdued during the next two fiscal years. The surplus on the external current account has recently turned into a deficit, owing to a decline in exports and a price-related surge in petroleum product imports. The real effective exchange rate has depreciated and net foreign official reserves have dropped, although they remain at relatively comfortable levels.

The slowdown of economic activity and the suspension of periodic adjustments of retail petroleum prices have negatively affected Mauritius' fiscal position. While the central government deficit was kept at about 5 percent of GDP during 2004/05, the State Trading Company (STC) incurred a rising deficit owing to the lack of adjustment of retail petroleum prices since early 2005. Unless corrective action is taken, the overall fiscal position during 2005/06 is expected to deteriorate further, owing to lower than originally projected revenue collections associated with lackluster activity and a further increase of the STC's deficit as the gap between retail prices and import costs of petroleum products widens.

Inflation has picked up since mid-2004, reflecting ample liquidity and higher import prices for petroleum products. More recently, price developments have moderated largely because of slower monetary growth and because increases in international oil prices have not yet been passed on due to the suspension of the adjustment of domestic oil prices.

Executive Board Assessment

Executive Directors commended Mauritius' impressive economic and social progress over the past two decades. However, they noted that a deteriorating external economic environment, particularly for the sugar and textile sectors, recently has led to a slowdown of economic activity, an increase in the external current account deficit, and a loss of international reserves. Directors underscored that the challenging external environment, the high level of domestic public debt, and the risk of higher inflation pose considerable policy challenges in the short and medium term. Against this background, Directors welcomed the authorities' recognition of the need for fundamental reforms to boost external competitiveness and ensure fiscal sustainability.

Directors urged the authorities to develop a comprehensive economic strategy early on, that combines structural reform measures and policies geared toward macroeconomic stability. Such an agenda would reassure international and domestic investors, improve the environment for private sector activity, and lay the basis for a return to high growth rates and the creation of employment opportunities.

In the structural area, Directors encouraged the authorities to explore options for a more active involvement of the private sector, including privatization, which would help foster investment and growth. In this context, they stressed the need to review the role of the public sector in commercial activities, including the financial soundness of the major public enterprises. Directors also underscored the importance of creating a more flexible labor market to facilitate the transfer of workers from declining to more dynamic sectors. However, they stressed that efforts to facilitate inter-sectoral movement of labor will need to be accompanied by training programs geared toward the needs of growing segments of the economy. Also, the impact of centralized wage negotiations on labor costs and competitiveness needs to be examined soon.

Regarding the textile and sugar sectors, Directors were encouraged by the authorities' restructuring plans, aimed at mitigating the effects of a loss of trade preferences. They welcomed steps under way to increase the overall efficiency of enterprise operations and seek new export opportunities for textiles. However, they cautioned against the use of fiscal incentives for the sectors, taking into account the difficult fiscal situation.

Directors commended the authorities' steady progress on financial sector reform, including implementation of several key Financial Sector Assessment Program (FSAP) recommendations. This has strengthened the banking system despite the adverse developments in the textile and sugar sectors. Directors welcomed the authorities' plans to intensify financial sector monitoring and to harmonize the tax treatment of domestic and offshore banks.

Directors urged the authorities to take steps to stem a further deterioration of the fiscal position in 2005/06. In this regard, they recommended careful monitoring of the financial situation of the major state-owned enterprises. They welcomed the recent adjustment of domestic petroleum prices and supported reinstatement of the automatic petroleum price adjustment mechanism to ensure full pass-through of the cost of imported petroleum products to domestic retail prices while cautioning that well-targeted safety nets will be needed to mitigate the impact on the poor. Directors also stressed the need to devise support schemes for the sugar and textile sectors that would not add to public outlays.

Directors emphasized that a strong and credible medium-term fiscal strategy will need to be formulated as quickly as possible to contain the public debt and ensure fiscal sustainability. They noted the scope for broadening the tax base and streamlining outlays through better targeting to groups in need of assistance. They encouraged the authorities to follow through with their plan to phase out all import tariffs, which will support efforts to bolster competitiveness. Directors also recommended that debt management be improved, including through a further diversification of debt instruments.

Directors emphasized that exchange rate and monetary policies will play a key role in securing external competitiveness in the short term while longer-term structural reforms are being implemented. Most Directors supported a cautious approach to tightening of monetary conditions in order to contain inflationary pressures and encouraged the authorities to manage liquidity more actively. In this regard, Directors supported the authorities' request for Fund technical assistance to develop a more diversified range of monetary policy instruments. Directors also cautioned against adopting a fully-fledged inflation targeting regime in light of the need to refine the instruments of monetary policy, the uncertain external outlook, and the need for fiscal consolidation.

Directors stressed that the exchange rate should reflect movements in macroeconomic fundamentals. To this end, they supported greater flexibility of the exchange rate, observing that interventions in the foreign exchange market should be limited to smoothing short-term volatility with a view to protecting international reserves.

Directors noted that Mauritius' data availability and quality are generally adequate for surveillance purposes. They encouraged the authorities to reconcile differences between official and externally collected debt data and to move the fiscal accounts to an accrual basis as soon as feasible.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.