Dr the Honourable Vasant Kumar Bunwaree,

Minister of Finance,

Government House,

Port Louis.

Dear Minister of Finance

In accordance with the provision of section 45 (1) of the Bank of Mauritius Act, I transmit herewith the thirty-second Annual Report and audited Accounts of the Bank for the year ended 30 June 1999.

The Mauritian economy performed well during 1998-99. This performance has been characterised by sustained economic growth, employment creation mainly in the services and manufacturing sectors, a reduction in the external current account deficit and a relatively comfortable level of net international reserves against the backdrop of global economic turbulence. Prospects for 1999-00 are clouded by the prolonged drought conditions. The economy is forecast to grow by 4 per cent in 1999-00 against the trend growth rate of around 5 per cent. However, a reversal to the trend growth rate is expected in the years ahead.

Several developments contributed to higher rate of inflation during the year under review. These include the high rate of monetary expansion during the preceding fiscal year, increases in salary stemming from the implementation of the public sector pay award in September 1998, drought conditions which prevailed since the end of 1998, the introduction of the value-added tax and the lagged impact of the depreciation of the rupee. In the light of these conditions, the Bank had no option but to immediately move for a tightening of monetary policy towards the end of 1998. This approach helped contain the inflation rate for the fiscal year 1998-99 to 7.9 per cent against the targeted rate of 8 per cent. For the fiscal year 1999-00, the Bank of Mauritius will be targeting an inflation rate of 6 per cent. While efforts will continue to be directed towards the development of an unfettered money market, a further strengthening of indirect monetary control is envisaged with a view to achieving lasting stability of monetary conditions. In this context, a principal objective of the Bank is to achieve a narrowing down of the inflation differential between Mauritius and its major trading partners in the medium term.

The re-orientation of the monetary policy stance towards the end of 1998 brought about a better integration of the domestic money and the interbank foreign exchange markets, thus imparting greater stability to the exchange value and restoring confidence in the rupee. The exchange rate of the rupee during the period under review has moved in consonance with both international trends and local market conditions. Banks have demonstrated a greater sense of discipline in factoring developments in the domestic economy as well as in the international foreign exchange market in the determination of their opening rates. As the Bank seeks to achieve a closer integration of our financial market with the world financial markets, market discipline will be a key factor in this direction. Since opening exchange rates quoted by banks set direction in the foreign exchange market, it is important that banks continue to exercise caution in the determination of their indicative exchange rates. The exchange rate of the rupee should continue to reflect the macroeconomic fundamentals of the country and, in line with current policy, intervention by the Bank of Mauritius will be guided by such considerations as to smooth out seasonal fluctuations and to avert disruptive short-term mis-alignments of the exchange rate of the rupee. Continued vigilance will be exercised to ensure that the competitiveness of our economy is not eroded.

The Mauritian economy was insulated against the Asian crisis. However, one of the major lessons that we should draw from the crisis is that a few good macroeconomic virtues are not sufficient to guarantee economic and financial stability. Monetary policy has to go hand in hand, for example, with a fiscal policy which plays its stabilization role. In the present context, increases in wages and salaries not related to productivity growth could threaten the external payments position of the country. A prudent and consistent wage policy is therefore warranted. Simultaneously, greater efforts inevitably need to be devoted towards speeding up the process of fiscal adjustment. This adjustment process, which has been set in a medium-term framework, is well under way with the replacement of the sales tax by the value-added tax and the improved buoyancy of tax revenue. Further fiscal consolidation is needed to reduce Government’s reliance on bank financing so as to keep monetary growth on an even keel and to broaden the scope for the sound development of productive sectors.

Net international reserves, which provide a more appropriate measure of import cover than the foreign exchange reserves of the Bank of Mauritius alone, remained comfortable during the year and would need to be maintained at prudent levels keeping in view the economy’s future requirements. In spite of the expected shortfall in sugar export receipts due to drought conditions, the Bank of Mauritius has initiated steps to ensure that our reserves position is not unduly affected.

The Asian crisis has demonstrated dramatically the need for financial institutions to operate on a sound basis. More than ever, greater attention is focused on the soundness of financial institutions in Mauritius. The operation of financial institutions should be well geared to advance rather than hinder economic growth. Prudential regulations, however stringent and unpleasant to individual financial enterprises, do in the end ensure robustness of the financial system. In a liberalised world financial environment, risks of failures are high. The urge to grow big too fast carries with it the seed for failures. The recent past is littered with examples of such failures. The limitations of the free market are commonplace. The case for prudential regulations that complement market forces by the adoption of a more responsive stance to the limitations of the market is strong. With a view to enhancing the soundness of the banking system, issues relating to the proper identification of non-performing loans by banks, the extent of provisioning made by them and management of risk associated with high concentration ratios in their portfolios have been addressed by the Bank of Mauritius.

The Mauritius Code of Banking Practice, prepared by the Bank of Mauritius in collaboration with commercial banks, became effective on 1 July 1998. Its main objective is to ensure that banks act fairly, reasonably and responsibly in all their dealings with customers, thereby increasing transparency by helping customers understand how their accounts operate and what they can reasonably expect from banks.

The Bank of Mauritius has actively addressed the millennium bug problem within the banking sector with a view to ensuring that this sector is Year-2000 compliant. As part of the measures forming part of its contingency plan, the Bank has made appropriate arrangements to ensure an ample supply of currency to suitably meet any Year-2000 related additional demands for cash.

The Bank revived its project for the implementation of a real time gross settlement (RTGS) system as part of its efforts to modernise financial system infrastructure and improve the working of the payments system. The implementation of the Mauritius Automated Clearing and Settlement System in the near term, with the assistance of the World Bank, will become one of the milestones for better integrating financial sector operations and opening up new and more efficient avenues in the provision of financial services to the public.

The Bank has made its contribution at the regional level in the South African Development Community (SADC) and the Common Market for Eastern and Southern Africa (COMESA) through its presence at the meetings of the Committee of Central Bank Governors. Mauritius hosted the meeting of the SADC Heads of State in September 1998. The Bank has also assumed an important responsibility in the harmonisation of regional banking supervisory standards in the Eastern and Southern Africa (ESAF) Group of Banking Supervisors.

Finally, I wish to place on record my appreciation of the sense of commitment and dedication with which the staff have served the Bank during the past year. No efforts have been spared by the management of the Bank to improve the physical work environment and working conditions of the employees and to invest in training and human resource development. Finally, the objectives of the Bank would not have been attained without the dedication and support of the Board of Directors.

Viewed against the backdrop of the recent global economic turmoil, the performance of the Mauritian economy during the fiscal year 1998-991 was quite commendable. It was characterised by the continued buoyancy of economic growth, a reduction of the budget deficit to GDP ratio, a lowering of the current account deficit of the balance of payments and the maintenance of a relatively comfortable level of net international reserves. Economic expansion was broad-based, driven by the sugar, Export Processing Zone (EPZ), tourism and the financial and business sectors. Reflective of this growth momentum, per capita Gross National Product (GNP) at market prices increased. This growth performance was also accompanied by employment creation mainly in the services and manufacturing sectors of the economy. While the Bank of Mauritius targeted an inflation rate of 8 per cent for the fiscal year 1998-99, the actual rate of inflation was 7.9 per cent. On the external front, the current account of the balance of payments posted a lower deficit in 1998-99 than in the preceding fiscal year. This improvement stemmed mainly from the increase in the surplus registered on the services account. The rate of monetary expansion, as measured by the growth of money supply M2, decelerated during the period under review.

Gross Domestic Product (GDP) at factor cost went up in nominal terms by 12.6 per cent in 1998 and is estimated to rise by 9.0 per cent in 1999. Real GDP registered an appreciable growth rate of 5.2 per cent in 1998 following the increase of 5.3 per cent in 1997. It is expected to fall to 3.0 per cent in 1999, largely on account of the adverse impact of the drought on the agricultural sector.

All sectors, except agriculture, witnessed positive growth ranging from 3.0 per cent to 8.6 per cent in 1998. The highest expansion of 8.6 per cent was recorded in "Insurance and Other Business Services" followed by "Financial Institutions", which grew by 8.0 per cent. Among the major contributors to GDP, the EPZ registered a growth of 7.0 per cent with exports totalling Rs23.0 billion as compared to Rs21.0 billion a year earlier. EPZ exports are expected to increase further to Rs29.0 billion in 1999. The tourism sector grew by 6.0 per cent in 1998 with tourist arrivals going up by 4.1 per cent to 558,195. Gross foreign exchange earnings from this sector, however, grew at a higher rate of 18.1 per cent as compared to 11.3 per cent in 1997.

Aggregate consumption expenditure went up in nominal terms by 11.5 per cent in 1998. Adjusted for price increases, the growth rate worked out to 4.4 per cent. Gross Domestic Savings (GDS), which is the difference between GDP and aggregate consumption expenditure, registered a growth rate of 16.0 per cent in 1998 as compared to 13.0 per cent in 1997. The savings rate, defined as the ratio of GDS to GDP at market prices, went up from 24.3 per cent in 1997 to 25.1 per cent in 1998 but is expected to recede to 23.3 per cent in 1999.

Gross Domestic Fixed Capital Formation (GDFCF) increased in nominal terms by 10.7 per cent in 1998, exclusive of the purchase of aircraft and marine vessel. In real terms, GDFCF increased by 5.6 per cent in 1998 and is expected to further pick up by 7.1 per cent in 1999. The ratio of GDFCF to GDP at market prices fell from 27.2 per cent in 1997 to 23.2 per cent in 1998 but is expected to pick up to 26.5 per cent in 1998.

The population of the Republic of Mauritius was estimated at 1,167,445 at the end of December 1998. The total labour force increased by 2.4 per cent to 517,000 in 1998. Employment, inclusive of foreign workers, was estimated to have risen by 2.5 per cent to 487,600 in 1998. The unemployment rate, which had been on a rising trend since 1991, declined by 0.1 percentage point to 5.8 per cent in 1998.

Reflecting the high rate of monetary expansion in the previous fiscal year, the salary increases stemming from the implementation of the public sector pay award, the introduction of the value-added tax in September 1998, the drought conditions that have prevailed since the end of 1998 and the lagged impact of the depreciation of the rupee, the rate of inflation for the fiscal year 1998-99, as measured by the average change in the Consumer Price Index (CPI), increased to 7.9 per cent from 5.4 per cent in 1997-98.

The basic thrust of monetary policy in 1998-99 continued to be directed towards the achievement of price stability and a stable exchange rate of the rupee, in the context of a broad interplay of market forces in the determination of interest and exchange rates. The Bank of Mauritius continued to use the Reserve Money Programme (RMP) and the liquidity forecasting framework as a basis for intervening in the money and foreign exchange markets. As part of the ongoing process of financial liberalisation, the cash ratio was brought down from 6.0 to 5.5 per cent while the non-cash liquid assets ratio remained at zero per cent. The tight monetary policy stance of 1998-99 was reflected in a general rise in interest rates. In spite of the higher inflation rate during fiscal year 1998-99, the real rate of interest remained positive. The auctioning of Treasury Bills of maturities of 30 days and 728 days provided financial institutions with additional investment opportunities. The launching of the over the counter market for Government of Mauritius Treasury Bills in December 1998 helped to enhance public awareness and investment culture in these Bills.

Aggregate monetary resources, that is, money supply M2, expanded by 13.2 per cent in 1998-99 as compared to an increase of 17.4 per cent in 1997-98. Net foreign assets of the banking system went up by 4.6 per cent, from Rs21,118 million at the end of June 1998 to Rs22,087 million at the end of June 1999, reflecting increases in the net foreign assets of both the Bank of Mauritius and commercial banks. Growth of domestic credit slowed down to 13.0 per cent in 1998-99 from a growth of 26.1 per cent recorded in the preceding year. Credit to the private sector expanded by 20.4 per cent in 1998-99 down from an increase of 32.3 per cent in 1997-98. However, net credit to Government by the banking system declined for the first time in four years.

The overall budget deficit for 1998-99 was Rs3,650 million, equivalent to 3.6 per cent of GDP as against to 3.7 per cent in 1997-98. Higher revenue was generated through the replacement of the sales tax of 8 per cent by a value-added tax of 10 per cent that covers a broader range of goods and services as well as through the increased buoyancy of tax revenue. Government efforts to curtail the growth of expenditure were partly mitigated by the salary increases stemming from the implementation of the public sector pay award. The budget deficit was financed exclusively from domestic sources, namely by the non-bank sector and the Bank of Mauritius. Total central Government indebtedness reached Rs51,001 million at the end of June 1999, with external and internal debt amounting to Rs10,027 million and Rs40,974 million, respectively. As a percentage of GDP, total central Government debt increased from 49.6 per cent at the end of June 1998 to 50.3 per cent at the end of June 1999. The debt service ratio of the country increased from 6.7 per cent in 1997-98 to 7.9 per cent in 1998-99, largely reflecting the partial redemption of the Floating Rate Note (FRN) in October 1998.

The reorientation of monetary policy towards the end of 1998 brought about a better integration of monetary and exchange rate policy. In that context, greater stability has been imparted to the exchange value of the rupee whilst also enhancing the attractiveness of rupee-denominated assets.

The current account of the balance of payments registered a deficit of Rs1,977 million in 1998-99 as compared to a deficit of Rs2,704 million in 1997-98. In relation to GDP, the deficit on the current account represented 1.9 per cent in 1998-99 as compared to a deficit of 3.0 per cent in 1997-98. This improvement in the current account of the balance of payments stemmed essentially from an increase in the surplus registered on the services account, from Rs4,364 million in 1997-98 to Rs5,681 million in 1998-99. Excluding the import of aircraft, the current account of the balance of payments recorded a surplus of Rs773 million in 1998-99, equivalent to 0.8 per cent of GDP. Exports, f.o.b., rose by 9.8 per cent to Rs39,732 million while imports, f.o.b., went up by 8.0 per cent to Rs49,189 million in 1998-99. The capital and financial account recorded a net inflow of Rs668 million in 1998-99.

Net international reserves of the country, made up of the net foreign assets of the banking system, the foreign assets of Government and Mauritius' Reserve position in the International Monetary Fund (IMF), increased from Rs21,349 million at the end of June 1998 to Rs22,575 million at the end of June 1999. Net international reserves, which provide a more comprehensive measure of import cover than the foreign reserves of the Bank of Mauritius alone, represented 5.4 months of imports, exclusive of the purchase of aircraft, at the end of June 1999 as compared to 5.5 months at the end of June 1998.

The foregoing economic and financial developments during the year 1998-99 are reviewed in greater details in the following chapters of the report.

In 1998, the economy maintained its growth momentum, expanding by 5.2 per cent as compared to the annual average growth rate of 5.5 per cent over the period 1990 to 1997. Economic activity was largely driven by the strong performance of the export sector, supported by growth in our major export markets, namely the European Union and the United States. In real terms, exports of goods and non-factor services went up by a higher rate of 11.1 per cent in 1998 as compared to 4.0 per cent a year earlier. In contrast, the expansion of real aggregate domestic demand fell from 9.9 per cent in 1997 to 0.2 per cent in 1998, largely due to a drop in gross capital formation in real terms.

Nominal GDP at factor cost rose by Rs9,420 million, from Rs75,019 million in 1997 to Rs84,439 million in 1998. Per capita GNP at market prices went up from Rs74,655 in 1997 to Rs83,027 in 1998. However, on account of the appreciation of the dollar vis-à-vis the rupee, it declined from US$3,525 in 1997 to US$3,441 in 1998.

Aggregate consumption expenditure expanded, in real terms, by 4.4 per cent for the second year in a row. Consumption expenditure of households grew by 4.6 per cent in 1998; that of general government went up by 3.6 per cent in 1998, higher than the increase of 3.5 per cent in 1997. Nominal aggregate consumption expenditure fell from 75.7 per cent of GDP in 1997 to 74.9 per cent in 1998. The ratio of household consumption expenditure to GDP declined from 63.8 per cent in 1997 to 63.0 per cent in 1998 while the ratio of general government consumption to GDP remained stable at 11.9 per cent.

Table I.1 shows the main national accounting aggregates and ratios from 1996 to 1999.

Gross Domestic Fixed Capital Formation (GDFCF) contracted, in real terms, by 7.5 per cent in 1998 after expanding by 10.8 per cent in 1997. The GDFCF to GDP ratio went down from 27.2 per cent in 1997 to 23.2 per cent for the year under review. Excluding irregular investments, namely the purchase of aircraft and marine vessel, a different picture emerged with GDFCF rising by 5.6 per cent in 1998 as against a contraction of 1.5 per cent a year earlier. The share of private sector GDFCF in total GDFCF, exclusive of the purchase of aircraft and marine vessel, remained virtually unchanged at around 72.4 per cent in 1998.

Reflecting the strong performance of the construction sector in 1998, GDFCF in "Building and Construction Work" recovered markedly in 1998, expanding, in real terms, by 5.1 per cent as against a contraction of 4.3 per cent in the preceding year. Investment in "Residential Building" was up, in real terms, by 5.0 per cent in 1998, contrasting with the decline of 9.0 per cent registered in 1997. Easier credit terms on mortgage finance coupled with Government policy to encourage investment in low-cost housing for low-income groups were the main factors driving capital formation in "Residential Building". However, investment in "Non-residential Building", essentially industrial building, fell for the second consecutive year while investment in "Other Construction Work" was sustained with a real growth of 13.9 per cent in 1998 as compared to 12.3 per cent a year earlier. Government capital expenditure on public works with a view to upgrading existing public infrastructure was a contributory factor explaining the recovery in the construction sector.

Investment in "Machinery and Equipment" contracted, in real terms, by 18.9 per cent in 1998 in contrast to an expansion of 29.1 per cent in the preceding year. However, exclusive of the purchase of aircraft and marine vessel, both "Other Transport Equipment" and "Other Machinery and Equipment" registered positive real growth rates. Investment in "Passenger Car" maintained its upward trend in 1998, increasing in real terms by 7.3 per cent in 1998 as compared to 20.4 per cent in the preceding year.

An analysis of investment by industrial use showed that investment in "Manufacturing" increased further in 1998 with a real growth of 19.2 per cent, higher than that of 16.4 per cent in 1997. Capital formation in the EPZ grew by 9.2 per cent in 1998 as compared to a higher rate of expansion of 28.5 per cent in the preceding year. Investment in the highly capital-intensive "Electricity, Gas and Water" sector was significant in 1998 after a sharp decline in the preceding year. The share of investment in "Financing, Insurance, Real Estate and Business Services" in total GDFCF was highest at 27.6 per cent in 1998 followed by "Manufacturing" with a share of 18.7 per cent.

Tables I.2 and I.3 show the growth of GDFCF by type of capital goods and by industrial use in real terms, respectively, for the period 1996 through 1998. Chart I.1 depicts movements in the ratio of GDFCF and Gross Domestic Savings (GDS) to GDP at market prices for the years 1992 through 1998.