Good Evening

Welcome to the Bank of Mauritius Annual Dinner.

At around this time last year when I assumed office, I had emphasised the strong policy commitment of the Bank to restore confidence and stabilise expectations with a view to paving the way for sustainable low inflation. Tonight, I must say that the Bank remains unwavered and determined in its policy commitment. Indeed, our commitment is to achieve durable price stability, that is, a situation where inflation would not be a disturbing factor in your investment and spending decision making process.

Tonight is also an opportunity for stock-taking as well as for "clearing the air" on some issues that are of direct interest to the business and financial community. In particular, I would wish to dwell briefly on issues relating to monetary policy, exchange rate developments and the topical subject of soundness of our banking system. Our policy stance has been straightforward. Some of our policy actions have, however, been misinterpreted leading to unintended perceptions. But before I move to the various points that I wish to highlight tonight, I should like to make a few observations.

Over the last 12 months I received more than 200 visits from individuals and representatives of our business community. We exchanged views on economic and financial issues. By and large these related to the exchange value of the rupee and the level of interest rates. I fully appreciated many of the points made by the visitors. However, let me share with you a particularly telling fable on disarmament as narrated by Sir Winston Churchill in 1928.

When it comes to protecting one’s own interests, it is quite natural for one to push for the interest of oneself. This is quite understandable. We cannot have linear expectations in a non-linear world. The behaviour of economic agents throughout the world is unfortunately not expressible as deterministic mathematical equations. Such agents do not behave in the predictable manner that the laws or equations might lead one to suppose. No wonder then, central bankers across the world have a lot to reconcile. This reconciliation task is a constant challenge to central bankers and is, indeed, becoming more difficult with the rising tide of economic and financial liberalisation. Every individual, everywhere across the world, shows the full force of profit motive. Owners and managers of money today have an obsessive fascination with the arts of money, which cuts them from any sensitivity to political and social consequences. It seems to be a permanent task for central bankers to shape order out of contradictions. Central bankers increasingly need to have a political sense and a second vision, too, just as sailors need a meteorological sense.

But, in the normal state of things, central bankers have only one policy instrument, that is, interest rate to reconcile conflicting interests, to shape order out of contradictions and to help restore and sustain internal and external balance. In short, central bankers have only one weapon to fight many battles and different battles. We, at the Bank of Mauritius, have made a calculated use of this instrument since December last. May I seize this opportunity to state that in the formulation of our interest rate policy, the Bank does not simply have to base its judgement on domestic considerations alone. Persistence of old habits of thinking lead many to overlook the stark reality that we no longer have exchange control. Hence, the Bank of Mauritius has also to assess its interest rate policy stance against the level of interest rates on the world’s major reserve currencies, for capital is mobile and very mobile indeed.

With the adjustment that was brought about in the monetary policy stance of the Bank of Mauritius towards the end of 1998, we have achieved a better integration of the domestic money and the inter-bank foreign exchange markets. This change in the policy stance of the Bank has imparted greater stability to the exchange value of the rupee and also enhanced the attractiveness of rupee-denominated assets. Exchange rate movements over the last twelve months have moved in consonance with both international trends and local market conditions. As the Bank of Mauritius seeks to achieve a closer integration of our financial market with the world financial markets, market discipline will continue to be a key factor in this endeavour. The exchange rate of the rupee will 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 that best serve the economy.

Allow me, Ladies and Gentlemen, to quote a few figures on the exchange rate front: -

Between January and November 1999, the rupee appreciated by 9.8 per cent against the Euro but depreciated by 9.4 per cent against the Japanese yen, by 2.2 per cent against the US dollar and by 0.5 per cent against the Pound sterling. The trade-weighted nominal effective exchange rate of the rupee depreciated by about 2.9 per cent during the 12-month period ended November 1999.

Concern has been expressed about the appreciation of the rupee vis-à-vis the Euro. However, the rate of appreciation of the rupee against the Euro has been much less than the rate of appreciation of some of the Asian currencies. Between January and November 1999, the Taiwan dollar appreciated by 13.9 per cent against the Euro, Singapore dollar by 12.6 per cent, Korean won by 11.9 per cent, Hong Kong dollar by 11.6 per cent and South African rand by 9.9 per cent. You will appreciate that there is nothing to suggest that the rupee has been appreciating vis-à-vis the Euro more than the currencies of some of our main competitors. In pressing their claim for a depreciation of the rupee, some have even leaned on the Turkish case and quoted the very high double-digit rate of depreciation of the Turkish currency. What is not mentioned, however, is that this high double-digit rate of depreciation of the Turkish currency has also been served with a helping of an inflation rate of as high as 64 per cent and of a short-term interest rate of as high as 70 per cent. Ladies and Gentlemen, you will appreciate that this is far from being a Turkish delight!

It makes more sense to view exchange rate developments over a period of time. Regarding the European single currency, we believe that there are good economic fundamentals that militate in favour of a stronger Euro in the medium term. I wish here to reassure the business community that vigilance will continue to be exercised to ensure that the competitiveness of our exports is not eroded. In the same vein, I should underline that depreciation is a double-edged sword.

Currency appreciation or depreciation cannot be a panacea for all our economic ills. We should not forget that appreciation or depreciation of a currency could be a mixed blessing. While appreciation may help us to contain inflation, it may also lead to a loss of international competitiveness. The depreciation of a currency, while beneficial to the export-oriented sectors, would also have potential inflationary consequences.

In terms of macro-economic policies, authorities usually have to make a policy trade-off between the degree of exchange rate adjustment and inflation rate. The way forward for Mauritius in the international game of competition is inevitably through the achievement of real productivity gains. Short-term exchange rate accommodation can only serve to postpone the need for addressing the real issues relating to good management and productivity improvement. In the more liberalised financial environment, i.e. with the absence of exchange controls and credit ceilings and the liberalisation of interest rates, export-oriented sectors should also adjust so as to operate without the protective net of exchange rate adjustment. In this endeavour, halting unproductive increases in wages and salaries as well as increases in fringe benefits in both the private sector and the public sector is equally imperative if competitiveness of the economy is to be sustained.

Allow me now to briefly touch on the subject of foreign reserves and foreign direct investment as these often make the headlines. Net international reserves have remained comfortable during 1999. In spite of the drought-induced shortfall in sugar export proceeds, the Bank of Mauritius has initiated steps to ensure that our reserves position is not unduly affected. At the end of November 1999, that is 3 days ago, the Bank of Mauritius foreign exchange reserves stood at an all-time high level of Rs17.8 billion. Net International Reserves stood at Rs24.9 billion, that is, at almost US$ 1 billion – an all time high level. This level of reserves represented an import cover of 5.8 months. Against the backdrop of a stable exchange rate and reflecting increased confidence in our economy, the level of foreign direct investment has attained an all-time high of Rs1.2 billion so far in 1999.

Hubris leads to nemesis. Central bankers are not exempt from nemesis; that is, punishment for excessive pride. The level of our foreign currency reserves is likely to decline in the year 2000. We will perhaps put the blame for the decline on the weather!

I explained to bankers recently, the signalling of the monetary policy stance of the Bank of Mauritius will become much clearer with the setting up of a Lombard Facility for commercial banks. The key rate to watch is the Lombard Rate, which we have fixed at 14 per cent. We will soon start with repurchase transactions as one of the principal methods of effective liquidity management. The Bank of Mauritius is targeting an inflation rate of 6.0 per cent for the current fiscal year. While the 12-month rate of inflation for the period ended November 1999 indicates that inflation has started moving on a downward path, there are, however, potential upside risks coming from the global economic recovery and the sustained rise in oil prices. The approach to fighting inflation has, however, to be a forward-looking one.

Economists usually tend to emphasise the importance of having what are usually referred to as good "macroeconomic fundamentals". However, there are certainly lessons that have to be drawn from the events of the recent years, particularly those relating to the Asian crisis. In an increasingly integrated world economy, a few macroeconomic virtues are not enough. Strong macroeconomic fundamentals are necessary, but they are not sufficient to guarantee economic and financial stability. While globalisation of the world’s financial markets offers opportunities, it also carries with it risks. Sudden shifts in market sentiments can trigger massive shifts in short-term capital and precipitate banking sector crises. The Asian crisis underscores the need for greater transparency and accountability and for the continuous monitoring of the soundness of the banking system.

Nearly a decade ago, frustrated and bewildered by the state of an ailing bank, I, as the then Director of Research, intentionally inserted in an internal memorandum to my bosses a quotation from The Prairie Farmer, as reprinted in the Weekly Press, Pennsylvania, February 6, 1858. The title of the Article is ‘Why Merchants are liable to Fail in Business’.

This excerpt applies to all types of businesses, including, I must say, the bankers’ own financial health and. It also teaches us that bankers should be watchful of the general conduct of the rogue customers' well being. Fortunately, our banks are in better shape today. Banks have positively adopted a more constructive approach in the conduct of their businesses. Nonetheless, we still do have to sustain the efforts being currently made by all of us in the banking industry. Both bankers and borrowers have to adapt themselves to the evolving financial environment. It is imperative that banks implement effective credit analysis, monitoring and control procedures if they are to contain the level of their non-performing loans.

Borrowers also have certain responsibilities to fulfil. There is today an inexplicable feeling in certain section of the business community that the Bank of Mauritius is over-tightening and hence the liquidity shortage and the high rate of interest. Arguments are being bandied across that economic growth will be stifled by the current policy stance of the Bank of Mauritius. I do not believe that interest rate is the sole determinant of economic growth. That is not called simply barking up the wrong tree, but being in a different forest altogether. The Bank of Mauritius does not derive machocistic pleasure out of monetary tightening.

Borrowers should refrain from betraying the trust placed in them by bankers in the normal course of their business. Before applying for a loan borrowers must judiciously examine the real purpose of the loan. Do they have a viable business plan to support financing? Do they have enough equity investment in their business to sustain additional credit? In other words, do they have a viable debt to equity ratio? Will their operations generate adequate cash flow to service the loan repayments in a timely manner? I would like to see greater realism in the borrowers’ expectations. Borrowers must first find answers to these types of questions before engaging in credit discussions with banks.

Let me now move to the supervisory approach of the Bank of Mauritius. In our view, the fundamental element is self-governance by the supervised banks. This concept is generally not readily digested by the banking industry and its advisors. In stressing sound governance and strong voluntary compliance procedures, I should like to emphasise the following three points regarding the responsibilities and independence of Boards of Directors, Managements of banks and their external auditors

• Pay as much, if not more, attention to your fiduciary responsibilities to depositors as to your entrepreneurial interests. Self-governance starts with boards. Boards must be active, interested and well informed.
• Sound corporate management, working under clear direction from the board, and featuring strong risk management policies and controls. Bad management has been a main ingredient in bank failures internationally. We believe that risk management by banks is critical. Quantitative criteria or ratios cannot replace risk management.
• Conservative and rigorous asset valuation practices, accounting policies, prudent loss measurements, particularly with respect to the timing of income recognition.

The role of bank supervisors in Mauritius is often misunderstood by quite a few in the banking industry. The good supervisors are more interesting and more philosophical people than their titles suggest. As they look into the banks’ secrets and survey the whole banking system and the economy their questions go far beyond any formal notions of accounting. Their approach is forward looking. Does the bank have adequate policy based controls and governance to prosper for a long time into the future? We look forward to a healthy dialogue and co-operation with the bankers. May I, however, underline that I will not accept unacceptable practices.

An appropriate macroeconomic policy stance is unlikely to be sufficient to maintain balance in the economy unless it is supported by sound underlying micro-economic conditions. This is no less true in the monetary policy area where sustaining a policy stance geared to price level stability requires a sound and competitive banking system to transmit monetary policy signals and ensure the efficient allocation of financial resources. Hence it is important that the central bank’s policies to further promote the soundness of our financial system through prudential regulations should not be perceived as going-back on economic and financial sector reforms but more as efforts to strengthen the micro-economic aspects of monetary management. If we believe in the laws of gravity, we cannot see water running uphill.

Ladies and Gentlemen, in the last twelve months, the spirit of our policies has been marked by a passion for balance. A middle course in the economic affairs of the country is a must. Prosperity without equity is not common sense. Co-existence without solidarity is not common sense. Power without any counterbalance is not common sense. Wealth without generosity is not common sense. Diversity without sharing is not common sense.

Economic development, as said by Max Weber, does not depend on labour and capital only. Economic development also depends on the collective attitude favourable to economic activity. This attitude often referred to as the ‘ethos of competitive confidence’ gave rise to the three miracles: the miracle of foreign trade by the Dutch, the miracle of industrialisation by the British and the miracle of high technology by the American. To some extent I may say that this collective attitude, this ‘ethos of competitive confidence’ gave us the Export Processing Zone. Let us, bankers, other players in the private sector, trade unions and all other decision-makers retain ethos, the right pattern of behaviours and the right attitude.

Finally, ladies and gentlemen, on behalf of the Board of Directors and staff of the Bank of Mauritius and on my own behalf I wish you and your family a merry Xmas, a happy New Year and Millennium.

May God Bless You.

Thank You.

3 December 1999