A year is a short time for much to be achieved in Economics, yet the budget over the last three years tells quite a different story. Each year, the ship has been steered towards the reform channel, boasting over the space of three years growth averaging 5.4%, falling unemployment which now stands at 8.5% and is expexted to decline to 7.5% by the end of the year, promising foreign and private investment which have also turned the tide for the balance of payments and international reserves. In the former case, we now enjoy a healthy surplus of Rs13.8 billion and in the latter reserves of Rs 81 billion, 50% higher than three years ago.

CPI statistics for financial year 2006-07 showed double digit inflation for the first time since 1993. Figures for fiscal year 2007-08 proved an improvement with inflation falling to 8.8% but still remaining well above the long term average. To better understand the persistent increase in prices over the past years or so, it is important to look at the state of the global economy over this period. There has been a global surge in commodity and oil prices driven mainly by rising demand in emerging markets, besides natural factors. According to The Economist, the industrialising world, which contributed around 40% of global GDP in the 50s, is expected to increase its share to nearly 70% by 2025. Demand for oil has been incessantly rising in the rapidly industrialising world. The CIA World Factbook even shows that oil consumption for China, India, Russia and South Korea matches the daily 14.5 million barrels consumed by the EU.

Even if America?s economy stalls in the aftermath of the credit crunch and Europe readies itself to catch the American flu, the world economy continues to grow resiliently. Furthermore, HSBC points to an investment boom with $1.2 trillion spent on infrastructure by emerging economies, twice the infrastructure-investment ratio of their developed counterparts. The developed world might have been subdued into slower growth, but the Asian tigers and South American countries look unlikely to give up their sprinting anytime soon. Growth and convergence for them is a priority, price stability a backburner. In this sense, given their high demand for commodities and oil, they have contributed largely to the inflation crisis buffeting the world.

Mauritius has not escaped these harsh exogenous factors causing high domestic inflation to persist. Coming back to the domestic economy, the 36.9% average increase in salaries in the public sector which, has not been matched by an increase in productivity, will put upward pressure on inflation expectations in the short run but the more serious consequences will only be felt in the months to come. The current Pay Research Bureau review will result in a wage/price spiral in spite of schemes to mop up the Rs 5.2 billion excess liquidity pumped into the system. There is also high likelihood of spillovers into the private sector where wage increases compensating for loss in purchasing power are not matched by an increase in productivity. This should further aggravate inflation in the medium run.

Our wage policy is not in line with our monetary policy. On the one hand, the central bank has resorted to monetary tightening to control inflation, but on the other, excess liquidity has been pumped into the market. Adding to this, the wage policy is bound to hurt the exports sector as well if wages in the private sector rise more than the growth in productivity. Costs of private enterprises will shoot up and competitiveness will be affected. Looking at it from both sides, we are equally doomed; higher inflation and weaker exports.

Monetary conditions have not eased the inflation crisis either. Interest rates have been lowered from 9.25% to 8% over financial year 2007-08 before recently being raised and maintained at 8.25%. The MPC argued that these drops in the repo rate would help the exports sector and business in general. If we try hard enough, we can see where the cuts in rates are coming from and why policymakers are being so relaxed about the price rise; you do not take a hammer to kill a fly. It was thought that high inflation was only temporary and squeezing growth would only result in unnecessary unemployment in the short run. The problem here is that while we expected hikes in the price of food and energy to be quickly stabilise, they did not. Food and oil prices continued to rise for over a year keeping up high domestic prices.

A question of credibility

To keep the current level of inflation under control, monetary policy needs to be tightened. Friedman stated that ?inflation was always and everywhere a monetary phenomenon?. Excess liquidity causes inflation in the sense that you earn more, you buy more. If we look at the growth in M2 for the fiscal year 2007-08, it has grown by over 17% as compared to 8% the previous year. Of similar significance is credit available to the private sector, this figure has increased by 22%. Looking at countries like Ukraine, which have a ridiculous credit growth of 80%, also have a ridiculously high inflation rate of 30%. Therefore, it would be wise for us neither to forget, nor to ignore, the lessons set by Friedman. Recently, the cash ratio was raised from 4% to 6%. This will slow the liquidity growth and put adverse pressure on inflation.

The behaviour of the Bank of Mauritius and the MPC with regards to the current problem has not been of great help. The Governor of the Bank of Mauritius has come under serious criticism lately because of the perception of a lack of decisiveness over monetary policy. This has serious consequences on the way expectations are formed. Almost as important is the question of credibility and independence of the central bank. For most of the year, policy makers have been caught in two minds, trying to boost the exports sector and control inflation. On the 30th June 2007, the repo rate stood at 9.25%. It remained at that level until February 2008, where it was then repeatedly cut, falling to 8% in the space of four months. A few months back, the reporate was shyly raised by 25 basis points to 8.25% and at the last meeting of MPC it was kept unchanged. Nothing hurts credibility and expectations more than u-turns in policy. In a little over 8 months, central bankers have raised rates, to focus on inflation, lowered rates, to focus on growth, and finally raised rates to target inflation again. To make matters worse, diverging views within the MPC refuse to end; a few members have been relentlessly fighting for lower interest rates despite the high level of inflation. For expectations to be properly anchored, we first of all need to figure out our priorities, whether it is more an aspect of growth or price stability. Then, with regards to credibility, the central bank should make its objective crystal clear to the general public and the private sector. For instance, if we look at other central banks like the Bank of England, their objective is clear cut; the bank has to maintain price stability, and, subject to that, to support the economic policy of the government, including its objective for growth and employment.

Ronald Reagan once described inflation as being as violent as a mugger, as frightening as an armed robber and as deadly as a hit man. There are three main culprits behind the current level of inflation. First comes the once temporary anticipated price shock of oil and food. According to the Economist food index, prices soared by 50% over the last year while the price of oil increased by over 80%. The second is strong domestic demand assisted by loose monetary policy; real interest rates have been low and credit growth too rapid. Last is the wage policy which in turn contributes to wage inflation. Two years ago, Mauritius needed an economic revival which could only be achieved by buoyant growth and boosted domestic demand. Today what we need is price stability for sustainable growth. The time has come to tap off the gas, let us put the mugger behind bars.

Nadeem JEETUN