“Speech is silver, but silence is golden.” Writing this out a few hundred times was a common punishment for talking in class when I was at school in the UK. Of course, the advent of computers and word processors has rendered the punishment redundant. However, it is still relevant in Mauritius, not to the Ministry of Education, but to the Ministry of Finance.

I have been contemplating Pravind Jugnauth’s deathly silence on the subject of the country’s finances. Unlike other political observers, I do not consider the boy an idiot. In fact, I suspect he might just harbour a little integrity along with his over-looked intelligence. So why be silent on the economy? Because telling it like it is will damage investor and consumer confidence.

“Oh really? Tell us how it is then!”

In two words: growth & devaluation.

State finance 101

A country is like a business and Mauritius’ revenues are tiny compared to some multi-national companies. A bank will lend money to a company ONLY if it is confident that the company can grow the business sufficiently quickly to repay the interest and the capital when it is due. Consider a company that wants to borrow an amount equivalent to 100% of its current turnover. If, in the first year, the company can grow the business at the same speed as the rate of interest on the loan then it can afford to pay the interest. If faster, then it can afford to pay back some capital as well. But if slower then the interest will compound, increasing the debt and future interest payments.

In other words, if a business’s cost of borrowing is higher than its rate of growth, then it risks going bankrupt because its debt may become unsustainable. I say “risks” because there are a few of nuances to this. On the positive side, as implied above, if the loan is significantly less than annual revenues, then meeting interest payments should not be a problem. Also, as growth compounds (just like unpaid interest), the company can effectively grow itself out of debt, provided, of course, it keeps growing fast enough and long enough. On the negative side, this analysis assumes that the company’s expenses do not increase with turnover. More precisely then, over the term of the loan, the company’s total profit before interest must be at least equal to the compounded interest and the initial capital.

[Pedantic economists might argue that I am ignoring the value of any assets that are purchased with the capital but I would reply that productive assets will depreciate to zero over the term of the loan and other assets are effectively investments (e.g silver, gold, real estate, shares, etc) which, if significant, would make the company in question more like a Wall Street investment bank.]

When applying this theory to countries, there is a further complication: national currencies. If the national debt is owned internally, e.g. as government bonds purchased by residents, then the complication is removed. However, if the national debt is owned externally, it will be denominated in foreign currencies and hence changes in the relative values of the currencies will have an effect. Basically, if a nation devalues its currency, then its external debt will increase proportionately, as will the interest payments.

This effect is further complicated since the costs of imports as well as the value of exports also change immediately, altering the “profitability” of the country. The “profitability” of the government of a country is effectively its tax revenues, which are then distributed to the population as services and payouts (health, education, law and order, subsidies, pensions, etc) in the same way as dividends are distributed amongst shareholders. Tax revenues are directly related to the profitability of the nation’s companies and the level of consumer spending (as significant revenue comes from VAT).

“So what does this mean for Mauritius?”

That’s the question that the Minister of Finance is supposed to answer…

[Before we go into that, who believes that Rama Sithanen and Ali Mansoor are financial experts? After the international ratings agencies lowered their ratings for Mauritius in 2007, the Ministry of Finance asked the US Embassy to explain why and what it meant. The Resident Advisor from the US Treasury Office of Technical Assistance duly obliged. Read his presentation and ask yourself why it needed to be so simplistic.]

First it means that if Mauritius devalues the Rupee, it will immediately increase the value of the nation’s external debt as a percentage of its turnover (GDP). This may lead to the ratings agencies lowering their ratings again. This would lead to an increase in the interest rate that new lenders would charge and this might lead to an unsustainable public debt. Even before this point, investor confidence would be reduced and Foreign Direct Investment (FDI) into Mauritius, would all but evaporate. It would also severely impact Mauritius’ standing as a financial centre.

If you think that the Governor of the Bank of Mauritius is refusing to devalue the Rupee to protect consumers from the consequences – higher prices for imports – then think again. His primary concern is to protect the sustainability of the nation’s external debt.

The problem is that the Rupee is going to lose value against international currencies no matter what the Bank of Mauritius does. The sad fact is that Mauritius’ open economy is extremely vulnerable (as we stated 4 weeks ago). Sithanen’s stimulus package basically robbed well run businesses to subsidise poorly managed ones and hence avoid job losses. For how long can that be sustained? Another part of it gave land developers tax breaks, increasing the attractiveness of covering our landscape with more concrete. But if nobody wants to buy or rent the buildings how can that continue?

Our economy is not going to grow fast enough. Consumers will spend less. Tax revenues will decrease. Our external debt will become unsustainable. The cost of borrowing will increase and we will spiral towards bankruptcy. Either we apply austerity measures now, reverse our annual deficit and reduce our national debt, or the IMF will impose much more severe austerity measures in the not too distant future. Does Pravind have the guts to call a silver spade a silver spade? Or does he prefer fools’ gold?

[For those who think that Mauritius’ situation is not so bad compared with other countries, click on the graph at the beginning of this article. It shows the per capita level of foreign-owned debt for SADC countries. The Seychelles are excluded because they are already effectively bankrupt. Mauritius stands head and shoulders above its southern African peers. Remember too that many of them can buy themselves out of debt with their mineral wealth. Source]