Selected macroeconomic indicators. Unit (1) 2004 (1) 2005 (2)

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Economic Outlook July 2005

Unit 2002 2003(1) 2004(1) 2005(2)

GDPmp Rs bn 142 157 175 188

GDP growth % 1.9 4.6 4.2 3.8

GDP growth excl. sugar % 3.3 4.6 4.0 4.1

Per capita GDP US$ 3,931 4,582 5,165 5,100

Inflation FY, % 6.3 5.1 3.9 5.6

Inflation CY, % 6.4 3.9 4.7 5.2

Budget deficit FY, % GDP 6.1 6.2 5.4 > 5.0*

Balance of visible trade CY, Rs bn -10.7 -12.9 -21.4 -28.1

Current Account FY, % GDP +5.4 +2.4 +0.9 -1.5

Overall Balance of Payments FY, Rs bn +5.9 +9.1 +3.2 -4.1

Unemployment (old base) mid-year, % 9.7 10.2 10.8 -

Unemployment (new base) June, % - - 9.2 9.5

* The budget deficit figure for FY 2004/05 is currently being reviewed by the authorities 1: revised estimates 2: MCB forecasts

Sources: CSO, MoF, BoM and MCB staff estimates

Selected macroeconomic indicators

GROWTH PROSPECTS

In the light of latest available data, our projections for growth in 2005 have been significantly brought down mainly on account of a major downgrade in the EPZ sector which has been severely affected by the end of textile quotas under the Multi-Fibre Agreement. Expansion is also expected to be lower than earlier anticipated in the tourism sector in view of dimmer prospects in some of our key markets while a contraction is now expected in the sugar sector consequent to adverse climatic conditions. On the other hand, the trade sector should fare better than initially forecast following tariff reductions in a number of commodities since April last although the impact would be mitigated by a slightly lower growth forecast for domestic oriented industry with the latter expected to

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face increased competition as a result of this Budget measure. Against this background, our projections for economic growth and expansion excluding sugar have consistently been downgraded since the beginning of the year to currently stand at 3.8% and 4.1%

respectively.

Forecast as at Overall growth (%)

Growth excl. sugar (%)

Oct-04 5.1 4.9

Jan-05 5.2 5.2

Apr-05* 4.5 4.7

Jul-05 3.8 4.1

* Internal assessment

Evolution of MCB projections for 2005

After a generally encouraging start, this year’s sugar crop has suffered considerably from excessive rainfall for prolonged periods during the month of March as well as from the passage of severe tropical storm Hennie. The dry weather conditions in April and May have also been detrimental to cane growth particularly in the North of the island.

According to the Crop Estimate Co-ordinating Committee, sugar production in 2005 should be around 550,000 tonnes, representing a decline of 3.9% as compared to last year. Whilst the growth rate in the sugar sector has hitherto mostly hinged on climatic conditions, it should in the medium term be also a function of the implementation of the reform plan regarding the EU sugar regime which, under its current form, proposes a gradual price reduction over the next four marketing years, starting by a cut of 5% in 2006/07 and reaching a cumulative 39% by 2009/10. Indeed, the timing and magnitude of the slash in guaranteed sugar prices could, in the absence of sufficient accompanying measures, temper the effectiveness of the restructuring process underway in the sugar industry thereby driving many domestic producers out of business. In this respect,

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diplomatic efforts should be stepped up with a view to at least delaying the planned reform of the EU sugar regime and obtaining adequate compensation to mitigate its financial impact. Besides, the diversification programme of the domestic sugar industry, inter alia aimed at increasing the production of high- value added sugar by-products as well as special sugars and energy from bagasse, should be actively pursued.

At the time of our previous projections, major uncertainties were clouding the outlook for the EPZ sector, the most prominent risk factor being related to the impact of the removal of global textile trade quotas. There are indications already that apparel exports by India, Pakistan and particularly China would surge in 2005 despite attempts by major importers to initiate protectionist actions principally targeting the latter country. Moreover, it is expected that price margins on textiles and clothing products would go down markedly thereby intensifying competitive pressures on the domestic industry. Consequently, another drop in the volume of Mauritian apparel exports is projected this year, the more so that prospects in our main market appear bleaker than previously anticipated. As a matter of fact, exports of apparel and clothing declined by 20.3% during the first quarter of the year as compared to the first quarter of 2004, contributing to a fall of 11.7% in total EPZ exports, despite a notable depreciation of the rupee on average against major currencies over the corresponding periods. Based on these trends, the outlook for the EPZ this year has significantly deteriorated and another contraction of a similar magnitude as in the past three years – corresponding to a cumulative drop of some 23% in output since 2001 – is now expected in the sector. However, important risk factors still prevail, implying that confidence intervals surrounding this projection remain fairly large.

Whilst growth in the tourism sector should pick up this year, the projected upswing could be somewhat less pronounced than earlier anticipated namely considering the less optimistic outlook in some of our principal markets. This may be gauged by the performance in the first five months of this year with tourist arrivals rising by a moderate

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4.2% as compared to the same period in 2004. As a result, our forecast for tourist arrivals in 2005 has been revised downwards to some 755,000, corresponding to a growth rate of 5.0% in the sector. Notwithstanding its below par performance in the past few years, tourism represents one of the most promising avenues of growth and employment – albeit subject to some extent to the evolution of exogenous factors such as the economic climate in our key markets and the global security situation – particularly considering its broad multiplier effects. Tapping on latent opportunities in the sector would call for prompt action plans as part of a clear and coherent strategy towards achieving set objectives within various segments. In this respect, there is a pressing need to remove bottlenecks impeding the sector’s development namely with respect to the country’s marketing and air access policies.

With banks engaged in the global business segment expected to post a technical rebound from the contraction recorded last year and domestic commercial banks projected to grow in line with past trends, the banking sector should register a robust expansion in 2005.

Appreciable growth rates are also forecast in the insurance and business act ivities segments, contributing to a notable expansion in business and financial services. As regards the other main sectors, growth should pick up slightly in trade following the reduction in customs duties as announced in the Budget. On the other hand, a less optimistic outlook is now foreseen in domestic oriented industry given that this sector is expected to face heightened competition from foreign produced manufactures. A weak performance is also expected in construction given the near completion of the implementation of large -scale public infrastructure projects. Moreover, prospects have been downgraded in the transport, storage & communication sector which should nonetheless record a notable expansion rate namely on the back of the thrust being given to Information and Communication Technology.

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Cumulative deviation of output from target

100 105 110 115 120 125 130 135

2000 2001 2002 2003 2004 2005 (f)

Growth Index (2000=100)

GDP excl. sugar 6% growth target (f) forecasts

INFLATION

The inflation rate has pursued an upward movement since June 2004 on the back of a general depreciation of the effective exchange rate of the rupee and high oil prices.

Whilst it might have been expected that the inflation trend would be reversed in the second quarter of this year given the important reductions in customs duty rates announced in the last Budget – which ceteris paribus were deemed to contribute to an estimated 3-point fall in the Consumer Price Index – actual price reductions turned out to be sensibly lower. Actually, the index remained almost stable from March to June 2005.

Inflation thus continued to edge upwards to stand at 5.6% as at June last.

In the second semester of 2005, upward pressures on prices should stem from expected rupee depreciation on average particularly considering the shift to a deficit of the current account as well as from persisting high oil prices on international markets. As a matter of

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fact, the falling trend in oil prices during late 2004 was reversed in the first quarter of this year but the rise was not translated in higher cost of petroleum-related products domestically through the Automatic Pricing Mechanism during the April review probably due to the timing of purchases. Besides, the authorities took the decision in May last to undertake the price adjustment exercise scheduled for July in October 2005. This portends that an increase in the relevant prices might be foreseeable at the forthcoming review, the more so that oil prices on international markets have remained high on average and that the rupee has generally been depreciating against the dollar since early 2005. However, the bearing on inflation in the short term at least should be somewhat compensated by the impact of the recent duty reductions, although the latter could pose inflationary risks in the medium to long term due to related pressures on the current account. Overall, inflation as at December 2005 should remain above 5% in spite of a positive statistical effect relating to the high CPI increases in October last kicking in as from the last quarter of 2005.

UNEMPLOYMENT

In line with a small increase in net job creation among Mauritian workers registered in the EPZ in the last quarter of 2004, the unemployment rate as per the new basis of calculation declined from 8.4% as at September 2004 to 7.6% as at December last according to the CSO. It might, however, be misleading to compare jobless rates between successive quarters as the reported statistics are unadjusted for seasonal effects. Given that the available figures currently restrict analysis of year-on-year quarterly figures on account of the new methodology being applied only since 2004, it might be hard to clearly establish the underlying trend for unemployment purely based on these data.

Moreover, caution should be exercised in interpreting the latter in view of their large confidence bounds as well as the atypical evolution in labour force estimates as shown in the table below.

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Mar-04 Jun-04 Sep-04 Dec-04

541,100 540,700 527,800 522,300

(15,500) (17,400) (16,600) (11,400)

8.7 9.2 8.4 7.6

(0.7) (0.7) (0.7) (0.6)

Figures in brackets represent standard errors Source: CSO

Labour Force

Unemployment Rate (%)

Estimated Labour Force and Unemployment

The unemployment rate is deemed to have risen back since the beginning of 2005 notably with the entry in the labour market of new jobseekers early this year and taking into consideration a fall in net employment among Mauritian workers in the EPZ in the first quarter. On these trends, it is estimated that the unemployment rate reached 9.5% as at June 2005. Looking ahead, although small and medium enterprises as well as some service sectors such as tourism should contribute positively to net employment creation, the latter could still lag behind the expected rise in the labour force given the inability of many productive sectors to generate sufficient jobs in net terms particularly considering the weak investment outlook. Indeed, the GDFCF to GDP ratio in 2005 is expected to stagnate at 21.7%, which is well below the 30% level advocated for sustained growth rates of over 6%, considered necessary for materially improving the job creation capacity of the economy. In particular, a projected decline in private inve stment from its already poor level of 15% of GDP in 2004 to 14.6% this year following an anticipated near- zero growth is a source of serious concern as highlighted in previous studies.

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Public Investment

0 2 4 6 8 10

2000 2001 2002 2003 2004 2005

% of GDP

Private Investment

0 5 10 15 20 25 30

2000 2001 2002 2003 2004 2005

% of GDP

Actual/Forecast Level Advocated Level

PUBLIC FINANCE

The incoming Government have hinted that the budget deficit for FY 2004/05 would overshoot the previous estimate of 5.0% of GDP mainly on account of differing treatments to be adopted with respect to public debt rescheduling and loans by some parastatal bodies. The persisting high fiscal deficit, if left unchecked, could severely constrain economic activity in the future namely through a further build-up in public sector debt whose ratio to GDP is already well above the 60% mark deemed to be the

“internationally acceptable indebtedness criterion”. In this respect, it is commendable that the authorities have committed to correct the current fiscal imbalances. As per approved estimates, the budget deficit for FY 2005/06 should reach Rs 9.5 billion, that is, 4.8% of GDP while the deficit on the primary balance is expected to widen to 1.4% of GDP.

However, these figures would in most likelihood be revised in the light of the new economic orientations to be adopted by the present Government.

EXTERNAL TRADE

Notwithstanding a relatively favourable behaviour of the euro in 2004 and a higher sugar production than one year earlier, total exports increased by a moderate 4.2% to Rs 55.2

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billion in line with persisting difficulties in the EPZ. The negative impact thereof on the balance of trade was compounded by a substantial 16.1% rise in total imports to Rs 76.6 billion against the backdrop of currency depreciation on average and high oil prices on international markets contributing to a 37.6% hike in the import bill for refined petroleum products. Overall, the deficit on the balance of trade reached a record Rs 21.4 billion last year, that is, 12.2% of GDP. The anticipated poor sugar crop this year coupled with the expected continued weak performance of the EPZ should stem the growth in exports in 2005. As for the import bill, it should once again bear the brunt of the forecast rise in oil prices and an expected depreciation of the effective exchange rate of the rupee on an annual average basis. Further pressures on the trade balance could arise from an increase in imports linked to the reduction in customs duties announced in the last Budget. In view of the above, it is projected that the deficit on the balance of trade would widen further to around Rs 28 billion in 2005, representing nearly 15% of GDP.

BALANCE OF PAYMENTS

Whilst the services account posted a strong positive balance in FY 2004/05 driven by an appreciable increase in gross tourism receipts, the deficit on the goods account is estimated to be worse than previously anticipated mainly on account of higher oil prices impacting negatively on the import bill. This should lead to a current account deficit for the first time in five years, representing some 1.5% of GDP. Accordingly, the balance of payments in the current financial year should post a deficit of around Rs 4.1 billion.

The deficit on the goods account should deteriorate in FY 2005/06 on account of the muted performance projected in our main export sectors coupled with a significant rise forecast in total imports on the back of rupee depreciation on average, continued high oil prices and increased demand linked to tariff reductions. This should contribute to another current account deficit in the current financial year although tourist remittances are

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projected to remain buoyant. As a result, in contrast to the surplus position registered for the six years to FY 2003/04, the overall balance of payments should for the second consecutive year be in deficit in FY 2005/06 leading to a projected fall in the import cover.

CURRENCY AND INTERES T RATES

Despite the large external deficit of the US, the dollar rallied against major currencies this year underpinned by encouraging economic data and resulting market expectations of further monetary tightening. Indeed, the greenback has gained around 10% against the euro since the start of 2005 amidst political uncertainty and soft economic conditions in the euro area while the pound sterling has depreciated by some 7.5% against the dollar partly on account of concerns that the Bank of England may cut interest rates in the period ahead. Reflecting the strength of the dollar on international markets, the rupee has depreciated against the latter by nearly 4% since January last on a point-to-point basis. As such, the domestic currency has gained 6.4% and 3.9% against the euro and the pound sterling respectively. On an annual average basis though, the rupee depreciated by 10.4%

vis-à-vis both the euro and the pound sterling in FY 2004/05 while shedding only 3.0% of its value against the dollar following the relative weakness of the latter during 2004.

Looking forward, the rupee should, on average, continue to depreciate in effective terms in line with a worsening current account position and persisting difficulties in key export sectors.

As regards interest rates, the phased cycle of monetary tightening in the US that started in June 2004 was pursued during the first semester of this year, with the Federal Open Market Committee raising the Fed Funds rate in February, March, May and June last by 25 basis points on each occasion, bringing the rate to 3.25%. Although this implies an increase in the Fed Funds rate of 2 percentage points in one year, it is deemed that the stance of monetary policy is still accommodative, indicating that the odds remain towards

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further tightening. Conversely, there are increasing market expectations of a monetary easing in the UK while the case for a cut in the ECB rate to boost flagging economies, such as Germany and Italy, has been weakened by a softer euro and signs of improved business confidence in some eurozone countries.

In the light of international developments and in response to an upward inflation trend domestically in early 2005, the Bank of Mauritius proceeded as expected to a rise in the Lombard rate by 25 basis points with effect from 10th February 2005. The monetary stance to be adopted in the period ahead should be a function of numerous factors including the evolution of foreign interest rates and the economic priorities of the new Government. Within the context of major uncerta inties currently characterising the economy, the challenge for the authorities would be to strike the right balance between price stability and broader objectives particularly pertaining to the real and external sectors.

J. Gilbert Gnany

Chief Economist 13/07/2005

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[SOURCES]

Bank of Mauritius, Annual Report, Various Publications Central Statistics Office, Economic Indicators

International Energy Agency, Oil Market Report

International Monetary Fund, World Economic Outlook and Various Pronouncements Ministry of Finance and Economic Development, Budget Speech, Draft Recurrent and Capital Budgets, Various Publications and Pronouncements

MCB Research & Strategy, Staff estimates

DISCLAIMER

This publication has been prepared by the MCB Ltd. on behalf of itself and its affiliated companies solely for the information of clients of the MCB Group. While reasonable care has been taken to ensure that the information contained herein is not untrue or misleading, the MCB Ltd. makes no representation as to its accuracy or completeness. Neither the MCB Ltd. nor any director, officer or employee of MCB Ltd. accepts any liability whatsoever for any direct or consequential loss arising from any use of its publication or its contents.

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