Current Account in Mauritius: Regime-Switch, Sustainability and Reversal

Abstract

Using quarterly data over the period 1999Q1-2012Q1, this paper finds that the current account dynamics of Mauritius are adequately portrayed by a three-regime self-exciting threshold autoregressive (SETAR) model that leads to two current account equilibria, namely a high deficit of 9% and a low surplus of 2.5% of GDP, on a seasonally adjusted basis. The current account is sustainable, as the model is globally stationary. The island has, notably, switched from the low-surplus to the high-deficit equilibrium in the latter half of the sample period. The model is used for stress testing the current account in order to trace probable current account reversal paths in the event of adverse shocks. These are identified as temporary or durable “capital and financial account” shocks that would lead to a transitory or permanent reduction in foreign currency availability on the domestic foreign exchange market, including through lower inward foreign direct investment (FDI) or withdrawal of existing foreign portfolio investment. The ensuing depreciation of the Mauritian rupee would lead to a J-type current account reversal process converging onto the 9% deficit equilibrium in response to temporary shocks but onto the 2.5% surplus equilibrium following durable shocks. In response to shocks, the authorities should intervene to smooth, but not counter, the reversal process. Any attempt to resist adjustment would lead to a harder landing subsequently. As the adjustment process could be painful, a better strategy would be for Mauritius to design and implement adjustment policies without waiting for shocks to materialise, in order to leave the high-deficit equilibrium and move back to the low-surplus equilibrium smoothly. These adjustment policies should aim to raise the international competitiveness of the island in the short-to-medium term. Regular monitoring in order to achieve some stability in the real effective exchange rate (REER) of the Mauritian rupee would, in this regard, constitute a useful first step.

Keywords: Current Account, Sustainability, Reversal, Regime-switching, Stress-Testing

JEL Classification: C22, C51, C52