## _wp08212

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---

### I. Introduction — context and key summary findings
- Large negative terms of trade shocks: phasing out of the Multi-Fiber Agreement (end of 2004); EU reduction of sugar price guarantees (starting in 2006); higher world commodity prices (food and petroleum).
- Current account (CA) deficit worsened to an average of 4 percent of GDP for 2004–07.
- Real GDP growth averaged 3.6 percent between 2001 and 2007 (versus 4 percent in the 1990s and 5 percent in the 1980s).
- Main research focus: assess competitiveness of Mauritius (1980–2007) via equilibrium real exchange rate (ERER) analysis and nonprice structural indicators (business climate, trade costs, ICT).
- Methodology: mix of panel and time-series techniques using FEER–MB, FEER–SE, CHEER, and ES approaches; supplementary nonprice competitiveness analysis.
- Key conclusion: the real exchange rate at end-2007 was aligned with its equilibrium value as determined by fundamentals; little adjustment may be necessary over the medium term. Conclusion consistent across methods.
- Policy implications emphasized: stimulate competition in goods markets; make labor markets more flexible; enhance skills; further reduce the cost of doing business.

### II. Evolution of the exchange rate — institutional history and recent behavior
- Historical regime chronology (selected dates and features):
  - 1848: currency-board-like system established.
  - Until 1870: switched between pound sterling (gold) and Indian rupee (silver).
  - 1878−1934: common monetary union with India; Indian rupee legal tender.
  - 1934: own currency under currency board pegged to pound sterling (until November 1967).
  - November 1967: peg to pound sterling; dual FX market; capital transfers subject to stamp duty initially 15 percent.
  - June 1972: left sterling area; central exchange rate with SDRs; second exchange rate for stamp duty.
  - January 1976: peg to SDR with 2 percent band (de facto crawling band around US dollar).
  - 1979 and 1981: devaluations after overvaluation.
  - July 1981: stamp duty on capital transfer raised from 36 percent to 45 percent.
  - June 1982: delinked from SDR; pegged to trade-weighted basket (de facto pegged to US dollar) with 5 percent band.
  - Early 1990s: multiple currency practice persisted via 15 percent tax on some capital remittances.
  - 1992: exchange rate restrictions lifted.
  - July 1994: foreign currency transactions fully liberalized; crawling band narrowed to 2 percent.
  - Mid-1990s onward: managed float; Bank of Mauritius intervenes to smooth fluctuations, not to alter trend.
- Nominal and real exchange rate trends:
  - Post-Bretton Woods: nominal exchange rate continuously depreciated against the US dollar due to higher inflation in Mauritius than trading partners; monetary policy accommodated inflation differentials to achieve a stationary REER.
  - Price-based REER indices indicate considerable real depreciation since 2002, interpreted as required depreciation after negative terms of trade shocks.
- Recent drivers of exchange rate behavior (mid-2006 to end-2007):
  - Depreciation above trend in mid-2006 because of a large real interest rate differential with the US dollar.
  - Appreciation beginning end-2006 after appointment of an independent Monetary Policy Committee increased monetary policy credibility.
  - Cuts in US interest rates since August 2007 not matched by similar cuts in Mauritius led to an increasingly positive interest rate differential and continued appreciation of the rupee.
  - Nominal MUR/US$ in December 2007: actual = 29.04; CHEER equilibrium = 31.7; 95 percent confidence interval = [28.8, 32.8] (actual within interval).

### III. Empirical approaches and conceptual points
- Four quantitative approaches used:
  - FEER-MB (macroeconomic balance).
  - FEER-SE (single-equation fundamentals).
  - CHEER (capital-enhanced equilibrium exchange rate combining PPP and UIP).
  - ES (external sustainability comparing CA to NFA-stabilizing CA).
- Comparative strengths and limitations:
  - FEER-MB and FEER-SE: reduced-form, policy-interpretable coefficients.
  - FEER-MB: multilateral consistency through normalization.
  - ES: cross-check deriving sustainable CA from NFA position.
  - CHEER: accounts for interest rate differentials and capital-account factors.
  - Shared limitations: sensitivity to assumed sustainable CA norm; sensitivity to trade elasticities and specification; short country samples and data quality can reduce degrees of freedom; Least Squares property can mask misalignment (actual and predicted REER share same sample average).

### IV. FEER-MB (macroeconomic balance) — estimation strategy, coefficients, and results
- Three-step procedure:
  1. Estimate determinants of CA using panel data for 140 countries (1980–2005).
  2. Project CA norm for Mauritius for 2008−13 using coefficient estimates and IMF forecast for fundamentals.
  3. Compute required REER adjustment to align underlying CA with projected sustainable CA using trade elasticities.
- Estimated panel specification (fixed effects used for reported CA norm) included time-varying fundamentals:
  - overall fiscal balance (ratio to GDP);
  - NFA/GDP;
  - relative per capita GDP (deviation from US income);
  - per capita GDP growth;
  - population growth.
  - Cross-sectional indicators: fuel exporters, financial centers, offshore centers, Eurozone membership, East Asian crisis dummy.
- Key coefficient interpretations (fixed effects):
  - Increase in overall fiscal balance-to-GDP ratio predicts CA higher by ⅓ of a percentage point of GDP.
  - Higher NFA/GDP associated with higher CA balance (coefficient smaller than fiscal balance).
  - Higher per capita income improves CA; higher per capita growth deteriorates CA.
  - 1 percentage point increase in population growth → CA lower by ½ a percentage point of GDP.
  - Offshore financial centers have CA balances 5–6 percentage points lower than onshore centers.
- FEER-MB Mauritius fitted vs. actual:
  - FY 2004/5 fitted (equilibrium) CA balance = 0.14 percent (of GDP)
  - FY 2004/5 actual CA balance = −1.8 percent (of GDP)
  - Interpretation: slight REER overvaluation implied by fitted vs. actual.
- Medium-term CA norm estimates (2007/8−12/13):
  - Fixed effects model average CA deficit = 4.7 percent of GDP
  - Random effects model average CA deficit = 4.2 percent of GDP
  - Underlying CA (based on medium-term WEO projections) averages a deficit of 4.4 percent of GDP
  - Difference between CA norm estimates and underlying CA is no more than ½ a percentage point.
- Trade elasticities and CA elasticity:
  - Export elasticity estimated = 1.6
  - Import elasticity estimated = –1.1
  - Average trade ratios: EXP/GDP = 57; IMP/GDP = 60
  - Using formula (export elasticity) × (EXP/GDP) − (import elasticity) × (IMP/GDP) → CA elasticity w.r.t. exchange rate = 1.6
  - Alternative estimates (Barkbu, 2006): export elasticity = 3.5; import elasticity = –0.8
- Robustness checks:
  - Alternative CA norms from middle-income sub-sample and pooled OLS; CA norm estimates plotted in Figure 5 are close to underlying CA (within 1 percentage point).
  - Statistical uncertainty acknowledged; confidence intervals preferred to point estimates.
- FEER-MB conclusion: REER close to equilibrium; little or no additional REER adjustment necessary beyond medium-term real appreciation incorporated in underlying CA.

### V. FEER-SE (single-equation fundamentals) — specification and findings
- Country-specific ARDL cointegration approach (1960–2007).
- General variables considered: terms of trade (TOT), government consumption (GCONS), openness (OPEN), relative productivity, NFA, capital controls dummy (post-1994).
- Parsimonious long-run cointegrating relationship retained three variables:
  - ln(REER)t = 0.53 × ln(TOT)t − 0.97 × ln(OPEN)t − 0.92 × ln(GCONS)t
  - Reported t-statistics: [2.22]***, [-3.51]***, [-2.19]*** respectively.
- Economic interpretations:
  - Positive TOT shock → REER appreciates.
  - Greater openness → REER depreciates.
  - Higher government consumption (~15 percent of GDP) → REER depreciates (suggesting composition of public spending favors tradables).
- FEER-SE conclusion: rupee close to equilibrium since 2003; exchange rate policy generally appropriate.

### VI. CHEER (capital-enhanced) — method and findings
- CHEER combines PPP and UIP; monthly sample July 1995–December 2007.
- VAR of nominal exchange rate, inflation differential, and interest rate differential; Johansen cointegration finds strong evidence of one cointegrating vector.
- Equilibrium nominal exchange rate obtained via Hodrick-Prescott filter.
- CHEER findings:
  - Deviations from equilibrium MUR/US$ explained by interest rate differential have been relatively small since July 1995.
  - December 2007: actual MUR/US$ = 29.04; equilibrium = 31.7; 95 percent confidence interval = [28.8, 32.8]; actual lies within interval (deviation not statistically significant).
- CHEER conclusion: exchange rate close to equilibrium, confirming other methods.

### VII. External Sustainability (ES) approach — benchmarks and implications
- ES applied with two NFA/GDP benchmarks:
  - Benchmark 1: end-June 2006 observed NFA ≈ slightly above 85 percent of GDP. Assuming medium-term GDP growth = 5 percent and inflation = 5 percent, the CA norm that stabilizes NFA at that level = 7.9 percent.
  - Benchmark 2: Lane and Milesi-Ferretti (2006) net external position = 21 percent (of GDP) at end-2004. Stabilizing NFA at that level over the medium term would imply a CA surplus of 2 percent of GDP (against an underlying CA of −4.4 percent of GDP).
- ES implications:
  - Both benchmarks suggest the REER is slightly overvalued (by 4 to 7.7 percent using the elasticities discussed) if targeting a medium-term NFA stock in this range.
  - Cautions: benchmarks have limited normative content; official NFA statistics in Mauritius affected by Global Business Licenses (GBLs) and may carry a positive bias because liability side of GBL activity is not fully captured.

### VIII. Structural competitiveness and policy recommendations
- Nonprice indicators analyzed: business climate, trade costs, ICT sector.
- Relative performance:
  - Mauritius often outperforms comparator small-island and regional economies; ranks in the top third of the Global Competitiveness Index.
  - Doing Business Report 2008: Mauritius named best-performing country in sub-Saharan Africa and ranked 27th in the world; strong on starting a business and securing a license.
  - World Governance Indicators: Mauritius ranks high by international standards.
  - Trade costs (Doing Business measures for Mauritius): Documents for export = 5; Time for export (days) = 17; Cost to export (US$/container) = 728; Documents for import = 6; Time for import (days) = 16; Cost to import (US$/container) = 763.
  - ICT indicators (selected): Telephone main lines per 1,000 = 289; International voice traffic (minutes per person) = 924; Mobile subscribers per 1,000 = 574; Internet users per 1,000 = 146; Broadband subscribers per 1,000 = 2.2; International internet bandwidth (bits per person) = 502.
- Areas needing improvement:
  - Relatively inefficient government bureaucracy.
  - Limited labor flexibility.
  - Underskilled workforce.
  - Need progress in registering property and cost of closing businesses.
  - Relatively limited access to credit.
  - ICT quality improvements needed, notably broadband access and telephone faults (telephone faults per 100 main lines per year = 41.5).
- Policy recommendations:
  - Continue FX market interventions aimed solely at reducing volatility rather than affecting trend under the managed float.
  - Structural reforms to bolster competitiveness: stimulate competition in goods markets; make labor markets more flexible; raise average skill level; further reduce cost of doing business.
  - Alternative medium-term CA/NFA targets may require small exchange rate corrections, which can be minimal if accompanied by structural reforms.

### IX. Data, robustness, and appendix highlights
- Panel FEER-MB sample: 140 countries, 1980–2005; many variables expressed as three-year moving averages; outlier trimming applied.
- Summary statistics (full sample, Table 1 excerpt):
  - CA/GDP: Obs 3191; Mean -3.07; Std. Dev. 6.05; Min -19.95; Max 19.12
  - Overall balance/GDP: Obs 3221; Mean -3.31; Std. Dev. 4.58; Min -24.96; Max 13.61
  - NFA/GDP: Obs 3550; Mean 9.52; Std. Dev. 24.03; Min -83.02; Max 147.43
  - Relative income: Obs 3818; Mean 26.59; Std. Dev. 27.46; Min 1.41; Max 153.77
  - Per capita GDP growth: Obs 3861; Mean 1.52; Std. Dev. 4.67; Min -32.47; Max 47.49
  - Population growth: Obs 4644; Mean 1.61; Std. Dev. 1.53; Min -44.41; Max 11.52
- Selected panel estimates (Table 2):
  - Overall budget balance/GDP coefficient (Pooled OLS): 0.372*** (0.030)
  - Net foreign assets/GDP coefficient (Pooled OLS): 0.039*** (0.006)
  - Offshore center dummy coefficient: -5.954*** (0.680)
  - 1=Fuel exporting dummy coefficient: 2.528*** (0.315)
- Unit root and cointegration diagnostics:
  - FEER-SE ADF level p-values indicate many series are nonstationary in levels but stationary in first differences.
  - CHEER: Phillips-Perron and ADF tests indicate key series generally I(1); Johansen trace and max-eigen tests indicate 1 cointegrating equation over adjusted sample 1996M09–2007M12.
- Notes on data sources:
  - Data drawn from IFS, INS, WEO, WDI, Penn World Tables Mark 6.2; Mauritius 90-day T-bill yield from Bank of Mauritius Monthly Statistical Bulletin (1994–2007).
  - Trading partners for REER (descending importance) listed in the appendix.

*Source: _wp08212 - References............................................................................................... ..24 (IMF PDF content provided).*

### References............................................................................................... ..24

### _wp08212 - References............................................................................................... ..24

### I. Introduction — context and key summary findings
- Mauritius experienced large negative terms of trade shocks from: the phasing out of the Multi-Fiber Agreement starting at the end of 2004; the European Union reduction of its sugar price guarantees starting in 2006; and higher world commodity prices, especially for food and petroleum products.
- The current account (CA) deficit worsened to an average of 4 percent of GDP for 2004–07.
- Real GDP growth averaged 3.6 percent between 2001 and 2007 compared to 4 percent in the 1990s and 5 percent in the 1980s.
- Main research focus: assess competitiveness of Mauritius (1980–2007) via equilibrium real exchange rate (ERER) analysis and nonprice structural indicators (business climate, trade costs, and ICT sector).
- Methodological approach: mix of panel and time-series techniques using the FEER–MB, FEER–SE, CHEER, and ES approaches; supplementary nonprice competitiveness analysis.
- Key conclusion: the real exchange rate at the end of 2007 was aligned with its equilibrium value as determined by economic fundamentals; little adjustment may be necessary over the medium term. This conclusion is broadly consistent across methods.
- Policy implications highlighted: stimulate competition in goods markets, make labor markets more flexible, enhance skills, and further reduce the cost of doing business.

### II. Evolution of the exchange rate in Mauritius — institutional history and regime chronology
- Early arrangements and currency history:
  - 1848: government established a currency-board-like system.
  - Until 1870: switched between the pound sterling (gold) and the Indian rupee (silver).
  - 1878−1934: common monetary union with India with the Indian rupee as legal tender.
  - 1934: introduced its own currency under a currency board pegged to the pound sterling; this regime lasted until November 1967.
- Post-1967 regime changes:
  - November 1967: moved the rupee from a currency board to a peg to the pound sterling; dual foreign exchange market separating capital account transactions from CA transactions; capital transfers subject to a stamp duty initially set at 15 percent.
  - June 1972: left sterling area and established a central exchange rate with special drawing rights (SDRs); maintained a second exchange rate for the stamp duty for capital transfers.
  - January 1976: officially pegged the rupee to the SDR, with a 2 percent band (in practice crawling band around the US dollar).
  - 1979 and 1981: rupee was devalued following a period of overvaluation.
  - July 1981: stamp duty on transfer of capital raised from 36 percent to 45 percent.
- Liberalization and managed float:
  - June 1982: rupee delinked from the SDR and pegged to a trade-weighted basket of currencies of major trading partners (composition undisclosed); exchange rate remained de facto pegged to the US dollar, with a 5 percent band.
  - Early 1990s: multiple currency practice maintained in the form of a 15 percent tax on some capital remittances.
  - 1992: exchange rate restrictions lifted.
  - July 1994: transactions involving foreign currencies fully liberalized; de facto crawling band narrowed to 2 percent.
  - Mid-1990s onward: maintained a managed float; Bank of Mauritius intervenes solely to smooth exchange rate fluctuations rather than alter the trend.
- Nominal and real exchange rate trends:
  - Post-Bretton Woods: nominal exchange rate (NER) continuously depreciated against the US dollar because inflation was higher in Mauritius than in its trading partners; monetary policy accommodated inflation differentials by allowing NER depreciation to achieve a stationary REER.
  - Price-based REER indices (CPI, GDP deflator, manufacturing unit labor cost, export prices) move closely and indicate considerable real depreciation since 2002 — interpreted as a required depreciation following negative terms of trade shocks.

### III. Empirical analysis of the equilibrium exchange rate — methods and conceptual points
- Four quantitative approaches employed to identify ERER:
  - Macroeconomic balance approach (FEER-MB): deviation from equilibrium assessed via projected CA relative to a sustainable norm implied by fundamentals.
  - Single-equation fundamental equilibrium exchange rate approach (FEER-SE): equilibrium exchange rate assessed based on a country’s macroeconomic fundamentals.
  - Capital-enhanced equilibrium exchange rate approach (CHEER): adds the uncovered interest parity (UIP) condition and capital-account factors to analyze deviations from equilibrium.
  - External sustainability (ES) approach: compares the underlying CA balance to the net foreign asset (NFA)-stabilizing CA balance (stock equilibrium concept).
- Comparative strengths:
  - FEER-MB and FEER-SE: reduced-form equations using economic fundamentals; estimated coefficients are policy-interpretable.
  - FEER-MB: attractive for multilateral consistency through normalization.
  - ES: useful cross-check as it derives sustainable CA from a stable NFA position.
  - CHEER: accounts for persistent real exchange rates via interest rate differentials and capital-account factors.
- Shared conceptual limitations highlighted:
  - FEER-MB and ES hinge on estimation of a sustainable CA norm; results sensitive to the assumed sustainable CA value.
  - Trade elasticities used in calculating real exchange rate adjustments are sensitive to trade equation specifications.
  - Data quality and short country-specific samples can reduce degrees of freedom and produce conservative misalignment estimates.
  - Least Squares property: actual and predicted REER share the same sample average by construction, which can mask misalignment.
  - Robustness checks across methods are therefore important.

### IV. Macroeconomic Balance Approach (FEER-MB) — estimation strategy and data
- Three-step FEER-MB analysis:
  1. Estimate determinants of the CA balance using panel data for 140 countries between 1980 and 2005.
     - Appendix Table 1 contains summary statistics for all variables used.
  2. Project the CA norm for Mauritius over the medium term (2008−13) using coefficient estimates and the IMF forecast for economic fundamentals (IMF, 2008, Table 1).
  3. Compute the real exchange rate adjustment required to align the underlying CA with the projected sustainable CA (trade elasticities and other elements used in the final calculation).
- Estimated specification (as presented):
  - Equation (1):
    CAFISCNFA
    RELGDPGROWTHPOP
    GDPGDPGDP
    ititititit
    ititit
    αηβββββε
    ⎛⎞⎛⎞⎛⎞
    =+++++++
    ⎜⎟⎜⎟⎜⎟
    ⎝⎠⎝⎠⎝⎠
  - Time-varying fundamentals included:
    - overall fiscal balance (ratio to GDP);
    - NFA position (relative to GDP);
    - relative per capita GDP (deviation from US income);
    - per capita GDP growth;
    - population growth (demographic control capturing fiscal pressures).
  - Cross-sectional heterogeneity addressed via indicator variables for major fuel exporters, financial and offshore centers, Eurozone members (identifying years since membership), and countries affected by the East Asian crisis (identifying post-crisis years).
  - Country-specific fixed effects (α_i) included to account for unobserved heterogeneity; year-specific shocks captured by time dummies (η_t).
- Data scope and rationale:
  - Large cross-section (140 countries) over 1980–2005 increases precision and leverages variation across countries and development stages to identify equilibrium relationships.

### V. Structural competitiveness and policy recommendations (from analysis)
- Nonprice indicators: business climate, trade costs, and ICT sector analyzed alongside ERER methods.
- Relative performance: Mauritius fares better than comparators (high-growth Asian economies, middle-income countries, and other small island economies) on structural competitiveness indicators considered.
- Policy recommendations emphasized in the paper:
  - Stimulate competition in goods markets.
  - Make labor markets more flexible.
  - Enhance skills.
  - Further reduce the cost of doing business.

*Source: _wp08212 - References............................................................................................... ..24 (IMF PDF content provided).*

### 3.      We determine the exchange rate adjustment that would be needed to close the gap, if

### _wp08212 - 3.      We determine the exchange rate adjustment that would be needed to close the gap, if

### Panel-estimated CA norm (FEER-MB) — estimation approach and coefficient interpretation
- Coefficient estimates are obtained from three panel estimators: pooled OLS, random effects, and fixed effects (Appendix Table 2). A Hausman test yields no evidence of systematic differences between the random and fixed effects estimates.
- Estimated relationships (fixed effects specification used to derive the reported CA norm) and interpretations:
  - An increase in the overall fiscal balance-to-GDP ratio predicts a CA balance higher by ⅓ of a percentage point of GDP.
  - A higher NFA/GDP position is associated with a higher CA balance (coefficient smaller than for fiscal balance).
  - Higher per capita income improves the CA balance; higher per capita growth causes it to deteriorate.
  - A 1 percentage point increase in the population growth rate is associated with a CA balance that is lower by ½ a percentage point of GDP.
  - Exporters of fuel, countries affected by the East Asian crisis, and global financial centers have substantially higher CA surpluses for the period.
  - Offshore financial centers (e.g., Mauritius as an offshore center example) have CA balances 5–6 percentage points lower than onshore centers.
- Fixed effects model (used to illustrate FEER-MB workings) reported as Equation (2) with the country-specific intercept estimated for Mauritius. Time-invariant explanatory variables are absent from the fixed effects equation because they cannot be estimated with this method.

### FEER-MB results for Mauritius: fitted vs. actual CA balance
- Over the sample period, the REER has been close to its equilibrium value according to fitted CA balances.
- At end of the time period considered (FY 2004/5):
  - Fitted (equilibrium) CA balance = 0.14 percent (of GDP)
  - Actual CA balance = −1.8 percent (of GDP)
  - Interpretation: slight REER overvaluation implied by the comparison of fitted and actual CA balances.
- Medium-term (2007/8−12/13) CA norm estimates:
  - Fixed effects model average CA deficit = 4.7 percent of GDP
  - Random effects model average CA deficit = 4.2 percent of GDP
  - Underlying CA (based on medium-term WEO projections) averages a deficit of 4.4 percent of GDP
  - Difference between CA norm estimates and underlying CA is no more than ½ a percentage point and thus considered negligible.
- Conclusion from FEER-MB: REER is close to its equilibrium value because the CA norm is close to the underlying CA; little or no additional real exchange rate adjustment—over and above the real appreciation incorporated in the underlying CA—is necessary over the next five years.

### Trade elasticities and CA elasticity with respect to the exchange rate
- Trade elasticities estimated using single-equation error correction models for exports and imports (1977–2006):
  - Export elasticity = 1.6
  - Import elasticity = –1.1
- Average trade ratios over the same period:
  - EXP/GDP = 57
  - IMP/GDP = 60
- Using the formula (export elasticity) × (EXP/GDP) − (import elasticity) × (IMP/GDP), the CA elasticity with respect to the exchange rate is 1.6.
- Alternative estimates cited (Barkbu, 2006) based on a vector error correction model over 1980–2004:
  - Export elasticity = 3.5
  - Import elasticity = –0.8

### Robustness checks for CA norms
- Alternative CA norms computed using:
  - Fixed effects model estimated on the sub-sample of middle-income countries (Appendix Table 2, last column)
  - Pooled OLS model of Lee et al. (2008, Table 1)
  - The average of the various CA norm estimates
- All CA norm estimates plotted in Figure 5 are close to the country’s underlying CA (within 1 percentage point).
- Note: Statistical uncertainty is acknowledged; confidence intervals for CA norms and the FEER would be more reliable than point estimates.

### Single-equation FEER-SE approach — specification and results
- Country-specific reduced-form structural relationship between REER and fundamentals estimated for Mauritius (data 1960–2007) using the ARDL approach to cointegration (Pesaran and Shin, 1999; Pesaran, Shin, and Smith, 2001).
- General model variables considered: terms of trade (TOT), government consumption (GCONS), openness (OPEN), relative productivity, NFA position, capital controls dummy (post-1994).
- Long-run cointegrating relationship retained three variables: terms of trade, openness, and government consumption.
- Parsimonious specification reported (Equation (3)):
  - ln(REER)t = 0.53 × ln(TOT)t − 0.97 × ln(OPEN)t − 0.92 × ln(GCONS)t
  - Reported t-statistics for coefficients: [2.22]***, [-3.51]***, [-2.19]*** respectively.
- Economic interpretation:
  - Positive TOT shock → REER appreciates.
  - Greater openness → REER depreciates.
  - Higher government consumption (about 15 percent of GDP) → REER depreciates, suggesting government spending composition may favor tradables and exert downward pressure on the trade balance.
- FEER-SE conclusion: Mauritian rupee has been close to its equilibrium value since 2003; exchange rate policy generally appropriate.

### Capital-Enhanced Equilibrium Exchange Rate (CHEER) approach — method and findings
- CHEER approach combines PPP and UIP, allowing medium-term influence of interest rate differentials on exchange rates and capturing capital flows; ignores real determinants such as relative output and NFA.
- Monthly sample: July 1995 through December 2007.
- Model estimated: VAR of nominal exchange rate, inflation differential, and interest rate differential; variables tested for unit roots (Appendix Table 4); Johansen cointegration finds strong evidence of one cointegrating vector (Appendix Table 5).
- Equilibrium nominal exchange rate obtained via Hodrick-Prescott filter.
- CHEER findings:
  - Deviations from equilibrium MUR/US$ explained by the interest rate differential have been relatively small since July 1995.
  - In December 2007:
    - Actual MUR/US$ exchange rate = 29.04
    - Equilibrium value = 31.7
    - 95 percent confidence interval = [28.8, 32.8]
  - Since actual value lies within the 95 percent confidence interval, the estimated deviation from equilibrium is not statistically significant.
- CHEER conclusion: results confirm previous methods that the exchange rate has been close to equilibrium.

### Overall assessment and policy-relevant implications
- Across multiple approaches (FEER-MB, FEER-SE, CHEER), the Mauritian rupee and REER are generally close to their estimated equilibrium values for the periods analyzed.
- Medium-term CA norms (various estimators) are within about 1 percentage point of the underlying CA (WEO-based), implying little or no additional real exchange rate adjustment is necessary beyond the assumed medium-term real appreciation incorporated in the underlying CA.
- Empirical results point to the importance of fiscal balance, NFA position, income and growth dynamics, demographics, openness, terms of trade, government consumption composition, and capital flows in shaping the CA and REER.

*Source: Authors' estimates and analysis in the provided IMF content unit.*

### conclusion that exchange rate policy in Mauritius has been appropriate in recent years.

### conclusion that exchange rate policy in Mauritius has been appropriate in recent years.

### Exchange rate behavior and recent drivers
- The nominal exchange rate has recently been somewhat volatile around the estimated equilibrium.
- The rupee depreciated above the trend in mid-2006 because of a large real interest rate differential with the US dollar.
- The rupee started to appreciate again at the end of 2006 because monetary policy became more credible when an independent Monetary Policy Committee was appointed.
- Cuts in US interest rates since August 2007—the beginning of the rupee’s deviation from long-run equilibrium—were not followed by commensurate drastic reductions in Mauritian interest rates, so the interest rate differential was increasingly positive.
- The increasingly positive interest rate differential explains the continued appreciation of the rupee against the US dollar and its slight deviation from trend toward the end of 2007.

### Major quantitative approaches applied
- Four quantitative approaches were used to analyze the equilibrium exchange rate:
  - The macroeconomic balance (FEER-MB) approach.
  - The single-equation fundamentals (FEER-SE) approach.
  - The capital-enhanced equilibrium exchange rate (CHEER) approach.
  - The external sustainability (ES) approach.
- All four approaches indicate the Mauritian rupee appears to be close to its equilibrium value.

### Key findings by approach
- FEER-MB:
  - Used parameters from a model estimated on panel data for 140 countries and the IMF forecast of economic fundamentals.
  - Found that the CA norm is close to the underlying CA stripped of temporary factors, suggesting little or no exchange rate adjustment may be necessary.
  - Results were robust to different estimators and samples of countries.
- FEER-SE:
  - Used time series methods with variation in openness to trade, terms of trade shocks, and government consumption.
  - Concluded that the REER and the equilibrium level have been aligned since 2003.
- CHEER:
  - Incorporated the uncovered interest parity condition and investigated monthly exchange rate variations and the interest rate differential with the US.
  - Despite some volatility, the nominal exchange rate appeared close to equilibrium at the end of 2007.
- ES:
  - Applied using the first approach (a backward-looking target) with two NFA/GDP benchmarks:
    - Benchmark 1: end-June 2006 observed NFA position of slightly above 85 percent of GDP. Assuming a medium-term GDP growth rate of 5 percent and an inflation rate of 5 percent, the CA norm that stabilizes the NFA position at that level is 7.9 percent.
    - Benchmark 2: net external position estimate from Lane and Milesi-Ferretti (2006) of 21 percent (of GDP) at end-2004. Stabilizing the NFA stock at that level over the medium term would imply a CA surplus of 2 percent of GDP (against an underlying CA of −4.4 percent of GDP).
  - Both benchmarks suggest the real exchange rate is slightly overvalued (by 4 to 7.7 percent using the elasticities discussed in footnote 14) if Mauritius were to target a medium-term NFA stock in this range.
  - Cautions relevant to ES results:
    - Neither benchmark carries strong normative content.
    - Official net external position statistics in Mauritius are affected by Global Business Licenses (GBLs); current statistics fail to capture the liability side of GBL activity and reflect only foreign assets of commercial banks sourced from the GBLs, creating a positive bias in the NFA estimate. A correction would imply lower (or negative) NFA/GDP ratios could be considered benchmarks, producing lower CA norms.

### Structural competitiveness and nonprice indicators
- Comparative indicator analysis finds Mauritius is one of the best performers in sub-Saharan Africa and often outranks comparator economies.
- Four indicators examined: Global Competitiveness Index (World Economic Forum); World Governance Indicators (World Bank); Doing Business Report indicators (World Bank); Corruption Perception Index (Transparency International).
- Specific results and observations:
  - Mauritius ranks in the top third most competitive countries in the world according to the Global Competitiveness Index.
  - Mauritius outperforms comparator small-island economies but trails high-growth Asian economies.
  - On World Governance Indicators, Mauritius ranks high by international standards, outperforming high-growth economies as well as small island states.
  - The Doing Business Report 2008 named Mauritius the best-performing country in sub-Saharan Africa and ranked it 27th in the world; performs particularly well on starting a business and securing a license.
  - Trade and ICT sector performance is strong relative to regional averages; in documents required, cost in US$ per container, and time to export/import, Mauritius is outperformed only by OECD countries.
- Areas needing improvement highlighted by indicators:
  - Relatively inefficient government bureaucracy.
  - Limited labor flexibility.
  - Underskilled workforce.
  - Need for progress in registering property and the cost of closing businesses.
  - Relatively limited access to credit.
  - ICT quality improvements needed, notably broadband access and minimizing telephone faults.
- Note on interpretation: structural indicators can conceal problems because economic agents adapt (example: power outages bypassed by firms buying expensive generators), so surveys may understate certain constraints.

### Policy recommendations and implications
- Given the managed float exchange rate regime, main policy recommendation:
  - Continue foreign exchange market interventions aimed solely at reducing volatility rather than affecting the trend.
  - Such interventions are likely to keep the real exchange rate close to its equilibrium level as determined by fundamental macro-variables.
- Additional policy implications:
  - Alternative medium-term target levels of the CA balance and the NFA position may require small exchange rate corrections; these can be minimal if accompanied by measures to address structural bottlenecks and bolster competitiveness.
  - Structural reforms recommended to bolster competitiveness include:
    - Stimulating competition in goods markets.
    - Making labor markets more flexible.
    - Raising the average skill level of the workforce.
    - Further reducing the cost of doing business.
  - These measures are important as Mauritius pursues becoming a business and financial services hub.

*Source: conclusion that exchange rate policy in Mauritius has been appropriate in recent years.*

### REFERENCES

### _wp08212 - REFERENCES

### References (selected themes)
- Bibliographic scope includes studies on equilibrium real exchange rates, external sustainability, current-account sustainability, FEER and FEER-MB methodologies, cointegration and unit root methods, and country-specific analyses for Mauritius and Sub-Saharan Africa. Key cited works include:
  - Barkbu, B., 2006; Calderon, C. A., N. Loayza, and L. Serven, 1999; Chudik, A., and J. Mongardini, 2007; Cottani, J. A., D. F. Cavallo, and M. S. Khan, 1990; Djankov, S., C. Freund, and C. S. Pham, 2006; Dornbusch, R., 1983; Driver, R., and P. Westaway, 2005; Driver, R., and Wren-Lewis, S., 1999; Easterly, W., 2001; Edwards, S., 1989; Faruqee, H., P. Isard, and P. R. Masson, 1999.
- Empirical and methodological references include Johansen and Juselius (1990), Pesaran and Shin (1999), Pesaran, Shin, and Smith (2001), MacDonald (2000, 2007), Lee et al. (2008), Isard and Faruqee (1998), Milesi-Ferretti and Razin (1996), and Reinhard and Rogoff (2004).
- Country- and region-specific analyses cited: Mauritius: Selected Issues and IMF Article IV (IMF Country Report No. 08/234, 2008); Mauritius: Investment Climate Assessment (World Bank, 2006); Bank of Mauritius Occasional Paper Series No. 1 (2006).
- Indicators and datasets referenced: World Bank Doing Business Indicators; Global Competitiveness Index; World Governance Indicators; Corruption Perception Index.

### Data sources and definitions
- Econometric analysis data extracted from: International Financial Statistics (IFS); Information Notice System (INS); World Economic Outlook (WEO); World Development Indicators (WDI); Penn World Tables Mark 6.2.
- Mauritius 90-day average T-bill yield source: Bank of Mauritius Monthly Statistical Bulletin (1994 to 2007).
- Trading partners used for REER (in descending order of importance): France, Germany, the US, the UK, Japan, South Africa, Italy, Belgium, Singapore, the Netherlands, Taiwan Province of China, Hong Kong SAR, Spain, Switzerland, India, Korea, Canada, China, Thailand. Trade weights obtained from the INS.
- Comparator country groupings (from WDI):
  - Small island economies: Comoros, Madagascar, Maldives, Seychelles
  - High-growth Asian economies: Hong Kong, SAR; Singapore; South Korea; Taiwan Province of China; Malaysia; Thailand; Indonesia
- Structural competitiveness indicators and sources:
  - Global Competitiveness Index and Business Competitiveness Index 2007/08, World Economic Forum (http://www.weforum.org)
  - World Governance Indicators 2007, World Bank (http://info.worldbank.org/governance/wgi2007/)
  - World Bank Doing Business Indicators 2008 (http://www.doingbusiness.org/)
  - Corruption Perception Index 2007, Transparency International (http://www.transparency.org/)

### Appendix — Key data summaries and econometric results

- Table 1. Summary Statistics for FEER-MB Approach (Full sample)
  - CA/GDP: Obs 3191; Mean -3.07; Std. Dev. 6.05; Min -19.95; Max 19.12
  - Overall balance/GDP: Obs 3221; Mean -3.31; Std. Dev. 4.58; Min -24.96; Max 13.61
  - NFA/GDP: Obs 3550; Mean 9.52; Std. Dev. 24.03; Min -83.02; Max 147.43
  - Relative income: Obs 3818; Mean 26.59; Std. Dev. 27.46; Min 1.41; Max 153.77
  - Per capita GDP growth: Obs 3861; Mean 1.52; Std. Dev. 4.67; Min -32.47; Max 47.49
  - Population growth: Obs 4644; Mean 1.61; Std. Dev. 1.53; Min -44.41; Max 11.52
  - 1=Fuel exporting: Obs 4698; Mean 0.13; Std. Dev. 0.33; Min 0.00; Max 1.00
  - 1=Financial center: Obs 4698; Mean 0.03; Std. Dev. 0.18; Min 0.00; Max 1.00
  - 1=Offshore fin. center: Obs 4698; Mean 0.05; Std. Dev. 0.22; Min 0.00; Max 1.00
  - 1=Asian Crisis: Obs 4698; Mean 0.01; Std. Dev. 0.11; Min 0.00; Max 1.00
  - 1=Euro zone: Obs 4698; Mean 0.02; Std. Dev. 0.14; Min 0.00; Max 1.00

- Table 1. Summary Statistics (Middle income countries)
  - CA/GDP: Obs 1522; Mean -3.36; Std. Dev. 6.24; Min -19.92; Max 18.42
  - Overall balance/GDP: Obs 1576; Mean -3.43; Std. Dev. 4.79; Min -24.40; Max 13.24
  - NFA/GDP: Obs 1993; Mean -0.45; Std. Dev. 4.89; Min -7.57; Max 14.03
  - Relative income: Obs 1706; Mean 11.52; Std. Dev. 23.61; Min -66.19; Max 147.43
  - Per capita GDP growth: Obs 1863; Mean 1.69; Std. Dev. 5.18; Min -30.80; Max 47.49
  - Population growth: Obs 1844; Mean 1.83; Std. Dev. 9.57; Min 1.98; Max 49.82
  - 1=Fuel exporting: Obs 2295; Mean 0.19; Std. Dev. 0.39; Min 0.00; Max 1.00
  - 1=Offshore fin. center: Obs 2295; Mean 0.08; Std. Dev. 0.27; Min 0.00; Max 1.00
  - 1=Asian crisis: Obs 2295; Mean 0.02; Std. Dev. 0.12; Min 0.00; Max 1.00

- Notes on sample definitions and data processing:
  - Financial centers: Belgium, Luxembourg, the Netherlands, Singapore, Switzerland, Hong Kong.
  - Offshore financial centers: St. Vincent & Grenadines; Dominica; St. Lucia; Grenada; St. Kitts & Nevis; Antigua and Barbuda; Barbados; the Bahamas; Mauritius.
  - East Asian crisis dummy = 1 starting in 1998 for Thailand, Indonesia, Korea, Malaysia, Laos, the Philippines, Hong Kong.
  - Euro zone dummy = 1 for countries adopting the Euro (1999 except Greece in 2001).
  - Fuel-exporting economies listed explicitly (Algeria, Angola, Bolivia, Cameroon, Ecuador, Egypt, Gabon, Indonesia, Iran, Iraq, Libya, Mexico, Oman, Syria, Trinidad & Tobago, Venezuela, RB).
  - Outlier trimming: CA and overall government balance/GDP trimmed asymmetrically around the 95th percentile; NFA/GDP trimmed symmetrically at the 99th percentile.
  - All variables expressed as three-year moving averages.

- Table 2. Correlates of the Current Account Balance — Panel Estimates (1980–2005)
  - Full sample: 140 countries; Sub-sample: 69 middle-income countries.
  - Econometric specifications and selected coefficient estimates (standard errors in parentheses). Significance: * 10%; ** 5%; *** 1%.
  - Pooled OLS / Random Effects / Fixed Effects (full sample) / Fixed Effects (middle-income):
    - Overall budget balance/GDP: 0.372*** (0.030); 0.388*** (0.035); 0.377*** (0.037); 0.335*** (0.051)
    - Net foreign assets/GDP: 0.039*** (0.006); 0.027*** (0.008); 0.024*** (0.008); 0.006 (0.011)
    - Relative income: 0.048*** (0.004); 0.035*** (0.010); -0.054* (0.030); -0.124** (0.057)
    - Per capita GDP growth: -0.073** (0.035); -0.101*** (0.034); -0.093*** (0.035); -0.019 (0.042)
    - Population growth: -0.028 (0.099); -0.350** (0.144); -0.403** (0.180); -0.601** (0.265)
    - 1=Fuel exporting: 2.528*** (0.315); 3.337*** (0.982) (reported in some columns)
    - 1=Financial center: 4.248*** (0.660); 4.316** (1.943)
    - 1=Offshore center: -5.954*** (0.680); -6.240*** (1.707)
    - 1=East Asian crisis: 5.611*** (0.811); 5.651*** (0.781); 6.231*** (0.773); 8.320*** (0.898)
    - 1=Euro zone: -0.858 (0.550); -1.825*** (0.537); -1.764*** (0.522)
    - Constant (where reported): -5.465*** (0.652); -4.704*** (0.742); -0.929 (1.181); -0.418 (1.537)
  - Observations: 2474 (full sample columns); 1173 (middle-income column).
  - No. of countries: 140 (full sample); 69 (middle-income).
  - Note: Dependent variable = current account to GDP ratio. Old-age dependency ratio and M2/GDP excluded due to insignificance. Middle-income defined by World Bank Atlas: per capita GNI in 2007 between $936 and $11,455.

- Table 3. Unit Root Tests for the FEER-SE Approach (variables in logs; constant and trend included)
  - Series: REER; Terms of trade; Openness; Gov-Cons.
  - Augmented Dickey-Fuller p-values:
    - Level p-value: 41.5% (REER); 38.0% (Terms of trade); 27.1% (Openness); 94.0% (Gov-Cons.)
    - 1st difference p-value: 0.3% (REER); 0.0% (Terms of trade); 0.0% (Openness); 0.0% (Gov-Cons.)
    - 2nd difference p-value: 0.0% for all four series
  - Note: Null hypothesis = unit root.

- Table 4. Unit Root Tests for the CHEER Approach (number of observations and conclusions)
  - Series: NER; MUS CPI; CPIUS; CPIΔMUS; CPIΔUS; MUS T-bill; US T-bill. Number of obs: 150,150,150,150,150,149,150 respectively.
  - Philips-Perron level statistics and MacKinnon p-values (selected):
    - Level test statistics: -1.31 (NER); -1.24 (MUS CPI); -2.46 (CPIUS); -11.32 (CPIΔMUS); -7.96 (CPIΔUS); -1.86 (MUS T-bill); -1.24 (US T-bill)
    - MacKinnon approximate p-values at level: 0.89; 0.90; 0.35; 0.000; 0.000; 0.67; 0.90
    - 1st difference Philips-Perron statistics: -7.85; -11.32; -7.96; -27.74; -15.34; -7.26; -7.81 — all MacKinnon p-values 0.000
    - Conclusion (Phillips-Perron): I(1) for NER, MUS CPI, CPIUS, MUS T-bill, US T-bill; I(0) for CPIΔMUS and CPIΔUS
  - Augmented Dickey-Fuller conclusions:
    - ADF results indicate I(1) or I(2) conclusions for some series; final ADF conclusions listed as I(1), I(2), I(1), I(1), I(1), I(1), I(2) respectively.
  - Note: All variables except interest rates are in logs. For the VAR, optimal lag length is 12. VAR includes dummy variables for large outliers and seasonal dummies.

- Table 5. Johansen Cointegration Test for the CHEER Approach (sample adjusted: 1996M09–2007M12; Included observations: 136)
  - Trend assumption: Linear deterministic trend (intercept, no trend in CE). Series: ln(NER), ln(MUS CPI), ln(US CPI), MUS T-bill, US T-bill. Lags interval: 1 to 12.
  - Unrestricted Cointegration Rank Test (Trace):
    - None: Eigenvalue 0.27; Statistic 97.56; Crit. Val. 77.82; Prob. 0.00
    - At most 1: Eigenvalue 0.18; Statistic 53.88; Crit. Val. 54.68; Prob. 0.01
    - At most 2: Eigenvalue 0.13; Statistic 26.40; Crit. Val. 35.46; Prob. 0.12
    - Trace test indicates 1 cointegrating eqn(s) at the 0.01 level.
  - Unrestricted Cointegration Rank Test (Maximum Eigenvalue):
    - None: Eigenvalue 0.27; Statistic 43.68; Crit. Val. 39.37; Prob. 0.00
    - At most 1: Eigenvalue 0.18; Statistic 27.48; Crit. Val. 32.72; Prob. 0.05
    - Max-eigenvalue test indicates 1 cointegrating eqn(s) at the 0.01 level.
  - Selected normalized cointegrating coefficients (No Trend / No Trend / Linear Trend reported):
    - Normalized on NER = 1: MUS CPI -5.17; US CPI -0.14; MUS T-bill 0.19; (SEs: (1.42), (3.19), (0.02), (0.03)); test-stats 0.9, 1.6, 7.0, 6.0.
  - Log likelihood: 1718.941

- Table 6. Relative Performance of Mauritius on Trade Costs (Doing Business measures — selected indicators)
  - Documents for export (#): 5 (Mauritius); comparative regional values shown for other groups.
  - Time for export (days): 17 (Mauritius)
  - Cost to export (US$/container): 728 (Mauritius)
  - Documents for import (#): 6 (Mauritius)
  - Time for import (days): 16 (Mauritius)
  - Cost to import (US$/container): 763 (Mauritius)
  - Note: Cost to export/import measures fees for a 20-foot container in US$ (includes documents, customs clearance administrative fees, technical control, terminal handling charges, inland transport; excludes tariffs/trade taxes).

- Table 7. Relative Performance of the Mauritius ICT Sector (selected indicators and comparative group columns)
  - ACCESS (per 1,000 people unless noted):
    - Telephone main lines: 289 (Mauritius)
    - International voice traffic (minutes per person): 924 (Mauritius)
    - Mobile subscribers: 574 (Mauritius)
    - Internet users: 146 (Mauritius)
    - Personal computers: 162 (Mauritius)
    - Households w/ television (%): 93 (Mauritius)
  - QUALITY:
    - Telephone faults (per 100 main lines per year): 41.5 (Mauritius)
    - Broadband subscribers: 2.2 (Mauritius)
    - International internet bandwidth (bits per person): 502 (Mauritius)
  - AFFORDABILITY (price baskets, selected):
    - Fixed line (US$ per month, residential): 7.9 (Mauritius)
    - Mobile (price of basket): 4.2 (Mauritius)
    - Internet: 17.5 (Mauritius)
    - Price of call to the US (US$ per 3 minutes): 1.59 (Mauritius)
  - INSTITUTIONAL EFFICIENCY AND SUSTAINABILITY:
    - Total TC revenue (% of GDP): 3.2 (Mauritius)
    - Total telephone subscribers per employee: 451 (Mauritius)
    - ICT expenditure (% of GDP): (not reported for Mauritius in table excerpt)
  - Source for ICT indicators: World Bank ICT at a Glance Tables.

*Source: _wp08212 - REFERENCES (IMF authors’ calculations and cited datasets).*

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