ANNUAL REPORT Year ended 30 June 2016 CONTENTS Page Letter of Transmittal 3 Statement from the Governor 5 1 About Bank of Mauritius 13 2 Review of the Economy 23 Statement on Price Stability 3 Regulation and Supervision 59 Statement on Financial Stability 4 Financial Markets Operations 89 5 Payment and Settlement Systems and 99 Currency Management 6 Regional Cooperation and International 109 Affiliation 7 Financial Statements 117 Appendices 165 List of Charts 186 List of Tables 188 List of Boxes 189 List of Acronyms 190 BANK OF MAURITIUS - ANNUAL REPORT: 2015-16 1 2 BANK OF MAURITIUS - ANNUAL REPORT: 2015-16 Letter of Transmittal The Governor Bank of Mauritius Port Louis 28 October 2016 The Honourable Pravind Kumar Jugnauth Minister of Finance and Economic Development Government House Port Louis Dear Minister of Finance and Economic Development Annual Report and Audited Accounts 2015-16 In accordance with the provision of Section 32(3) of the Bank of Mauritius Act 2004, I transmit herewith the forty-ninth Annual Report of the Bank, which also contains the audited Accounts of the Bank for the year ended 30 June 2016. Yours sincerely Rameswurlall Basant Roi, GCSK BANK OF MAURITIUS - ANNUAL REPORT: 2015-16 3 4 BANK OF MAURITIUS - ANNUAL REPORT: 2015-16 STATEMENT FROM THE GOVERNOR lobal growth remained subdued in 2015-16, with uncertainties hampering a sustained turnaround. Leading international institutions have revised downward their global Ggrowth projections as economic prospects continue to weaken in major advanced economies while emerging market economies and developing countries are experiencing manifold challenges, notably anaemic recovery in their partner countries, volatile global financial conditions, persistently low commodity prices, and dim prospects for world trade and capital flows. In June 2016, Britain’s decision to leave the European Union (EU) sent shockwaves across the world and added a further layer of uncertainty to an already vulnerable global financial market. The ‘Brexit’ phenomenon led to rising financial market volatility in the days immediately following the event, although volatility somewhat eased in subsequent days. Monetary policy continues to be divergent across various parts of the world. After increasing interest rate in December 2015, the US Federal Reserve looks poised to delay a further hike in its federal funds rate until late 2016. While the Bank of England left its key policy rate unchanged at 0.5 per cent at the July 2016 meeting, the European Central Bank continued its program of injecting liquidity into the euro area – already plagued with negative interest rates – by activating a corporate bond purchase program as from June 2016. Concerns over inflationary outlook have led the central banks of Brazil and of South Africa to hike interest rates. In contrast, emerging nations such as India and China have cut interest rates in order to boost economic activity. In a similar vein, some of our other trading partners, Australia and New Zealand in particular, have pursued expansionist monetary policies, on account of their bleak growth outlook and lesser concerns about inflation. The divergent approaches to monetary policy worldwide coupled with unanticipated events have contributed to exchange rate volatilities among major international currencies, thus impacting on international flows of capital. The Mauritian economy performed moderately well in 2015-16. It started 2016 on a strong footing as real economic growth hovered at 3.7 per cent in 2016Q1 – the fastest expansion in seven successive quarters. Buttressing this performance was continued support from household consumption and an increase in government expenditure. Consumption, which accounts for the lion’s share of GDP among aggregate demand components, made positive contributions to GDP growth in 2015. Investment performance, however, remained lacklustre, weighed down by the decline in private investment amid high corporate indebtedness and deleveraging process initiated by some corporate entities. On the external front, in real terms, exports of goods and services contracted by 0.9 per cent in 2015 compared to an expansion of 10.9 per cent in 2014, while imports of goods and services grew by 6.2 per cent. This contraction of the export sector in 2015, notwithstanding a more favourable exchange rate of the rupee, raises concerns about prospects for the sector the more so given tepid outlook for our main exports markets, barring the exceptional performance of the tourism sector. As I mentioned in the last edition of the Annual Report, the current account has persistently been in deficit since 2003-04, mainly due to the widening balance of trade deficit. Key behind the growing merchandise deficit over the years has been bleak growth outlook among the main trading partners, growing competition from low-cost competitors, and eroding competitiveness as a result of wage increases in excess of productivity gains. The current account situation has improved slightly as of late. For the fiscal year 2015-16, the current account deficit is projected BANK OF MAURITIUS - ANNUAL REPORT: 2015-16 5 Statement From The Governor to decline to Rs15.9 billion (3.8 per cent of GDP) compared to Rs23.1 billion (5.8 per cent of GDP) in 2014-15, mainly on account of lower merchandise trade deficit (Rs64.4 billion in 2014- 15, as opposed to Rs70 billion in 2015-16). Net inflows into the capital and financial account, including reserve assets, are estimated at Rs18.0 billion in 2015-16, an increase of over Rs2.2 billion compared to 2014-15. Exclusive of transactions by Global Business Companies, direct investment flows in Mauritius net of repatriation are projected at Rs7.7 billion while direct investment flows abroad net of repatriation are forecast at Rs2.0 billion. The country recorded a balance of payments surplus of Rs26.8 billion in 2015-16 compared to a surplus of Rs15.1 billion in 2014-15. The level of international reserves, in terms of US dollar, rose from US$3,980 million as at end- June 2015 to US$4,745 million on 30 June 2016, representing an import cover of 8.5 months as at end-June 2016. As regards foreign exchange reserves, the Bank continued its active and judicious foreign exchange reserves management initiated since early 2015. This strategy has permitted a gradual shift from fixed-income assets to a more diversified, multi-asset portfolio as well as satisfactory returns on the country’s reserves in an environment of low interest rates globally. With a view to enhancing governance and conducting proper risk appraisals while pursuing active reserves management, the risk management framework was strengthened this year with the creation of a separate Risk and Product Control Division. Domestic inflation has remained low, reflecting subdued global economic activity that supressed commodity prices and an absence of upward domestic price pressures. Between July 2015 and June 2016, inflation was contained in the range of 0.9 per cent to 1.5 per cent. Inflation stood at 0.9 per cent in June 2016 and stayed at that rate even in August 2016. Overall, food and non- alcoholic beverages remained important drivers of the overall Consumer Price Index. Reflecting benign external commodity price outlook, imported inflation dropped to 0.8 per cent in June 2016. Inflation is forecast at around 1.5 per cent for the calendar year 2016. The rupee has remained relatively stable and is broadly in line with macroeconomic fundamentals. The Bank has been conducting sterilised interventions in the foreign exchange market in order to prevent undue volatility in the exchange rate. In the current conjuncture, the domestic economy is subject to the vicissitudes of a number of key risk drivers, namely (a) the fallouts of Brexit, (b) prospects in the global business sector stemming from the revisions to the Double Taxation Avoidance Agreement (DTAA) with India, and (c) structural supply-side bottlenecks. These factors represent sources of downside risks to economic growth. There is still ambiguity regarding how Brexit will affect growth trajectory in the UK and in Europe. Moreover, the imbroglio persists about the shape of future trade agreements between the UK and Europe, and between the UK and the rest of the world. In the very short term, the sharp depreciation of the Pound sterling will impact on exports of Mauritian goods to UK (which represent around 12.5 per cent of our exports) and on earnings from British tourists (UK tourist arrivals represent around 11 per cent of total tourist arrivals). It is noteworthy that out of total exports, excluding re-exports, a proportion of 6.5 per cent is invoiced in Pound sterling while 58.7 per cent is denominated in US dollar. If the Brexit phenomenon results in 6 BANK OF MAURITIUS - ANNUAL REPORT: 2015-16 Statement From The Governor negative spill-over effects on Europe at large in the medium term, the odds will be high that our economy will catch the cold, given its relatively high degree of euro-centricity. On 10 May 2016, Mauritius signed a protocol with India to amend the Double Tax Avoidance Agreement (DTAA) between the two countries. The initial fears in the financial industry that this would be a severe blow to the jurisdiction has subsided to some extent. Looking ahead, however, the mass of businesses generated on the basis of the DTAA could suffer in the absence of further compelling actions to innovate the business models that the sector has embraced for years. It is reassuring to note that since the announcement of the General Anti-Avoidance Rule (GAAR) by India in 2012 and protracted debates heralding the amendments to the DTAA, domestic banks had started diversifying their deposit base and asset exposures and to tap new opportunities. The Bank had established prudential norms on liquidity risk several years ago which all banks, including those exposed to GBCs doing businesses with India, have been observing.