Analyse: Much ado about trade deficit

The Mauritius trade deficit attracts considerable attention from the media as it is viewed with alarm by policymakers. The underlying negative connotations of the term “deficit” itself prompt them to make reassuring statements on the issue. In the National Assembly, the Finance Minister has announced a series of measures that would supposedly reduce the current account deficit. In his address at the Bank of Mauritius annual dinner, the Governor welcomed the fact that the loss of wealth resulting from the collapse of “a distressed insurance group involved in shadow banking” had had “a dampening effect on consumption of non-essential items this year,” and this “should reflect in a narrowing of the current account deficit of our balance of payments.” Actually, a declining trade deficit is not a herald of economic recovery. A country records a trade deficit when the market value of its total export of goods and services is lower than that of its total imports. These transactions are shown on one side of the balance of payments, the current account. The other side comprises capital flows, posted in the capital account. The latter is in surplus if foreigners invest or buy stocks and bonds in Mauritius (capital imports) more than Mauritians do abroad (capital exports). Under a floating exchange rate regime, such as the one adopted by Mauritius, a deficit in the current account directly correlates to a surplus in the capital account: the balance of payments is, well, always balanced, i.e. the amount of products bought and sold equals the amount of money spent and received from abroad. This is not an economic theory but an accounting truism. Our policymakers are modern-day mercantilists who focus on the trade deficit because they falsely believe that money is the source of prosperity. A trade deficit suggests that more money is flowing out of the country than in, and this apparently shows a deteriorating economy. This would be a worry if the world was still governed by the gold standard, under which the local stock of gold would plummet alongside a trade deficit, causing a fall in the domestic money supply and thereby restraining output and employment. Such concerns are no longer justified in the present paper money system. The money leaving a country because of trade deficits must somehow find its way back. Trade deficit and net inflow of capital are flip sides of the same coin: It is by running a current account deficit that Mauritius enjoys a capital account surplus! It is impossible to have a situation where foreigners buy more our local goods and services than Mauritians spend on foreign products, and at the same time invest more in our local assets than Mauritians invest in foreign assets. So the level of our current account deficit for the year 2015 does not really matter. The Bank of Mauritius projects it to be 5.5 per cent of GDP, similar to 2014, whereas the Ministry of Finance forecasts it at 4.8 per cent. Economists generally consider 5.0 per cent a warning sign for an economy. But remember that despite a deficit of 13.8 per cent of GDP in 2011, our economy has showed remarkable resilience, witnessing an appreciating external value of the rupee and a buoyant domestic foreign exchange market… The Mauritian situation underpins the work of Eugen von Böhm-Bawerk, who wrote that the capital account would reign over the trade balance. It is said that a growing trade deficit should lead to a depreciation of the local currency. The rise of our current account deficit has instead been accompanied by an appreciation of the real effective exchange rate of the rupee. The country’s gross official reserves have increased steadily, representing an equivalent of 7.3 months of imports of goods and services at the end of September 2015. This demonstrates that there is no clear-cut causality between the exchange rate and the trade deficit, both variables being driven by other determinants. A trade deficit per se is not a sign of a bad economy, especially for a developing country. Our current account deficit is rather a reflection of the strength of the Mauritian economy as an investment centre. As long as Mauritius is perceived by foreign investors as providing a business environment conducive to favourable capital return rates, the country is likely to remain in a position to accumulate capital account surpluses. With the increasing internationalisation of investment and savings, so much the better.