Open letter to Dr V. Ramadoss, publisher of The Rising Sun newspaper and outgoing Chairman of SCCI
On the matter of your fulsome praise of and credit to President Michel for our country’s US$ 195 million of official foreign currency reserves.
On the front page of your newspaper, The Rising Sun, (19 March, 2010) you bestowed fulsome praise on President Michel “for the achievement of having so far amassed $195 million of Central Bank reserves”. I do not wish to deprive the President (or anybody else for that matter) of any credit because I believe every devil deserves its due or rather, we should give credit where credit is due.
Whilst I cannot question your knowledge of medicine, which I believe was your noble profession before you became a successful entrepreneur among us, I must, nevertheless, question your understanding of macro-economics and central banking, two closely associated subjects in the social sciences field. I have yet to hear if our burgeoning university has any plan to set up a faculty on these two subjects which, judging from your understanding of them, urgently needs teaching.
It, perhaps, may have escaped you that President Michel has effectively been the second of only three finance ministers our country has ever had. He has been directly and fully in charge of that ministerial portfolio from 1991 until 2006, and indirectly till now. For a period of time, he was effectively running the Central Bank too, since on two occasions the Governors of the Central Bank were also the Principal Secretaries of Finance – his ministry’s chief civil servant.
The foreign exchange reserves that you mention, on the other hand, are a very recent phenomenon, barely a year old. This begs the question, therefore, when did President Michel get the brain wave or rather perhaps, the St Paul moment, when he saw the light?
Whilst your praise was fulsome and short, you failed to give us (your readers) any inkling as to how Mr Michel managed to achieve this feat in so short a time during last year, something that eluded him for the last 18 years? The fact is you have no clue.
In fact the answer is very simple. It is all explained by the Central Bank on its website right on the Homepage (www.cbs.sc). Here’s what the Central Bank writes:
Reserve money consists of currency in circulation and commercial banks’ deposits held at the Central Bank.
On the same website the Central Bank gives the actual figures (in rupees) of these two items up to the end of February 2010. It reveals that currency notes and coins in circulation totalled R543.83 million, whilst commercial banks’ deposits held at the Central Bank totalled R1,360.47 million giving a grand total of R1904.30 million. The actual foreign currency reserves (net foreign assets) was valued at R2,288.49 million which includes funds already in reserve prior to the reform.
You may wonder why commercial banks keep so much money with the Central Bank?
First, the Central Bank forces them to give up 12% (raised from 5% to 13% in June 2008) of all the deposits of their clients (Minimum Reserve Ratio –MMR). And that money must be transferred to the central Bank in foreign currencies, not rupees.
Second, commercial banks keep other funds with the Central Bank (excess reserves) in order to facilitate the clearing of cheques from other banks, etc., as well as funds they cannot on-lend.
And, finally, the notes and coins in circulation. You may wonder how R543.83 million of currency notes and coins turned into foreign exchange. The answer is simple. Each time commercial banks need currency notes and coins to give to their customers, they must surrender the face value equivalent amount of bank deposits to the Central Bank. In effect we, the public, make an interest free loan to the Central Bank when we use cash. As a matter fact, the foreign exchange reserves are based on a huge interest free loan from all of us to the Central Bank . The profit the Central Bank made on this money in 2009 allowed it to transfer R66.98 million to the Consolidated Fund after deducting its expenses.
So why didn’t Mr Michel adopt this simple trick from the very beginning, eighteen years ago, instead of releasing the police on us, who chased and harassed us everywhere for black market foreign currencies and treating all of us as criminals, especially the small traders that, I am told, you are now courting in order to garner enough votes to keep you as chairman of the SCCI for another year? Don’t you think Mr Michel could have saved us a lot of bother and our country from the consequential economic decline, if he knew what he was doing then? I leave it to you to find out the answer from him, as a good friend and confidant.
On a final note, our President has been chastising the commercial banks about the “high” interest rates charged on bank loans, and wondered when they would reduce it to a politically convenient and correct level. The answer to that can be found on the Central Bank website too.
All the money the Central Bank has taken from the commercial banks in order to build up our external reserves earns no interest for the commercial banks (well it pays 0.25% on MMR). So the banks must earn sufficiently (10% to 14% on loans) on what is left with them in order to pay us a meagre interest of 3% to 4% on our deposits, as well as make a profit for their shareholders, among them our own government which owns 2 commercial banks out of the six in business. Somehow I wonder, if it was as simple as the President makes it out to be in his public statements, why won’t he order Nouvobanq and Savings Bank to lower their lending rates to 5%? After all, Nouvobanq paid R38 million to its shareholder (government) in dividends in 2009, most of it earned from lending to the Government at lower interest rates than it was charging its private sector customers.
On SBC last night, after visiting the Central Bank, Mr Michel said that nowadays the institution cannot force the commercial banks to lower the interest on their loans . That is not exactly correct. The Central Bank has the same power to compel the commercial banks to do anything that it had when Mr Michel was running it. Then he set a maximum interest on loans (ceiling) and a minimum interest rate (floor) banks could pay on savings deposits. We all know how this ended up. So now we know, as the loyal knight said to his King, “you are all powerful, Sire, and you can do anything with a sword, except sit on it”. The lesson is that in a free market if we make our economics fit our politics it leads to economic disaster, and that sound economic management is a matter of tradeoffs and that there is no such thing as a free lunch.
You see, there’s a simple answer to everything, if only you would remove your blinkers and be honest with your readers.
I realise you would not print this letter in your publication because you have refused to do so before (censorship), hence the reason why this one is an open letter circulated via the internet.
Paul Chow
PS. I just thought I would remind you of the letter to the editor your newspaper refused to entertain, which I am sure would interest your readers.
10 February 2010
Sir,
In your front page article “Loans reduced at HFC” in your issue of 09 February, you wrote, “Mr. (Charles) Bastienne (the chief executive of the Housing Finance Co.) said the new terms (of loan repayment) will be based on the borrowers’ ability to repay the sum in a sustainable way”.
If this statement is what I believe it means, that a person would qualify for a loan simply on the basis of what he or she can repay rather than what is needed to repay the loan in full during the life of the loan (say 20 years), HFC will eventually stop making new loans because it will have run out of money. Hence, HFC will have to rely on its sponsor, the Government, to provide it with fresh funds to continue in business.
A lending institution can lend many times its starting capital because the repayment income is new capital for lending. If the repayment to its own lenders falls short, HFC would have to use more and more of its depositors’ funds to make up for the difference. This means that under the new scheme where prospective borrowers invest 10% of their incomes into HFC in the form of a deposit, in the hope of getting a loan in the future, HFC may not be able to fulfil that promise. Hence, it may turn out that, unwittingly, HFC had got itself involved in a Ponzi scheme à la Bernard Madoff.
In the early nineties, soon after the Constitution of the Third Republic was adopted, the government introduced a housing loan scheme based on the borrowers’ ability to re-pay something rather than what was required to service the entire loan. Ten years later it was forced to reduce the book value of these properties so that the borrowers could own them during their working life. In other words, the government never got all its money back. This was our own version of sub-prime mortgage debt which we are still paying to this day.
You also reported that as of March 1, HFC would be charging “a flat rate of 8.5% and the term of payment will be 25 years” on all their current loans. Whilst this may be viable in today’s economic environment, what would happen if interest rates on deposits were to rise due to a different economic and financial environment and depositors wanted to take advantage of this situation by depositing their money with another financial institution? To entice its existing depositors to keep their money with them, HFC would have to raise its deposit rate and hence reduce its net income.
The economic principles underlying a small open economy such as ours is that when the currency tends to appreciate (as it has been doing since the middle of 2009) interest rates tend to fall. The reverse applies too.
In general, fixed rate mortgages were possible only through building societies, which is a financial institution owned by its members. Hence, the government would be best advised to turn HFC into one rather than pretend it is a commercial lender if it is serious in keeping HFC in business. Otherwise, it would find that its fixed (interest) rate loans too would be unsustainable.
Paul Chow