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Developing long term sustainable growth structures, resilience of Seychelles’ economy |20 July 2020

On June 29, 2020 the World Health Organisation warned that ‘… the hard reality is this pandemic is not close to being over. In fact, it is speeding around the world...’

These words speak volumes because they could mean that as the coronavirus continues to wreak havoc on world economies, as a tourism dependent economy, Seychelles will continue to endure heavy losses and hardships if no remedy is found to free the world of the pandemic and of the fears of the unknowns and provide the safety-confidence for mass travel.

Six months into the COVID-19 crisis many Seychellois seem to be still taking it casually and the normal way of life continues, many people seem distant and oblivious to the adverse economic reverberations the world over.

There seems to be no urgency to curb our spending tendencies, no urgency to save money for the difficult times ahead and no urgency to re-adapt to the new economic realities. And by the looks of things, difficult times might not be too far away if there is no improvement in the country’s foreign earnings.

The generosity of government in temporarily paying the salaries of workers and the bills of many businesses has kept aggregate demand relatively stable and the shaking domestic economy rolling despite at a lower speed and despite the heavy loss of employment. It would appear that Seychellois have not yet felt the economic recession creeping in.

As the world economy continues to take two small steps forward and one big step backward with no end in sight, Seychellois must take note and start acting now to avert a catastrophe at our home and country level.

 

So, as ordinary citizens, why should we be concerned?

David Bianchi assesses the situation and shares some thoughts:

“Firstly, the country uses rupees for its daily motion. But it is actually foreign currencies that fuel our economy. And presently, there is a situation whereby the earnings of foreign currencies fall short of demand, hence the increase in the exchange rates of the principal currencies (US dollar, euro and British pounds amongst others). This has its own adverse impacts through inflationary pressures on the prices of imported goods and throughputsas well as locally produced goods and services. There exists a case of too many rupees chasing too little forex and we are already seeing the beginning of the results.

Secondly, the country has international debt, payable in foreign currencies. In rupee terms, the value of the foreign debt has increased as a function of the rise in exchange rates. This means that Seychelles will need more rupees to pay the principal and interest components of its international debt. As the foreign exchange rates continue to rise, the rupee cost of the debt will rise further! Higher debt repayments deprive the country of greater development prospects. Each one of us must be conscious and must do our part by curbing our purchasing habits and help reduce pressure on the demand for foreign exchange.”

The longer the pandemic persists and the longer the tourism industry remains in hibernation the more the demand pressure on the dwindling foreign currency reserve and one can expect even more increases in the exchange rates and on the cost of living. Unless the country finds a Good Samaritan, it will have to resort to borrowing even more internationally to prop up its foreign currency reserve to sustain its social and economic needs. Whilst more borrowings will help ease the exchange rates and contain the rises in prices, it will put major pressure on the economy when it comes to repaying these loans. One must not forget the pre-2008 debt situation of the country which necessitated the macro-economic reforms.

 

What is the way forward?

Mr Bianchi tries to explain the situation using a simple but useful formula that stipulates that AD = C + I + G + X – M where ‘AD’ is Aggregate Demand, ‘C’ is spending by Consumers on goods and services produced locally, ‘I’ represents domestic and foreign Investments, ‘G’ is Government spending, ‘X’ is Exports and ‘M’ represents Imports. The formula is sometimes used to determine policy options in order to maintain macro- economic stability and growth in the economy (i.e. keep the economy in equilibrium, that is where Aggregate Demand = Aggregate Supply = GDP (at a given price level). The Gross Domestic Product (GDP) measures the monetary value of all goods and services produced within a country’s boundary during a specified period of time and can be used to estimate the size of the economy and its growth rate.

In Seychelles, when compared to import ‘M’, the component ‘C’ is not very large but significant because of the small productive base (agricultural, artisanale fisheries, manufacturing and services) as well as the preference of Seychellois to buy imported items. Mr Bianchi says that “through the right policies and encouragements, ‘C’ needs to be stepped up because it stimulates domestic investments, production, employment and GDP growth.

On the other hand, ‘M’ is relatively large since we import most of the commodities that we use. ‘M’ is a withdrawal or outflow from our GDP, i.e. it is money (foreign currencies) that leaves our economy and contributes to the GDP growth in other countries. ‘M’ must be curbed at all times if we are to have a stable economy but more so during this critical COVID-19 period and if that can be done, then the money can be used for other priority purposes. Curbing ‘M’ however, will bring less trade taxes to the Government coffers. Less taxes can mean less money available to government to spend, i.e. ‘G’.”

He says that “From the formula, domestic Consumption ‘C’, Government Spending ‘G’, Investment ‘I’ and Export ‘X’ constitute the main components that make up our economy (or GDP). Tourism is export of a service and in the absence of tourists, ‘X’ comprises mainly export of fish (tuna) and financial services.”

“If these main components of GDP are weak or collapse, then our economy will also be weak or will collapse which will have devastating consequences for everyone including our citizens, the business community, the various institutions and the Government’s ability to deliver their services.”

The economy of several countries have experienced a collapse in the past (manifested by high or hyper-inflation, low business confidence, high unemployment, closure of businesses, decline in GDP, rise in poverty and other social problems) when their principal economic sector collapsed.

Government spending ‘G’ is what we hear in the budget every year and depends on its revenue collection through taxes, selling of financial instruments (treasury bills and bonds), loans and grants. It is critical for the country to have a good and efficient tax collection system in order to have a strong ‘G’.

At the moment, with a business sector that is not operating at its best, it will be a challenge for Government to raise taxes from them. The possibility of cutting the civil service and salaries will also generate less income taxes. Therefore, in future, Government might be constrained in its spending, i.e. ‘G’ can be low.

‘I’ is investments that have been realised by individuals, local businesses and foreign direct investments. If Government continues to lay some emphasis on creating a good enabling environment, Investment ‘I’ can be increased. Increases in ‘I’ causes a rise in ‘C’ because investments (setting up and expansion of businesses) produce more goods and services locally for people to consume. Increases in ‘I’ can also raise ‘X’ if the investments are geared towards export activities.

The level of uncertainty that exists makes it hard for businesses to contemplate positive investment decisions, i.e. ‘I’ is quite low at the moment.

Seychelles is, therefore left with ‘C’ and ‘G’ and ‘X’ to keep the economy (GDP) afloat. But ‘G’ and ‘X’ can become relatively small if the present situation persists and if we do not export more or derive more from what we are exporting, i.e. fish.

Based on this quick assessment, Mr Bianchi fears that “if the economy is not revived and the foreign currency earnings are not stabilised by March 2021, unemployment and inflation might be rampant and there might be a permanent situation where the economy gravitates towards a low level equilibrium trap and remains there for a prolonged period. This is a situation where the low level of domestic salaries hence low savings is insufficient to sustain domestic investment and other economic parameters including foreign direct investments do not provide the impetus to achieve a minimum of GDP growth. With a possible birth rate that will be above GDP growth rate and increasing socially-dependent and non-productive sections in the country, any small economic gains can only sustain the growth in population and other social groups leaving no capacity to save, to borrow, to invest and therefore, there is a vicious cycle of continuously low or negative economic (GDP) growth. The economy thus finds itself trapped at a low level of development which further erodes the standard of living. There are several countries in the world that are trapped at low levels of equilibrium even in normal times and cannot provide the means of escape.”

In order to avoid a low level equilibrium trap, Government needs to find non- inflationary financial mechanisms for a ‘big push’ to kick- start, re- invigorate and re- energise the supply- side economy and provide strong impetus and incentives to spur GDP growth. A culture of private savings (through attractive schemes) and investment must be encouraged because they provide the ‘nuts and bolts’ for business set-ups, employment and production. A good share of investments must be outward-looking, i.e. oriented towards the export markets that can help ease the foreign currency stresses.

Mr Bianchi continues by saying that “the ‘consumer society and spending culture’ that exists in the country must be curtailed because it over-stresses the economy and produces little in terms of value addition and productivity but merely helps other economies to grow rather than our own. It is harmful because it puts pressure on the foreign exchange rates, it imports inflation and it causes more local inflation through demand pressures for both forex and goods. Too high an inflation rate is detrimental to the productive economy, dampens business confidence and exports and discourages all types of investments including FDI (foreign direct investment). The real economy might stagnate or contract further when inflation gets too high.”

In the event that Government is unable to raise sufficient revenue to spend, i.e. ‘G’ is low, one of the casualties will be the public sector. Jobs might have to be cut as Government will not be able to pay the salaries and the remaining civil servants might have to take a pay cut. Question is: who will employ the personnel who are laid off? How will they sustain themselves and their families? How will they pay their bills and what will be the revenue consequences for the utilities companies and their ability to function efficiently? Government might not be in a position to provide financial assistance this time.

At the moment, the private sector is itself in economic difficulties and has no appetite or capacity to absorb more workers.

Public essential services such as health services, social protection services, education, law and order might be cut back and so is the maintenance of public infrastructure such as roads, schools, hospitals and so forth. These can have serious setbacks for the country. How will the country handle the array of social ills that might emanate from all this?

Mr Bianchi says that “financial reserves that might have been depleted to mend the economy during the pandemic will have to be replenished and this could imply even more taxes in future. So will higher taxes be required to pay increased domestic and international debts in the event of more borrowing?”

A common question is why does the country not print more rupees to solve its financial issues? Not going in too much technical details, Mr Bianchi simply says, “this is not advisable because printing more money can create more damage to the economy (through hyper-inflation and its far-reaching consequences). And besides, it is foreign currencies that the country now needs most. Seychelles cannot print the currency of another country.”

In conclusion, Mr Bianchi says that “it is opportune that in order to bolster long term resilience, the country needs to review the structure of our GDP and adopt a more pro-active and scientific way to restructure it in line with the Keynesian macro-economic model. A right balance between ‘C’, ‘I’, ‘G’, ‘X’ and ‘M’ must be found to ensure stability and sustained growth or at least to cushion the economy better so that it is not too severely impacted even during the most challenging of events.”

“In particular, strong emphasis must be laid on private savings and investment as well as local production and export. Development of the necessary mechanisms to encourage higher quality, standard, reliability and competitive pricing in local production needs to be instituted to encourage more consumption of domestically-produced goods which can also generate more employment and more tax revenues to the Government.”

In the end, what matters is that the country will have an economic (GDP) structure that is stable, more diversified, does not depend too heavily on only one or two main components and the risk is spread across more sectors. We will have a circular flow of income that stays in the country more with less outflows to foreign countries but one that creates more inflows through exports.

Whilst Government continues to adopt measures to stabilise the current social and economic sectors, it must also continue to find a new approach through bold and pragmatic policies and strategies to develop the long term resilience and sustainability of the economy.

In 2018, the GDP of Seychelles was equivalent to US $1.5 billion. In 2020, the COVID-19 impacts are likely to see a drop in the GDP by 10 to 15%.

 

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