Monetary and Fiscal policies

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Neo-realism gives weight to structural explanations in clarifying the behaviour of small States. According to neorealism, the weakness of small Island States makes their survival more difficult in comparison to great powers. From the perspective of Neo-realism, the most immediate and noteworthy feature is the huge power disparity in resources between the big powers and the small Island States. All of this means that the  five major islands in the Indian Ocean; Mauritius, Seychelles, the Maldives, Sri Lanka and Réunion  are at the crossroad of  a major transition  and they have not been able to exert much power in the international system. 

In most IOR island economies, the pandemic had large adverse effects on their external balances and GDP growth rates. Several of these tiny tropical islands are at a great risk of external debt distress. Small Island States tend to have the highest rates of external debt. Dwindling foreign currency reserves from tourism, the key source of dollars remains restricted leaving these islands with few options. The latest signals indicate that economic recovery is continuing to progress. Given the risks associated with the unsteady international landscape the outlook on inflation remains somewhat unclear for these five Indian Ocean islands.  

Since the Covid- 19 pandemic, the economies of the IOR Islands have been gradually catching up but the improvement continues to be riddled with uncertainties and vulnerabilities. In order to recover, these economies need to adopt new and innovative funding mechanisms while external borrowing should identify the immediate requirements of islanders. The wider aim of macroeconomic policy is to contribute to economic and social well- being in an equitable and sustainable manner. In order to have sustainable macroeconomic policies and build resilience to external shocks, a strong fiscal framework is vital for these five islands. 

As a prerequisite for economic growth, these five IOR islands pursue export oriented  economic development policies. Currency stability amongst these islands permits importers and exporters to develop strategies for long-term growth.  These challenges can lead to macroeconomic volatility and fragility in economic development if not dealt with appropriately. By working towards safeguarding stability and integrity of the international financial system, the World Bank Group (WBG) and the International Monetary Fund (IMF) provides monetary cooperation and financial stability to these small island nations. The relationship between the economies of these five islands as an alliance will be a force to reckon with to uphold regional stability in the Indian Ocean specifically in the context of interdependency of IOR Islands. One of the political priorities of the IOR islands’ economic interests is economic diplomacy. These five islands benefit from deep-rooted traditions of diplomacy and derive their strength from several aspects including their geographical positioning within the Indian Ocean.

Economic crisis response

Covid-19 which necessitated several strict lockdowns severely hit Sri Lanka’s economy causing a loss of tourism income. Inflation continues to be on the rise, reaching double digits. Growth estimates for 2021 indicate economic recovery to be slower than expected. In addition, due to pre-pandemic tax cuts annual fiscal deficits exceeded 10 per cent of GDP.  While the country is in the midst of its worst economic crisis, Sri Lankans are facing fuel and food shortages and steep price increases. A widening current account deficit and repayments of external debt have led to shortages in foreign exchange.   As Sri Lanka grapples with a massive economic crisis, India in keeping with its Neighbourhood First policy has extended support worth over US$ (US Dollar )  3.5 billion this year alone to Sri Lanka to overcome current difficulties (Indian High Commission, Colombo). Beyond the present crisis, tighter monetary policies are required to contain rising inflationary pressures.

Post-Covid economic scenario

After an unprecedented pandemic the Maldivian economy is recovering with a partial recovery in tourism resulting in an improved growth outlook. Maldives has displayed commendable resilience in its real, financial, fiscal and external sectors when challenged by the unprecedented shocks triggered by the pandemic.  The Maldives remains at high risk of external debt distress and high overall risk of debt distress. Well-coordinated fiscal and monetary policies will be required to safeguard macroeconomic stability and restore debt sustainability. A tighter monetary policy stance may be required to lower external imbalances, guarantee compatibility with the exchange rate peg and build up reserves.  Besides, the ongoing economic recovery process, India has offered financial assistance to help repay debts and increased its budgetary grants for the Maldives. India’s financial assistance to the Maldives includes loans and grants for projects exceeding US$ 2 billion.

Emerging economies

Mauritius is an island steadily recovering from the pandemic. Due to surging fuel and food prices annual inflation is expected to rise further in 2022. Fiscal consolidation is needed in order to restore fiscal space and ensure debt sustainability. In the medium term, the public debt of Mauritius which rose notably amidst the pandemic is set to stay at elevated levels. Safeguarding the independence of the central bank and improving effectiveness of monetary policy need to remain as priorities. To support recovery and to achieve the aspiration of becoming a high-income country, it is critical for Mauritius to diversifying its economy.

The economy of Seychelles recovered strongly in 2021 with an estimated 8 per cent growth in real GDP.  However, in the long run the nation’s open economy remains highly vulnerable to external shocks.   Seychelles has made striking progress in reestablishing macroeconomic balances.  The country has recently approved the public enterprise monitoring Bill. Impressive progress in implementing the Extended Fund Facility has been made by its government. Seychelles has significantly reduced its debt vulnerabilities. Sustaining the buildup of buffers against shocks remains crucial and necessitates the continuation of prudent macroeconomic policies while safeguarding international reserves.

Réunion’s economic development relies on a dynamic and efficient workforce. With economic growth dented by the pandemic, current recovery is likely to leave output below the pre-crisis trend this year. The island is afflicted by high rates of unemployment which is three times the European Union average for young people.  For Réunion, greater cooperation with its neighbouring States, greater mobility, employability and new skills for young people will help curb in particular the high unemployment rate.  

Sound budgetary policies

It is now time to construct these various observations into a conclusion. For Mauritius, Seychelles, the Maldives, Sri Lanka and Réunion it is crucial to maintain macroeconomic stability to ensure sustained and inclusive development. Sound public finances and monetary and budgetary policy settings aimed at low and stable inflation are conducive for long-term growth. Stabilising the macro economy is about creating such conducive political conditions for these IOR islands.  In this regard, currently, Economic Diplomacy is the key feature in foreign relations for these island nations.

 Dr. Srimal Fernando received his PhD in the area of International Affairs. He was the recipient of the prestigious O.P. Jindal Doctoral Fellowship and SAU Scholarship under the South Asian Association for Regional Cooperation (SAARC) umbrella. As a Lecturer he focuses on comparative politics of Small Island Developing States (SIDS). Dr. Fernando is an academic specialist in International Relations and an adviser on New Regional Diplomacy. He has received accolades such as the 2018/2019 ‘Best Journalist of the Year’ in South Africa (GCA) Media Award for 2016 and the Indian Council of World Affairs (ICWA) accolade. He is the author of ‘Politics, Economics and Connectivity: In Search of South Asian Union.

By Dr. Srimal Fernando