Pritish Behuria, University of Manchester
Mauritians will head to the polls by November 2024 and politicians are considering the economic direction of the island country.
For the last two decades, the country’s economic growth has depended heavily on its offshore sector – the provision of financial services by banks to foreign firms.
As an isolated country located in the south-western Indian Ocean, Mauritius has linked itself to global financial sectors by easing the flow of capital into and out of its economy. It has signed double taxation avoidance agreements with other countries, and its capital gains taxes are attractively low.
Through double taxation avoidance agreements, foreign entities can establish funds in locations outside their home countries, to take advantage of lower taxes.
But recent initiatives have dimmed prospects for the offshore sector. For instance, the OECD’s (the Organisation for Economic Cooperation and Development) multilateral convention to implement tax related measures significantly limits the incentives available under double taxation avoidance agreements.
As a political economist, I take an interdisciplinary approach to studying development challenges in today’s connected world. My work examines how countries with relatively little economic power manage domestic and external forces to achieve economic transformation.
Tax haven strategies have allowed countries such as Mauritius to gain huge amounts of foreign exchange. But in a recent paper I argue that these strategies may not have the same appeal in years to come. This leaves Mauritius at a crossroads once again.
The Mauritian government has previously found ways to diversify its economy during times of crisis. First, from sugar to industry. Then to tourism. Later to the offshore sector. Now there is talk of investing in the blue economy, but there are few signs that a clear strategy has been defined. With offshore revenues threatened, the Mauritian economy may soon struggle to identify new sources of foreign exchange.
Diversified economy
Mauritius is Africa’s most widely celebrated democratic developmental state – held up as a shining example. It transformed itself from a country with a per capita income of US$260 in the 1960s to one with a per capita income of more than $10,000 in 2021.
At independence in 1968, observers had little hope for the Mauritian economy. Nobel Prize winner James Meade predicted a tragic future for the island nation. He cited sugar dependence, population density and diverse ethnic composition as its weak points.
Yet Mauritius has defied pessimistic predictions and conventional economic theory. It has become among the most diversified African economies.
In the 1970s, economic development was largely focused on industrialisation to reduce dependence on imports. While there was minimal growth in exports, manufacturing employment grew from 5% to 20% of the labour force over the decade. But as sugar prices fell in the late 1970s, the Mauritian economy plunged into crisis.
In the early 1980s, Mauritius adopted reforms, adhering to conditions set by the International Monetary Fund and the World Bank. The government decided to go further than simply liberalising its financial sectors and reducing capital controls. Against the advice of multilateral donors and foreign governments, Mauritian politicians decided to build an offshore financial centre.
In the late 1990s and 2000s, Mauritius was widely celebrated for rapid economic growth and diversity. This came from special economic zones (promoting textiles and apparel growth), tourism and the offshore sector.
For decades, African countries have sent government officials on study tours to learn from Mauritian success.
But like most late developing countries (or former colonies), Mauritius is still heavily reliant on imports. Its offshore sector has provided vast amounts of foreign exchange to buy imports. If offshore sector revenues dry up, Mauritius might have to apply to the International Monetary Fund for loans.
Mauritius as a tax haven
In my paper, I describe the evolution of Mauritius as a tax haven. It started with strategic state involvement. The Mauritian government amended its banking legislation to offer lower taxation and exemption from exchange control.
Its tax treaty with India soon became the most significant avenue for the development of Mauritius’ offshore businesses. An increasing number of Indian funds moved their businesses to Mauritius to take advantage of tax benefits.
Similarly, Mauritian entities have been the leading investors in India since 2000. Mauritius-based funds have invested around US$170 billion in India this century. But things are changing. There are signs that funds are now selecting Singapore (as well as other competitors to Mauritius) as the preferred destination for investments.
India’s response to the OECD’s convention to implement tax related measures has gone further than many other countries. The Indian government agreed to remove the capital gains exemption that entities held in Mauritius had enjoyed over the years. By 2018, Singapore had overtaken Mauritius as the leading investor into India.
In March 2024, India and Mauritius amended their double taxation avoidance agreement to comply with the OECD’s measures. Among the changes, firms do not qualify for tax incentives if the principal purpose of their transaction is simply to avoid tax.
What next for Mauritius?
The new amendments to the double taxation agreement are likely to constrain the growth of Mauritius’ offshore sector. The financial sector has not transformed beyond providing basic services like fund administration. This is unlike other more diversified financial sectors like Singapore, which specialises in capital markets, foreign exchange, commodity trading and corporate banking, aside from fund administration.
With foreign firms recently buying some of Mauritius’ biggest offshore management companies, there are signs that Mauritian banking will be relegated to simply doing basic work for larger financial centres. It is likely that overall revenues and foreign exchange from the sector will reduce.
Focusing resources on a new pillar for Mauritian growth is more urgent than ever.
In the last few years, Mauritian political discussions have been characterised by questions over Prime Minister Pravind Jugnauth’s authoritarian turn, as well as accusations of corruption, nepotism and cronyism. The nation will have to reach a new political and economic consensus to avoid future economic difficulties.
Pritish Behuria, Senior Lecturer in Politics, Governance and Development, Global Development Institute, University of Manchester
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Source: The Conversation
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