Monday 1 April 2002

Cash (non) Flow

Maltastar


“In an economy as small as ours the passage from shortage to excess means crossing a very fine line.”

One thing everybody seems to agree upon is that the economy has developed serious cash flow problems.   Credit periods are getting longer, the business risk of incurring bad debts is increasing and barter is becoming the norm rather than the exception, especially in large business deal involving construction and outfitting contracts.

Few have however made any serious attempt to see what’s behind this phenomenon and how it ought to be addressed.

Through this article I try to fill this void in the hope of stimulating further discussion on the subject.

I propose that three major reasons for the cash flow problems which is strapping our businesses are the following:

·        As the economy slows down overcapacity has developed in many sectors as past investment premised on unrealistic assumptions of growth and consumption continues to add to existing capacity.

·        Government’s fiscal enforcement is strapping business of the limited cash flow at its disposal forcing business to default on its obligations to banks and the private sector in order to meet its tax commitments and avoid extortionist penalty rates.

·        Banks are not behaving as a shock absorber so much necessary for the economy during a slowdown or recession ensuring that economic units survive in order to propel the economy back into growth as the cycle turns.

Overcapacity

In an economy as small as ours the passage from shortage to excess means crossing a very fine line.    We have practical examples of this.   One private hospital was two little but two became too many so much so that one had to be sold involving loss of the original investment barely two years after it opened its door.


“Be as it may enforcement is extracting scarce cash flow from businesses.”

Luxury real estate development on Tower Road was brought to a near standstill by the arrival of the Portomaso real estate project.

Overcapacity is evident in many sectors.    Contractors re finding it heavy going as only those extremely well equipped can  compete for large projects and in many cases they have to accept barter terms which small contractors can never consider.

Retailing again is undergoing reform which is throwing up pockets of over-capacity in many sectors.   The Price Club saga has ended the mad rush towards the discount supermarket, giving a few breadths of much needed oxygen to smaller retailing food stores.   In the clothing and fashion sectors the dispersion of retailing to major towns and villages continues,  and Sliema and Valletta no longer carry a monopoly for fashion shopping.

Overcapacity takes time to even out by the dual effect of closure of the uncompetitive units and economic growth to increase demand to accommodate the surviving units.   I would say that we are about entering the stage where no new supply would be coming onto the market to exacerbate the existing over-capacity and would need at least two more years for the capacity to drop whilst demand could pick up by the normal progression of the economic cycle.

Fiscal enforcement

If government has failed on all fronts it has certainly not failed on fiscal enforcement where substantial progress has been made.   Normally this ought to be greeted with respect and cheer,   However the fact that increased taxation flow extracted through more efficient enforcement is just being channeled to finance increased expenditure meets the disapproval of all serious economic analysts.

“Unfortunately my experience would suggest that banks are currently not meeting this challenge”


Be as it may enforcement is extracting scarce cash flow from businesses.   Two particular factors are leading to this.   Hefty, near extortionist, penalties are forcing business to extend credit terms from private sector suppliers to ensure that it pays income tax, provisional tax, VAT, NI Contributions without any delaying invoking such penalties.

Secondly administrative changes are by the stroke of  pen adding cash flow burdens on the business sector without as much as a simple pre-announcement.   Take the recent legal notice through which business have found out to their dismay that the advantage of initial allowance on investment expenditure has been removed.   This simple administrative decisions forces business to foot higher tax bills in the early years when the investment has been made and therefore cash flow is probably tight.

Whereas most countries encourage small business by softening the impact on their cash flow by tax payments, in Malta,  the government, strapped as it fiscally is, does exactly the opposite.

Banks as shock absorber

Malta has been through recessions before and in each case banks played a significant role in pulling the economy back to sustainable growth paths.    During recessions banks normally  go out of their way to promote and assist new productive investment and go gentler on those economic units that are finding it hard to service their commitments but can prove that their problems are cyclical not structural.

Unfortunately my experience would suggest that banks are currently not meeting this challenge.   Competition is forcing them to take a very narrow view of their business and  the regulator is failing to use its moral authority to force the banks to meet their social responsibility.   After all it is in the banks’ own long term interest to ensure that the economy reverts to a growth path without delay.

Unfortunately banks are more interested these days in pushing their foreign wealth management products to private clients rather than to assist their business clients out of their cash flow problems.

Next week I will analyse and propose some solutions.













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