Unconventional Solutions for Unconventional Problems

The Malta Independent  

 

GDP figures published for the first quarter of 2003 make unpleasant reading. For the first time ever the economy has contracted not only in real terms ( -1.9% over same quarter last year) but also in terms of current market prices ( -0.8% over same quarter last year).

It is acknowledged that the first quarter was influenced by quite exceptional factors. On the domestic front the referendum and election campaign forced people to postpone investment and consumption. On the international front the build up to the Iraq war has no doubt effected demand for our exports and slowed down our tourism.

It would therefore not be objective to build doomsday scenarios on the basis of one-quarter results. But on the other hand one should not ignore that even the bigger picture is far from comforting. Real GDP growth in the last nine quarters (1st quarter 2001 to 1^st quarter 2003) shows negative growth in five quarters, no growth in two quarters and decent positive growth in only two quarters – the second and third quarter of last year.

Our performance over the last two years may be likened more to that of Japan, officially in state of deflation, rather than to the anaemic growth experienced by euro area and to a certain extent by the US.

Traditional economic tools of monetary and fiscal policy seem to have lost their effectiveness and the economy is not responding. Lowering of interest rates is not serving to stimulate investment except in the residential property market fuelled by cheap and easy mortgages. Excessively lax fiscal policy, way out of EMU criteria and moving in the opposite direction from that stipulated by the Euro Growth and Stability Pact, is not delivering economic growth. In the first quarter of 2003 the structural fiscal deficit increased from Lm68 million to Lm105 million, a whopping 54%. This has helped to increase consumers’ expenditure by 2% and government consumption expenditure by 16% during the quarter over the same quarter of last year. Yet overall the economy contracted.

Unless we mean to manage the economy by hope and prayer or unless we think we can just talk up the economy into positive gearing, then we have to consider unconventional solutions to unconventional problems. Real solutions come from serious economic re-structuring but these need time, discipline and persistence and cannot be expected to deliver solutions in the time scale required.

I am tempted to suggest an unconventional solution. Central Bank research shows that the real rate of exchange of the Maltese Lira is some 10% above its 1995 level. A devaluation of this size would immediately restore competitiveness to the Maltese productive sector boosting exports and tourism.

It would also address, at least partially, the risk of joining the euro at an unsustainably high rate and take pre-emptive measures to ensure rate of exchange stability during the two year period we would have to spend waiting in the Exchange Rate Mechanism before we join the Euro.

There is clearly a social cost to this. Imports will become expensive and this will unavoidably boost inflation. Given that we are travelling at historically very low inflation rates such boost need not cripple the economy. Indeed it could avoid the risk of deflation especially if we maintain the price impulse as a one-off item avoiding any spiral effect.

Yet the social aspect cannot be ignored. But devaluation in the region of 10% would produce a one off profit of Lm112 million for the financial sector, i.e. The Central Bank and the Deposit Money Banks. This exceptional gain could be sterilised by fiscal measures ensuring the government gets hold one-off exceptional funds which produce manoeuvrability to take fiscal measures to protect socially sensitive sectors. May be government could agree with the opposition and the social partners on the MCESD to use such bonanza on a balanced package to give the economy a kick start – something the opposition had proposed in its manifesto.