Friday, 29 April 2005

Hints of Panic

The Malta Independent 


Is it my dirty mind or are government and the monetary authorities, as we approach the important decision of selecting a central parity rate for the Maltese Lira to join ERM II, panic stricken`

Two recent events seem to suggest the latter rather than the former.

The first is the monetary authorities decision to start raising interest rates, or rather the reasons given for such measures. Raising interest rates on a morbid economy that has practically not grown in real terms since the year 2000 is of itself a curious decision which would need substantial justification. The Central Bank could have made a reasonable case to justify such a measure if they purely indicated the need to protect the value of money from asset price inflation.

There is undisputed evidence that in spite of absence of economic growth, we have, since 2002, experienced abnormal asset price growth in our real estate and equity capital markets.` It is as yet unclear as to whether these price rises have features of a speculative bubble but it is undoubtedly the duty of the monetary authorities to conduct the interest rate policy to keep such prices in check, to avoid the formation of such speculative bubble which when burst could hurt the stability financial markets and the economy in general.

However rather than use this very valid reason for justifying the abnormality of applying higher interest rates on a stagnant economy, the Central Bank has instead justified its decision on the loss of its international reserves, caused amongst other reasons, by the supply of cheap consumption credit by the banking sector.

Even if there could be something more structural in the loss of external reserves than usual seasonal fluctuations, having the Central Bank and the monetary authorities officially admitting their concern about their loss is threading on dangerous ground. It is like my asking you not to think of a white horse. You cannot but help thinking of a white horse.

Giving loss of reserves as a reason to justify increasing interest rates could indicate to the population at large that the monetary authorities, on the eve of such an important decision in the process of join the Euro monetary system, are not in control of the situation, are reacting rather than pre-empting, and are putting into question their own ability to defend the central parity rate they will choose for ERM II.`

Without a plentiful supply of official reserves as a high percentage of the entire money supply it would be difficult to give credibility to the country`s ability to defend the chosen rate of exchange mechanism. Rather than putting the quantity of reserves into question, the monetary authorities should be ensuring that they send strong signals to the market of their intention and ability to defend central parity by arranging substantial standby credit lines to increase the supply of such reserves as may be necessary in the circumstances. As the Romans dictum goes, if you want peace you have to be ready for war.

Perhaps a clearer indication of the panic surrounding our public finance administration is the hurried launch of a revised third version of the Investment Registration Scheme (IRS). The frequency with which such tax amnesty schemes are being issued cannot but dent credibility of our tax administration, in the process rewarding offenders at the expense of abiders, and giving strong incentives for tax offenders to postpone their coming in line until the next amnesty scheme is launched.

Tax amnesty systems can only be effective if they are used very very sparingly and in very exceptional circumstances. If they are used as a pure funding measure each time public finances go off track, which unfortunately is quite often, then they are likely to become counter-productive.

Take the IRS as a case in point. It was first announced in the budget for 2002 with a cut-off date for eligibility regarding investments that were held overseas on 1st September 2001. The scheme had been structured with three expiry dates with the penalty rising gradually from 3% to 5% if the later expiry dates were selected rather than the earlier ones. As a one-off measure, with an ample time window of one whole year for compliance, it made sense. It produced results.

What made less sense was the extension of the scheme in its second version when the 5% penalty rate and the original cut off date of 1st September 2001 was retained. It penalized those who came into line in the first edition of the scheme at the 5% rate, who had they known that a second edition was coming up could have waited to enjoy their tax free status a bit longer. The results it produced were more modest.

Now suddenly, after so many categorical assurances that the second version of the IRS was definitely one last chance to come in line, government hurriedly issued the third version keeping the 5% penalty but bringing forward the cut-off date to 31st March 2005. So now even those who put money overseas illegally after the first version of the IRS was issued have the opportunity of regularizing their position through this `one last chance` extension of the IRS.

The problem is why should people believe the one last time offer if government has already promised it twice before and broke its promise` Why should people not simply assume that further down the road, as government finances miss their targets, the government will have to launch another amnesty scheme so one always has the opportunity to catch tomorrow`s train even if tomorrow never comes`

And if government proclaims that through the European Savings Tax Directive it will now have the mechanism to catch tax offenders why is it necessary, after having given them two final chances, to give them a third chance to comply rather than use the new mechanism to catch offenders and punish them in terms of law in full justice to the tax abiding citizens`

If you are identifying signals of panic in our fiscal and monetary management systems than you are probably right.

Friday, 22 April 2005


The Malta Independent 


The process of selecting the new Pope was much shorter than many anticipated. This can only mean that the chosen candidate carried broad agreement to clinch the two-thirds majority needed to elect a new Pope in such short time frames.

This is surprising when considering that most observers expected that the split between the liberal and the conservative schools of thought within the College of Cardinals was nothing like two-thirds to one-third. The most credible interpretation that can be given to such a speedy outcome was that all schools of thought considered that the next Pope, even if a liberal were to be elected, would have found it difficult to depart so quickly from the conservative school of Pope John Paul II and the best solution was to go for a brief interregnum.

In fact in my contribution of two weeks ago I had opined that:  

As the next Pope will be elected by a college of Cardinals who have almost all been appointed by John Paul II who was not known to promote dissenters, it is most unlikely that the Pope`s successor will be willing to depart substantially` from the conservative teachings promulgated under John Paul`s II tenure .` The liberal element with the Church can at best hope that the next Pope will be a short inter-regnum to allow a cooling off period before the liberal elements within the Church can gain sufficient influence in the corridors of the Vatican.

What I like best about Pope Benedict XVI is in fact his hair and his age. Being past 78 years makes him the oldest Pope elected for over two centuries and promises an interregnum papacy where Pope John Paul II`s conservative style will start losing its shine as it gets promulgated by a new leader who does not command the same charisma and strength of character.` It could set the scene for the bigger change needed at some not too distant point in time when a Pope with more liberal views, possibly with a character formed by a third world up-bringing, will possibly inherit St. Peter`s chair at the Vatican.

Another brief interregnum seems destined to befall the EU constitution. There is every possibility that the French electorate will kill the project in its tracks by voting no in the referendum due on May 29th. This notwithstanding that through Giscard d`Estaing`s Presidency of the Convention that piloted the EU Constitution Treaty, the French had a significant say in its authorship.

Even if the French vote were to scrape through the likelihood of the Treaty being approved by the British referendum seems facing long odds and Tony Blair, who devised the referendum in order to avoid rendering the EU constitution a winning card for the Conservatives for the election due on May 5th, was this week quick to indicate that if the EU Constitution fails the French test it is doubtful whether he would go ahead with the British referendum next year.

The Malta Labour Party seem to have missed learning from Tony Blair`s lesson.` The EU constitution is a delicate issue for the MLP who on the matter is internally split into two opposing factions.

There is the KMB faction which is consistently against the approval of the Treaty and would be prepared to stick to their principles even if as a consequences they prejudice MLP`s chances of making it to government on an anti-EU ticket. There is the opposite faction who are pro-EU Treaty and would wish the Party to vote in favour of the Treaty so as not to leave the EU as an open election issue which could give the PN a further advantage at next elections just as it did in 2003.

The added complication for the impossibility of reconciling these two views in one common party policy regarding the EU is that the party is led by a person who has diametrically changed his position regarding the EU and therefore lacks the necessary credentials to broker a sensible Party policy regarding the EU constitution.

The fact that the two of the three internal reports that are suggesting that the Party votes positively for the ratification of the EU constitution were authored by deputies in Labour`s pre-2003 election leadership team, does not help to make their recommendations more credible.

Because the pre-2003 MLP leadership team did not use to argue that EU membership was inferior to their Partnership proposal, but that the country could still survive inside the EU as much as outside it as ultimately the future is what we make it.` It used to argue that EU membership was sure death to our economic development and politically sovereignty, and use to describe EU membership in `allaharesqatt` terms.

They did not argue that lemonade is better than cola. They used to say that lemonade was delicious and that cola was poisonous and drinking it leads to sure death. `Now, at the expense of losing credibility, they have to argue that cola, although not as good as lemonade, is not poisonous, certainly does not kill and once the people preferred cola to lemonade we should not argue more about it but will be suggesting that we should start drinking cola from lemonade green bottles come next elections.

I would have thought that it would have served MLP`s credibility much better if the internal reports were authored by someone distant from MLP`s pre-2003 leadership and that the quest for a positive party policy regarding the EU was spearheaded by the new deputy leaders. Or at least they should have insisted that the decision is taken by the people in a referendum during which, given the internal division on the matter, the MLP would take a neutral stand and accept the people`s verdict.

May be the French would have come to our rescue as well.

Sunday, 17 April 2005

Forty percent Out

The Malta Independent on Sunday 


The 2003 election is now two years behind us and the government has approximately three years to go before having to refresh its mandate through a general election.

The Prime Minister this week marked the occasion by singing himself glory on the great achievements of the last two years whilst noting the tall order that still awaits delivery in the remaining three years.

Whilst there should be total agreement on the latter, i.e. that there is a tall order to be delivered in the next three years before approaching the electorate for its judgement, the claim of great achievements in the past two years is questionable, to say the least.

These last two years we have had a shocking reality wake-up call, at least for those who alluded themselves and refused to read the writing on the wall before last elections and went along with the false claims of our political leaders.

We were assured two years ago that public finances were sound and improving only to find out soon after that 2003 was the worst fiscal deficit performer since 1998 and that the promised public finance sanitisation programme 1999-2004 has failed. A new medium-term sanitisation programme 2004-2007 had to be launched as part of the convergence programme to gain credentials for accession to Euro.

We were assured two years ago that EU membership would herald a new spring of blooming opportunities which would spur investment and promote economic growth. The reality is now rubbing on us that the EU can at best help us to wear the discipline to come in shape and that it is up to us to adopt this discipline to grasp the opportunities which would otherwise pass us by, as competitors will take advantage of our lethargic and lead-footed economic restructuring.

Is it an achievement of the last two years to have the slowest economic growth in the whole EU, to place last in the table of competitiveness in terms of the Lisbon agenda, to miss out on the investment flows that are benefiting other new EU member states, and to register continued loss of jobs in the manufacturing sectors as entrepreneurs invest to save costs rather than expand activities`

Attempted re-structuring in loss making publicly owned enterprises we have seen these past two years can optimistically be considered as an expensive and ineffective patch-up. What benefits does the economy draw from paying substantial sums to able-bodied persons to go into early retirement` Can we build economic growth on paying people for dropping out of the labour market or by transferring surplus labour in a publicly owned commercial enterprise to central government where commercial controls are less stringent and certainly far less evident`

Certainly the achievements of the last two years do not augur at all well for our capacity to deliver on what is expected of us in the remaining three years.` We have had mountain-sized meetings, discussions, seminars, round-tables and what have you and then rather than produce a rounded and effective social pact to guarantee re-acquisition of international competitiveness, we gave birth to a mouse in the form of a few more working days without additional compensation, which measure, insignificant as it may be, is still the source of industrial friction at micro-level.

Now compare this insignificant measure to what is expected of us to deliver in the next three years if we are to achieve the targets of the Euro convergence programme by 2007.` In this respect let me quote from the Central Bank Governor`s Statement in the 2004 Annual Report that has just been published:

`If (we are) to succeed, the quest for greater competitiveness should, therefore, be pursued as a collective effort and perceived as being in the mutual interest of all social partners. It must be premised on an acceptance of the need to raise output levels without increasing costs and to invest a larger proportion of available resources.

In the labour markets there is need for more flexible work practices`unemployment benefit systems should be further reformed so as to transform into effective instrument of employment creation rather than of social dependence.

In the area of public health and welfare, the extensive range of services and benefits offered should be assessed with a view to ensuring their financial sustainability. Their provision at zero cost to the end user induces excess demand and waste`. It is necessary to move away from universal schemes towards more focussed programmes`.as it is clear that the country can no longer afford to provide such a wide range of goods and services free for all irrespective of incomes levels.`

In layman`s language the Central Bank Governor is arguing that to come in shape to join the Euro in 2008 we have to roll back our standards of living by starting to pay for public health services which are currently free, work harder and more flexibly without demanding additional compensation and reduce consumption in order to start saving for our supplementary pensions as the state cannot provide pension coverage to guarantee a decent standard of living throughout retirement.

From an economic point of view this makes sense. But given the travails we had to go through to agree, or really impose, the removal of leave in lieu of public holidays that fall on the weekend, can we have reasonable confidence on the government ability to deliver on these hard measures as it enters the more politically sensitive second half term of the legislature`

What makes our Central Bank so confident that the government can deliver on its convergence programme 2004-2007 when it has failed so clearly on the 1999-2004 medium term financial programme` I for one do not share such confidence.

May I take this opportunity to salute the memory of Louis Galea who passed away this week at the age of 91. Louis Galea was the de facto dean of local bankers and financial practitioners. I and many others owe a lot of our career to Louis Galea who was always a role model of integrity and commitment and the hallmark of calm, clear and objective judgement. So long Mr Galea!

Friday, 15 April 2005

A Matter of Interest

The Malta Independent 


  The increase in the central intervention interest rate by the Central Bank as announced last Friday following the meeting of the Monetary Policy Council (MPC) proves that monetary policy has become sterile.

At a time when the economy is pretty flat it is generally quite counter productive to raise interest rates which can only lead to discourage productive investments needed to reacquire a sustained tempo of economic growth.

But when you have an economy like ours suffering from long years of benign neglect and money-no-problem fiscal irresponsibility, there comes a time when the choice has to be one of the lesser evil.

The MPC is facing a choice of either risking loss of reserves necessary to defend the rigid rate of exchange peg it has adopted, or else having to apply higher rates that could suffocate a fragile economy.

Really the Central Bank, having publicly committed itself to defend a rigid exchange regime right through ERM II until fusion of our currency into the Euro, at the earliest possible date, cannot but raise interest rates without much concern regarding the state of the internal economy. Hence my argument that monetary policy has already become a sterile instrument for economic management.

The increase in interest rates announced last week cannot but be the first in a series. The rate

was last changed in April 2003 when it was dropped by a quarter point to 3% being the 4th such consecutive quarter point drop in less than 12 months. Since then for a period of nearly 2 whole years the rate was kept steady at 3%.

In April 2003 the composite intervention based on the basket of currencies in our exchange rate peg was 2.2% allowing a premium of 0.8% to holders of Maltese Lira to help them resist the attraction of converting their savings into foreign currency without incurring exchange risks.

Since then the UK has increased its rate from 3.5% to 4.75%. The US has increased its rates from 1% to 2.75%. The British Pound Sterling and the US Dollar have a combined 30% weighting in our exchange rate peg. The other 70% is in Euro which has not experienced any increases in interest rates.

Whilst the US and UK have seen strong economic growth, explaining the need to tighten up their monetary conditions by raising rates, the Euro area economy has had worryingly low economic growth and hence why interest rates for the Euro have stayed steady at record low levels.

Before last Friday`s MPC`s decision the composite interest rate of the Maltese Lira exchange peg was 2.625% offering Maltese savers just 0.375% premium reward for the risk of holding a conspicuously over-valued currency.`

Is it any wonder that savers have decided to start switching their liquid savings from Maltese Lira to foreign currency` Why refer to such sensible measures of capital protection as speculation when Maltese savers are merely reacting to the scant reward for the risk of holding a manifestly over-valued currency`

The quarter point rate rise widens the premium to 0.625% which is hardly sufficient incentive for holding the currency of an economy that has hardly grown these last 4 years, with chronic fiscal imbalances and arguably inadequate reserves to support the chosen exchange peg.

Raising rates in a series of measured

pace approach seems therefore quite likely. This will however do nothing to achieve the real restructuring necessary in the economy. On the contrary it could continue to enrich the financial sector at the expense of the productive sector.

It could also risk

stimulating the very process it is trying to impede. As interest rates are perceived as set to rise, it could force Maltese Lira bond investors to switch into more liquid and less interest rate sensitive investments, thus prompting consideration of switching into foreign currency, investments formerly locked out of the money supply measurement.

All this blind faith in the virtues of rigid exchange rate peg fixed at clearly uncompetitive level will continue to oppress the real economy stimulating capital flight and forcing the need to raise domestic interest rates to protect our reserves position.` Our exchange rate policy, with the consequent high interest rates necessary to defend it, is in fact a barrier (amongst many others) to economic growth at our true potential, without which it will be just too painful to address the fiscal deficit.

A good hard reconsideration of the need to realign the central exchange rate to the Euro at a competitive level, which can be defended throughout ERM II without being forced to apply high interest rates on a flat economy, will not only give a growth boost to productive sector but will help to keep monetary policy attuned to domestic realities.` Only when the economy is stable and growing at normal rates can we afford to give up our monetary and exchange rate policy management and fuse our currency in the Euro.

Friday, 8 April 2005

Beyond John Paul II

The Malta Independent 


Tony Blair has been UK`s Prime Minister for less than eight years, had to seek confirmation from the electorate after four years and can only continue in office beyond next month if the UK electorate nods approval for another parliamentary term.` In spite of leading over one of the most prosperous and peaceful terms in British post-war history Tony Blair can at best expect to be returned with a much reduced majority.

Karol Wojtila was elected Pope more than 26 years ago, never had to worry about seeking confirmation from those that elected him to continue in his job and only death last Saturday could terminate his mandate.

One might say that the comparison is faulty as the Pope leads a religious organisation that receives its mandate from the Almighty and has a final objective to conduct its faithful to a way of life that leads them to the prize of eternal happiness in whatever awaits them beyond this valley of tears, whilst mortals like Tony Blair get their mandate from lesser mortals who, unlike the Almighty, are prone to errors of judgement and switch of opinions.

Today we bury Pope John Paul II.` Much praise has been heaped on him to the extent that he has been hailed as John Paul the Great by strong Vatican sources who normally reserve such superlatives to someone unquestionably on the fast track to sainthood.

The greatness of John Paul II is contestable.` Anybody who stays for more than 26 years as head of an organisation spanning the globe and counting its members in billions, can claim greatness. If such person comes with the strength of character, charisma, intelligence, energy, communication skills and fortitude as Karol Wojtila than his greatness gets emphasized. If on top the papacy comes at a time when a social system embraced by half the world in the various forms of communism, starts crumbling internally under the weight of its inherent economic inefficiency and the pressures of disgruntled citizens against oppression of their civil liberties, disgruntlement well known and directly experienced by the Pope himself, than the Pope`s greatness can be equated in the minds of world opinion as making a significant contribution to accelerate the collapse of the communist system, restoring liberties to millions in Eastern Europe and beyond.

So there is broad agreement that Karol Wojtola was a great man, a great statesman, a great politician and a world leader with moral authority bigger than that of elected politicians whose stay in power is briefer and more transitory.

But when it comes to analysing whether John Paul II was a great Pope, opinions are not one-sided. A significant element of catholic opinion, especially those elements inspired by liberation theologies who wish to advance the spirit of the Vatican Council to continue to take the Church closer to its people, consider John Paul II`s` rigid conservatism as reducing the relevance of the Church in the ordinary life of its faithful.`

The argument has been made that John Paul II was good for the world, good for Christianity, good for other religions with whom the church re-established cordial relationships but very doubtful if he was good for his catholic flock.

To the oppressed in communist countries he could deliver fortitude and inspiration to unite and use their collective force to change the system to a democratic one built on capitalist principles.` He delivered what was neigh impossible for many other world leaders to deliver even though it was more within their competence than the Pope`s.

But to the poor who are dying of malnutrition and Aids, the Pope did not deliver what only he could deliver and what was well within his power to deliver i.e. more liberal teachings regarding procreation and the use of condoms.

The conservative elements within the Church argue that the Pope`s duty is to conserve the teaching of Christ the Lord and not to adjust principles to contemporary fashion. So they argue that it beyond the Pope`s remit to change the principles on which the Church has been founded and his duty is to guide the faithful to comply with the Church`s teachings rather than allow changes to suit the wishes of the faithful.

Probably in time if the world survives, our descendants will look back at such teachings the same way we now look at the Church`s mediaeval treatment of Galileo. But passing judgement in real time is difficult and the conflict between the liberal and conservatives within the Church will now erupt more forcefully than ever both in the process of selecting a successor Pope and beyond.` It is unlikely that the next Pope can command the same stature and character of Karol Wojtila who could silence dissent merely by his looks.

As the next Pope will be elected by a college of Cardinals who have almost all been appointed by John Paul II who was not known to promote dissenters, it is most unlikely that the Pope`s successor will be willing to depart substantially` from the conservative teachings promulgated under John Paul`s II tenure .` The liberal element with the Church can at best hope that the next Pope will be a short inter-regnum to allow a cooling off period before the liberal elements within the Church can gain sufficient influence in the corridors of the Vatican.

If the next Pope is elected by the college of Cardinals then the vast millions of Catholics who are detached from the Church because their life and social values cannot adhere to its teachings (and these include the vast majority of married couples who disregard the Church teachings regarding birth control) can only expect to continue living in a religious desert. If the Pope is chosen by the Holy Spirit there is better hope of getting a new Pope who is less of a politician but a better Church leader who hears the moans of his faithful and takes an objective fresh look in adapting the Christ principles to the relevance of their current way of life.

And if the next Pope is to use the moral authority of his position on the world stage let him be the defender of the poor, especially in the African continent, who are not partaking a fair share of the riches that God bestowed to his Earth.

Sunday, 3 April 2005

Neighbours and Mirrors

The Malta Independent of Sunday

The argument that Banks are abusing their dominant position is often made as many wonder how Banks could return record profit growth in the context of a stagnant economy. The disconnection between the lackluster performance of the economy and the stellar performance of the main banks could, to some, be only explained by the excessive exploitation or outright abuse of the banks’ dominant position.

That the two main banks have a dominant position on the local market is uncontestable. That there is no effective competition in the local banking sector is a well founded suspicion especially since the acquisition of Mid-Med Bank by HSBC has reduced an important competitor that HSBC were previously offering via Midland Bank.

The accusation of abuse of dominant position in the banking sector has now received a strong boost as it has been made in quite explicit terms by none other than the Governor of the Central Bank who is ultimately responsible for monetary policy and financial stability. This is what he had to say in a recent interview about the Bank’s paying unrealistically low interest to their depositors.

Another factor that has undoubtedly served to encourage consumption, and even possibly investment abroad, has been the relative unattractiveness of the traditionally preferred saving outlet, the 12-month fixed deposit. The gradual reduction in the Central Bank of Malta's central intervention rate these last years was followed by more than proportionate cuts in the rates offered by banks on fixed deposits, probably because of the abundant liquidity available at the time. In today's tighter liquidity conditions, a 12-month fixed deposit rate of about 2.6 per cent may now be considered inappropriate.

While the impact of these behavioural shifts on the balance of payments is likely to stabilise over time, the Bank is nevertheless concerned about the apparent imbalance between spending and saving patterns and will be monitoring developments much more closely.

This accusation is so serious that one has the right to ask why is it that the Governor is simply complaining lightly about it rather than using the authority of his position to correct what needs to be corrected. Whilst the Central Bank is no longer the direct regulator of the banking sector, its monetary policy and financial stability functions afford enough tools to ensure that banks start giving more weight to their macro-economic responsibilities. Their size and dominant position should offer easy profit maximization opportunities but these need to be tempered by their responsibility not to damage the stability of the economy by inducing excessive consumption and discouraging savings.

Is the Governor right in claiming that in the context of a Central Intervention Rate of 3% which has been kept steady for more than a year by the Monetary Policy Council of the Central Bank, a fixed deposit rate of 2.6% for a 12 months fixed deposit is inappropriate to stimulate a sustainable balance between saving and consumption and to protect the official reserves of the country as extremely low interest rates offered to local depositors force them to seek better investment opportunities outside the country?

There is no clear case for the Governor’s contention. The overnight deposit facility that the Central Bank offers to banks is 1.5% whilst the deposit rate for 14 day deposit is 2.95%. Six month Treasury Bills yield 2.98% whilst 2 years government paper yield 3.20%. Given that banks have to make a margin on their deposits does it seem that a rate of 2.6% for 12 months deposits is out of sync with the general money market condition?

I try to shed some light on the matter by tracking interest rates paid by banks on time deposits in comparison with the 6 month Treasury Bill rate:

                                              Weighted average time deposit rate             six month T B rate          margin

1998                                                     5.35%                                          5.50%                  0.15%

1999                                                     5.43%                                          4.96%                  -0.47%

2000                                                      5.25%                                         4.94%                  -0.31%

2001                                                      4.98%                                         5.04%                   0.06%

2002                                                      4.39%                                         3.80%                  -0.59%

Dec 2003                                               3.45%                                         2.93%                  -0.52%

Dec 2004                                                2.87%                                        2.98%                    0.11%

Source: Central Bank of Malta

While it is true that in 2004 Banks have succeeding in closing the gap between the interest rates they pay on time deposits and the six month Treasury Bill rate, this was only following 2 years where this margin had widened to record level as interest rates were coming down and banks were locked in to pay higher interest on their time-deposits during 2002 and 2003 . During 2004 the central intervention rate remained steady at 3% and therefore the banks had the opportunity to renew their deposits at the lower rate catching up on previous years.

Especially if one looks at the experience prevailing in 1998 when there was more competition in the banking market, there is nothing to support the Governor’s conclusion that banks are under-paying interest on their deposit through some abuse of their dominant position. If anything it was only in 2004 that Banks had the opportunity to restore their margin to somewhere near they were in 1998 and only because the central intervention rate stopped falling.

So if the Governor is unhappy with the rapid fall in savings ratios and the loss of reserves as savers start preferring foreign investment products rather than the traditional fixed deposits, it may well be that he may have to look for the real reasons somewhere much closer to his seat.

Banks are paying low interest on their deposits because the Central Bank has brought the central intervention rate to a level that neither stimulates savings nor offers sufficient safeguard against the risk of capital leakages. At the same time the low interest rate in the context of an uncompetitive economy is not increasing the demand for investment finance so that the economy remains overly liquid. The consequences of this over-lax monetary policy is pretty well reflected in the asset price inflation we are experiencing as shown in the House Price Index published by the same Central Bank in their Quarterly Review 2004:4 and in the MSE Index which shows a strong inverse correlation with the movement of the central intervention rate.

Is the Central Bank joining the national habit of blaming neighbours before looking at the mirror?


Friday, 1 April 2005

Plain Talk About the Euro

The Malta Independent 

Just when we needed some plain talk about the project to join the European Monetary Union (EMU) by giving up our national currency and adopting the Euro as our common currency with other EMU members, the Governor of the Central Bank came out with a long-winded interview which does nothing if not confuse issues more than are already confused.

I have not heard any serious objection about the final destination of Malta`s Euro project.` Indeed this was an obligation which we took upon ourselves as part of the package to become EU members and as such is already beyond the point of any argument of whether we should or should not.

What remains to be decided is when should we join the Euro and at what rate should we fix the conversion of the Maltese Lira into the Euro.` The Central Bank has been quite adamant on these points. We should join earlier rather than later and ideally not later than 2008 and we should join at current central parity of about EUR 2.30 for every Maltese Lira.

The Central Bank`s argument for these dogmatically held views are however unconvincing. They verge on the irresponsible in neglecting the daily realities of the Maltese way of life and could blindly expose our social fabric to sharp shocks through the dire consequences of joining the Euro in an unprepared state and at a rate that conserves and accentuates our lack of global competitiveness.

This is what the Governor had to say about fixing the Maltese Lira into the Euro at current level :

`the methodologies and the results of the Bank's study were shared with local and foreign experts, from the ECB and from fellow national central banks in the EU and in North America. Subject to the caveat referred to above, these experts generally share our conclusion that there is no unequivocal indication of a significant misalignment in the exchange rate`

Read it several times before proceeding and realise that the Governor does not usually give impromptu interviews but reads out well rehearsed text to pre-advised questions so that each word is carefully selected to be factual even if tilted to deliver the message the Governor wishes.` Note that the Bank`s views are subject to conditions about fiscal consolidation and economic restructuring which have been promised long and delivered short.` Note the experts consulted share the Bank`s views only generally. Inevitably this means that were divergent views on several details.` And to what views do such experts agree only generally` To the view that there is no unequivocal indication of significant misalignment in the current exchange rate level.

This could mean that: there are indications that the rate of exchange is significantly misaligned but these indications are not unequivocal` ( what is unequivocal in this uncertain world other than death and taxes, may I ask`)

that the general view including that of the Central Bank is that the current rate of exchange is misaligned but not to a significant degree.

All these double negatives and convoluted way of expressing views on such a crucial matter indicates that the Bank`s views are based more on dogma rather than proper objective analysis.

In fact the Bank continually preaches the virtues of maintaining stability in the exchange rate peg even in the process of fusing the Maltese Lira into the Euro but avoids the more important issue that needs to be addressed. At what level do we want stability for the exchange rate ` at the nominal level or the real level`

My argument has been that real level stability in the rate of exchange is much more important than nominal rate stability and it is important for the central parity conversion rate into the Euro to be fixed at an equilibrium rate that restores stability to the real rate of exchange. This in order to make us internationally competitive and to generate growth based on productive efficiency rather than unsustainable consumption fuelled by unrealistically hard exchange regime which makes consumption imports cheaper to the detriment of our export potential.

As to the date when we should join the Governor said: The argument has been made in some circles that the adoption of the euro should be postponed to allow a slower pace of fiscal consolidation. My reaction to that - which is spelled out in my speech to the Institute of Financial Services in November 2004 - is that fiscal consolidation is an end in itself, regardless of whether Malta adopts the euro in the short-term or not because healthy public finances are a fundamental aspect of sound economic management. A country cannot live beyond its means indefinitely. Easing the pace of fiscal consolidation, moreover, would also make meeting the fiscal criteria at a later date even more difficult as it would result in the accumulation of debt and higher debt-service payments, requiring even greater cuts in non-interest spending or increased taxation later on. This would send negative signals abroad about the country's resolve to undertake the necessary reforms, probably leading to a downgrade by credit rating agencies and harming both Malta's image as an investment location and the exchange rate. I would be the last one to disagree with such views.` But I am realist and I know that fiscal consolidation in the second half of a legislature is as likely as snow in August. We are more likely to have figure fudging rather than real fiscal consolidation. We have had such figure fudging in each and every second half of the last two full legislature i.e. 1992-1996 and 1998 -2003.

Can we take the risk of adopting the Euro before actually delivering on fiscal consolidation and before restoring the competitiveness of our economy through real restructuring which involves adjustment pain that politicians normally avoid in the second half of a legislature

Do our monetary authorities realize the hard choice they would face if people lose faith in our ability to defend central parity under the new rules of ERM II` Are such fears not stoked by the possibility of approaching elections that could return a government that needs to use exchange rate as a policy instrument as the Leader of the Opposition has already indicated that he might wish to do if elected`

Timing is of essence for such a grand project as that of adopting the Euro which unlike EU membership does not allow for much transitional adoption of the new rules.` Indeed the rules of the game would change before we join the Euro from the moment we enter ERM II and declare the central parity.

Timing for Euro adoption is more suited for the first half of a legislature so that 2008 seems an odd choice.