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.

No comments:

Post a Comment