Revisiting a warning

29th December 2006

The Malta Independent - Friday Wisdom

On 24th February 2006, I had given this stark warning, through the medium of this column, to investors of Maltese shares quoted on the local Exchange. It is a warning worth revisiting:

“If you are investing in the quoted shares of our three main banks (HSBC, Bank of Valletta and Lombard), you have to be a momentum investor. Momentum investing is the antithesis of value investing. Whereas value investors search for the intrinsic underlying value based on fundamentals and only invest where they see that the market price discounts such fundamental value, momentum investors do not care much about fundamental intrinsic value.

Instead, momentum investors base their investment decision almost exclusively on the psychology reigning in the market. If there is a momentum building round a particular share or a particular market sector – even if this creates serious and sometimes awesome gaps between the market price and the underlying intrinsic value which would make such investment totally inconsiderable for a value investor – the momentum investor joins the pack and simply assumes that market momentum will continue to push share price(s) forward.

History shows that money has been made under both investment philosophies. The difference is that while value investors may have to wait quite some time for the market to discover the value discount and thus produce the capital gains they desire only on a long term basis, momentum investors can generally reap their returns within a relatively short time. The problem with momentum investing is that when the momentum peters out, as it unavoidably will once the price surge runs out of steam, there would be nothing left to support the wide gap between the market price and the intrinsic value and the value argument will have to come back into the equation. And just like a rocket that runs out of fuel it cannot keep hanging in the air; if it cannot surge forward it will have to fall back to a reasonable distance of the intrinsic value pulled by the investment value gravity.

There is nothing wrong in being a momentum investor, provided one knows what one is doing. Whoever chooses such an investment strategy must however realise that if it is too good to be true, then it is generally not true, and when the whole process would have run its course, there will be winners and losers – but the sum of the parts will be the same. Such investors have to make sure that they leave the party when the champagne is still flowing – as, the moment the champagne stops, there will only be tears for the road.”

The timeliness of this warning can be gauged with the benefit of hindsight, The share price of HSBC Malta is 28 per cent off its end February 2006 value and 35 per cent of the highs reached in March 2006. Bank of Valletta share price is 22 per cent off its end February 2006 value and 28 per cent off its peak in March 2006. Lombard is marginally still above its end February 2006 values and off only 11 per cent the peak reached in March 2006.

In spite of this sharp correction in equity prices in the second half of 2006 there is still evidence to suggest that, in comparison with their international peers, local equity prices still carry an unjustified premium, keeping value investors away from the market.

What is puzzling is why the share price of Lombard Bank seems to be living in a different planet from the share of the two bigger banks. There could be several reasons for this. Firstly the share price of Lombard Bank had not reached the dizzying heights reached by the other two Banks so the correction needed could be less pronounced.

Secondly Lombard could be commanding a premium in its price through a development which occurred during the second half of 2006 whereby Lombard acquired a strategic equity stake in Maltapost.

The market could well be pricing in the growth which Lombard could experience if this strategic acquisition is turned into an effective delivery channel to challenge the broad branch network of the two larger banks.

Yet Price Earnings Ratios of 15.24 for Bank of Valletta, 23.27 for HSBC Malta and 18.90 for Lombard still represent a substantial premium over the average of 12.58 for international financial services companies. The higher the price earnings ratio the more expensive the share price is in comparison to the profit generated by the organisation whose share price is being assessed for value indicators.

There is no rule that local equities should not justifiably command a premium over international peers but when such premium gets way out of anything that may be considered reasonable, then it is inevitable that sooner or later the market will have to adjust.

The question for 2007 is whether the price adjustment process has been completed or if there are pains yet to come as this process continues into next year.

As years go by

22^nd December 2006

The Malta Independent - Friday Wisdom

Another Christmas, another year! Time flies away so quickly. The year 2006 will soon be consigned to history. Sports enthusiasts will remember it as the year of the World Cup in Germany where Italy defied most odds and won a coveted prize from the clutches of Brazil that were considered as unchallengeable favourites.

Yet 2006 will probably be remembered for much more serious issues of life and death, war and peace, poverty or prosperity. In particular two new realities came to be in 2006 which will undoubtedly influence the developments of international relations for the years ahead. Both events are somehow related. Firstly 2006 was the year when Americans joined the rest of the world in the long held view that the war in Iraq is un-winnable for the US and allied forces. It is the year where the US has been frozen in Iraq in a quasi desperate situation where they know that they cannot reach their invasion objectives, but at the same time they cannot afford to leave without risking that Iraq tears itself apart in a religious civil war which will increase Iran’s influence in the region and threaten the stability of oil exports so indispensable for the world economy.

It is the year when Americans finally realised they elected the wrong president who led them into a cul-de-sac in international relations and brought to the fore the limitations of the undoubted military superiority power of the world’s sole superpower. It is the year when the Americans were forced to abandon their policy of staying the course in Iraq whatever the consequences, to the realisation of the imperativeness of seeking a more tolerable diplomatic solution by engaging Iraq’s neighbours in such negotiations.

The other major development is related. The 33-day war of Israel on Lebanon again exposed the limitations of using military power to obtain diplomatic concessions from non-state organisations like Hezbollah, whose value of life, even their own, is much lower than that of organised state powers and can therefore afford human shields, suicide bombers and other such like strategies to cultivate international pressure against the organised military force being used against them.

With the effective use of America’s international military power and Israel’s regional war capabilities substantially dented by these two events and with Iran strengthening its influence in the region not least through the use of the substantial money flows from its oil resources, it is fair to wonder whether Iran, and Syria, are not the real winners of wars they are involved in only by proxies.

There is nothing to suggest much confidence in the thesis that if Iran and Syria are engaged in multilateral discussions at diplomatic level to influence a negotiated settlement on the issues of Iraq and Palestine, the price they would expect for such engagement would be one that the international community should be prepared to pay. Iran will probably insist on its right to become a nuclear power in the region and Syria is likely to insist on its continued hegemony over Lebanon.

America’s impotence through the loss of the deterrent value of its military force, coupled with that of Israel’s following the unsuccessful Lebanon invasion, which has failed in all its major objectives, is leaving a dangerous void in the Middle East which does not augur well for future stability in the region based on the continued democratic development of its single constituents.

This void must be filled and it is the duty of the European Union and other European states not to allow this void to be filled by those whose values are not anchored on democratic principles and who think they can impose their fundamental religious beliefs on the entire Middle East region and then proceed to fight an oil war against western democracies.

A solution to the oil issue is an indispensable chip in the equation for a lasting solution in the Middle East. We are presently caught in a dangerous spiral where the more instability anti-western oil states create, the richer they become as the oil prices start reflecting a premium for the prospective instability of future supplies. This circle needs to be broken.

Inevitably the prize for breaking this circle is the re-emergence of Russia as a power at world level. As a non-Opec member Russia will be a crucial provider of energy exports to stabilise supply disruptions that could result from Middle East instability. Engaging Russia at international level and accepting that democracy in Russia cannot achieve perfection instantly and that occasionally lapses into autocracy are unavoidable in order to keep controlled development towards a working democracy, are essential for smoothening international relations.

But the bulk of the void needs to be filled by the EU. The success of engagement of former communist states into full membership is remarkable. In spite of short-term pain the long-term gain is there for all to see as the EU economy is now growing and is more competitive than it would have been without the enlargement to the East. Without fixing unrealistic time schedules the enlargement to the east must continue. The process of engagement itself would bring stability among neighbouring states. Without such stability the EU will have socially upsetting waves of illegal immigration and conflicts with bordering states.

May this Christmas bring peace to everyone. May world leaders reflect during this Christmas break on the need to lay down arms and work for peace through long-term diplomatic engagement. May they come to realise that the road for peace in Baghdad passes through Palestine and Israel rather than the misguided Bush strategy that the road for peace in Palestine passes through Baghdad. Tony Blair was always right; he was simply not forceful enough to make George W. Bush see the light and is finishing his career paying a price for a misguided policy he intrinsically never really believed in.

Cautious Optimism

15^th December 2006
The Malta Independent - Friday Wisdom

Economic data is continuing to show a general improvement in Malta’s economic performance. Provisional estimates for the third quarter of 2006 indicated an annual GDP growth in real terms of 2.7 per cent. International trade statistics for October 2006 have shown a small narrowing of the trade deficit for the month compared to the same month last year, with a 17 per cent increase in exports and a 22 per cent increase in imports of industrial supplies. The latter is indicative of further potential for export growth in the pipeline.

None of this should necessarily lead to the euphoria expressed over the weekend by the Prime Minister during the normal Sunday ritual of economic bulletins within the strange confines of local political party clubs, where people are more interested in beer than economic statistics.

However there is scope for cautious optimism; so much so that the opposition’s criticism of the government’s economic performance is rapidly losing its punch.

A 2.7 per cent real annual GDP growth is to my mind way below our natural potential for growth which is nearer to five per cent. We do in fact need much higher growth rates nearer to our indicated potential if we are to make progress to catch up on the EU average of GDP by 2013, after which period we will experience a substantial reduction in EU grant revenue. But considering that we are coming from a negative outturn of –2.3 per cent in 2003, a meagre 0.8 per cent growth in 2004 and 2.2 per cent in 2005, the progress is noticeable.

What gives scope for cautious optimism for 2007 are several factors which seem to augur for a stronger economic performance for next year. The economic growth recovery in our main export markets of the EU is remarkable and all indications are that economic growth in Europe will overtake that of the US next year. Strong economic growth in overseas markets leads to stronger demand for our manufacturing exports and in fact we are witnessing substantial growth of pharmaceuticals and microchip exports.

The 2006 performance is encouraging considering that one of our major industries, tourism, was working at half throttle. Nobody should doubt our potential to re-achieve strong growth in our tourism sector and if we manage to do it in 2007, then by and of itself this could add between one and two per cent to the GDP growth for 2007.

If on top of this we could be favoured by a more benign environment for international energy prices, even if this were to mean merely that oil prices would stay at around the current $60 level and the US dollar stays at around 1.32 to the euro, then the government could justify converting such cautious optimism into real registered growth that could lead to pre-election euphoria.

Clearly the government is banking on this sort of scenario as a favourable background leading to the general elections, hoping that the feel-good factor resulting from such economic growth will be enough to persuade the electorate to stay the course with whom they know rather than opt for change for change’s sake.

The government also knows that infrastructure projects to be financed by the EU grants under the 2007-2013 financial programme, will add further impetus to economic growth and resultant feel-good factor.

Yet there is no doubt that among the electorate, the government is suffering from fatigue and perceived arrogance. Many I meet doubt whether any amount of feel-good factor would be enough to overcome the desire for change after more than 20 years of the same faces in power, excluding the largely forgotten interlude of 1996-1998.

It would take a very high dose of such feel-good factor to give the PN scope for euphoria about their prospects for re-election.

On the other hand, the PN knows it has more than the feel-good factor to aid them in winning the electorate’s favour.

The point that Labour has been fossilised under an unsuccessful leadership for 15 years is being made with forceful persuasion.

Pity Labour could not find the courage and wisdom to present itself for the electorate’s choice not only with new policies but more importantly, with new candidates who do not carry the baggage of the misguided policies that changed the freshness of the1996 victory into failure of not being able to hold on to the executive power delegated by the electorate for even half a legislature in 1998.

Labour is not helping democracy to express itself through practical alternation of power.

Over Compliant

8^th December 2006
The Malta Independent - Friday Wisdom

 

Is it just an impression or are we really changing, and from a laissez-faire society we are fast turning into an over-compliant one? Are we becoming Swiss in the Mediterranean, giving up our sense of improvisation and turning into a regimented society?

What sparked off this strange thought was an experience I had last Monday evening. Just before six in the evening while at my office, my scheduler set off an alarm reminding me that I had to pick up my son from a football nursery at St Andrews.

I rushed for the usual road towards St Julian’s and when it was too late to turn I realised that I had put myself into a traffic bottleneck due to works started on the Manwel Dimech Bridge, which reduced this main thoroughfare to a one-lane road. Notices with deviation signs had sprung all over the place and warnings have been duly issued to avoid this traffic juncture while works were going on. I could only blame myself for negligently forgetting about these warnings.

I drove on and could not believe my eyes when I managed to sail through the tunnel approach and the tunnels themselves in a one-lane stream without any problems. My trip to St Andrews proved much smoother than usual when traffic arrangements are normal.

Evidently so many cars had followed the deviation routes that driving through the feared congestion proved totally smooth and effortless.

The conclusion can only be that when we were made to perceive compliance as less burdensome than non-compliance, irrespective of the real thing, perceptions prevail and people willfully comply. Nobody forced anybody to take the deviation. But warnings were duly given that if the normal route is chosen the congestion delay could exceed the delay for following a divergent route. And it worked so well that the feared congestion did not result at all.

Can we transfer this analogy to other areas where compliance is still deficient? How can we use it to achieve better compliance in our tax systems?

This is an area where compliance is important not just to ensure that the burden of financing the working of society is carried as intended by the tax planner, but also because a high degree of tax compliance is essential to ensure that social transfer payments are made on the basis of real needs. Unless we achieve a fairly high degree of tax compliance, many of the means-tested social benefits go to those that do not really need them and are denied to others who have a genuine claim for such social assistance.

Tax compliance obviously depends on the quality of the enforcement mechanism. Human nature being what it is, people generally try to avoid paying taxes if they see that the enforcement mechanism is lax.

In a lax enforcement scenario the cost of compliance is perceived to be higher than the cost of non-compliance and those who have a choice opt for the cheaper route.

However it is realised that enforcement needs resources and could become quite expensive in deviating a large amount of scarce resources to enforce taxes rather than to create wealth. It is not in the national interest to do so.

So before enforcement can be upgraded we need to find a natural balance where the marginal tax rate is low enough to tip the balance of choice. It has to be a rate where the cost of compliance is perceived to be equal to or less than the cost of non-compliance.

Once this fine balance is achieved the compliance ratio increases so much that the scarce enforcement resources could be applied vigorously onto the much smaller residual base that continue to avoid compliance. This would reinforce the culture of compliance as it increases the cost of non-compliance.

I know this is easier said than done. There are all sorts of implications that need to be taken into consideration but one must at least have a sense of destination of where we have to go with our tax systems. And I have no doubt in my mind that we need to arrive at the destination of creating a frame of mind similar to the one created for the traffic deviation system of the Manwel Dimech bridge. A frame of mind where tax compliance is perceived less taxing than non-compliance.

A frame of mind where tax-compliance is cheap enough to permit compliance so that we can use our traditional creativity and flair for improvisation for the proper use, both for consumption and investment, of the bigger residual value of the tax paid earnings, rather than to avoid tax and having to stash the tax liable funds idly under the mattress.

That December Feeling

1^st December 2006
The Malta Independent - Friday Wisdom

 

Unbelievable how time flies! Eleven months of 2006 are history and today we start the last month leading to a James Bond year.

Government is softly, softly slipping into an electoral mode and is doing all that is possible to create that feel good factor which has been missing since soon after the last election we discovered that rather than having government finances on a strong footing much more belt tightening was needed to come into euro shape.

Now no opportunity is lost to inform us that, inflation permitting, we are already in euro shape. This is however not the same as saying that we are in good economic shape. Having public sector deficit, public debt, interest rates, exchange rate and inflation within or moving gracefully towards the Maastricht criteria, is not necessarily synonymous with an acceptable economic performance.

The true criteria for the latter are much wider. They have to include employment creation, labour participation, balance of payments situation, level of investment and overall size and nature of economic growth always benchmarked to that of our main competitors which in our case ought to be the new members of the EU rather than the old ones.

Yet there is no denying that achieving a smooth fusion into the euro monetary system is an important economic milestone which could be a catalyst for the achievement of the wider economic objectives. The euro project will dominate the economic calendar of 2007 and will no doubt be used by the government to generate a sense of pride and achievement which will generate a feel good factor for an election which could be held with a few months on either side of the actual euro entry in January 2008.

This December, possibly being the last Christmas month before the next election, will be a good launching pad for the government to stimulate such feel good factor so essential for the electoral democratic test. Facing the run up to Christmas with budget discussions well behind us will no doubt help to focus people’s attention on increased consumption which is typified by the quantity of people in our best shopping streets and malls.

The new traffic and parking arrangements for Valletta, which are only suffering the consequences of their success in that the car park at Blata l-Bajda gets full too early each morning, should make more people rub shoulders in our Valletta streets and in the process rubbing on each other the feel good factor which comes from the joy of Christmas shopping.

International events are also helping to permit the government some latitude to engineer an immediate increase in the spending power of the population without involving budgetary measures. Free parking for Valletta shopping is a small but significant contributor in this regard. Shifting the wardens’ focus from negative fine levying disciplinary attitude to more positive supervisory and environmental duties also eases a drag on the feel good factor.

However it is the happenings in the international energy and foreign exchange markets which are the best harbinger of good news to the local consumer. With oil prices stable at around 60 dollars well off the peak of 78 dollars hit earlier this year, and with the US dollar sliding back in value against the euro, and consequently against the Maltese lira, to the lowest levels last seen this time in 2004, will permit the government to announce on this very same day a substantial reduction in the surcharge on utility bills and reduction of fuel prices at the pump.

All these things falling together at the right time seems to be a coordinated effort, aided by a stroke of international luck, to generate what the GRTU has proclaimed as having the prospect of being the best Christmas for a very long time, from a commercial point of view.

Other measures of a more social nature should also help in having a better Christmas than last year. Certainly the curtailment of open bar parties is an overdue step in moderating the binge drinking culture among our youth.

Yet even while enjoying a good December and a peaceful holiday season we must not think that all is fine and dandy. The fact that the economic situation is better than it was in the first half of this decade is not the same thing as saying it is fine and where it should be.

With tourism, one of our most forceful economic engines working at half throttle, we can never be satisfied with our economic performance. What can sustain or wither away the December feel good factor for the rest of the run up to the general elections is the performance of our tourism sector where we have long been operating well below our capacity.

If we can put our house in order from a (hard and soft) quality point of view and render Malta as a cool destination on the European tourism map, possibly aided by the availability of flights on newly operating low cost airlines, next year we can possibly have the best performance in tourism since the turn of the millennium. No other industry can have the same multiplier effect generating a sustainable feel good factor than tourism, where the value added stays locally given the domestic ownership of most tourism outfits.

Our performance in the tourism sector next year could make or break the feel good factor which this December could help set in motion.
   

Fixing Labour`s Leaks

24^th November 2006

The Malta Independent - Friday Wisdom

The best cure for corporate information leaks is transparency. Contrary to common wisdom, transparency does not give unfair advantage to opponents in getting wind of corporate plans. On the contrary, transparency is indispensable to get everybody on board and fire up everyone in the organisation with enthusiasm for achievement of the set mission.

Most of the time in corporate affairs what matters is not what you do but the way that you do it. While what you do could be easily copied, the way that you do it is much more difficult to copy.

Getting everybody pulling in the same direction, imbued with the enthusiasm of a mission worth toiling for, demands inspirational leadership which cannot be copied. When all resources of the organisation are brought working smoothly together, re-enforcing each other, and covering each other’s weaknesses, leakages do not happen.

If they do they are harmless and best ignored as normal human weaknesses. Because leakages, if they happen under inspirational leadership, would concern what we do, which through transparency is generally already in public domain and hardly worth leaking out. The more important how-we-do-it is simply not capable of being leaked out. It is intrinsically copyrighted and protected from piracy.

So the very existence of leakages is proof that not all is well within Labour and that the leader has not succeeded in injecting everyone with the enthusiasm of the supposedly coming victory as he had done in the period 1992 to 1996. There were no leakages then. There was hard work, dedication, and enthusiasm focused on the ultimate objective. It seems different now. Labour’s energy is now dispersed in internal factions who seem more concerned in protecting their turf rather than in getting the PN off their pedestal.

So the first obvious conclusion Labour ought to reach is that the leakages are proof that the leader is failing in performing up to scratch. This is hardly surprising given the way that the leader achieved his re-election following the 2003 electoral defeat. At the time I was a delegate of the general conference tasked with electing the leader from among three candidates, the incumbent and two challengers.

In being forced to vote to choose a leader for the next five years before conducting a deep and objective analysis of the causes of the 2003 failure was putting the cart before the horse and giving an unfair advantage to the incumbent. I did not accept it, tried to use internal persuasion to avoid it, and finally after exhausting all internal avenues and got nowhere I wrote officially about it and was warned that my absolute truth was harming the party. I quit as I can only work in organisations where things are done right down the middle.

Wherever I lead in business the boardroom is generally an open door and I insist that the more people know what we are deciding and why, the more likely it is that we find cooperation rather than obstacles in the execution of such decisions on which ultimate success depends.

On the crucial things I could not afford leakages, and these are generally tactical, not strategic. I just keep them to myself and try even not to look at the mirror lest it also suffers from the human weakness of enjoying breaking the news as a show of more importance and superior knowledge.

So there is no doubt in my mind that the indirect cause of Labour’s leakages is its lack of inspirational leadership. As to who is the immediate source of the leakages, for as long as the information was known to two persons, you can never be sure about it.

What is strange however in this whole affair is that the leakages are weakening the position of both deputy leaders. Charles Mangion is in the eye of the storm, accused of taking business friends in an official delegation to Dubai. Frankly as long as they paid their bill I fail to understand what’s wrong in having trusted friends to advise on technical matters. Their inclusion in an official delegation was no doubt blessed by the leader. I would be more suspicious if they were in a separate unofficial delegation. Do the PN expect to decide whom Labour should take advice from?

Why Alfred Sant is making very little effort to do the work of a true leader amuses me. A true leader would take full responsibility for the Dubai visit and send the PN packing, telling them to take care of glaring conflict of interest within their ranks, rather than get scandalised with eventual potential conflict of interest of a future Labour government. Alfred Sant’s standoffish behaviour must have a meaning.

But even more meaningful is his public outbursts on having cornered the “snake” within Labour who was supposedly making these leakages directly to the PN headquarters and pointing to a key assistant to the other deputy leader, Michael Falzon. Unless the objective is weakening Falzon’s public image a true leader would first admit to himself that he is failing in inspiring all and sundry with his mission, and then treat such matters with internal persuasion and if necessary internal discipline. Public outbursts harm the organisation and throw us back to the times of Robespierre in the French revolution.

Unless of course Sant means to stay as Opposition Leader even in his pension age and leakages serve a purpose in providing an excuse for lack of electoral success when it really matters.

Barbarians at Kirkop Gate

 17^th November 2006
The Malta Independent - Friday Wisdom

Kirkop’s relevance here is that it hosts Malta’s primary manufacturing industry, ST Microelectronics, by far our largest exporter and certainly one of our major success stories in manufacturing, wherein a small industry that started here in the early 1980s grew and developed itself at the cutting edge

of the semiconductor technology.

We owe much for this to Sicilian born Pasquale Pistorio, a former Motorola executive, who managed to turn the French and Italian chronically loss-making semiconductor companies into a profitable Franco-Italian combination. Even better, it has grown to become the world’s fourth largest supplier of microchips after Intel who command 15 per cent of the world market, Samsung with seven per cent, Texas Instruments with five per cent. It holds the fourth ranking jointly with Toshiba at four per cent each.

Pistorio was the person responsible for locating the plant in Malta in 1980, no doubt motivated by the possibility of quality production at a low cost. Since then the plant found many other reasons beyond the cost factor to flourish at Kirkop. It is with good reason that Malta recently bestowed upon Pistorio a state decoration. We owe him much more.

Pistorio is now retired but his privately expressed views are still sought within the industry. Recently during a conference in Paris he reiterated his long held view that the semiconductor market will ultimately be concentrated around a handful of giants with a myriad of smaller niche satellite players alongside.

This basically means that the market is ripe for a period of consolidation through mergers and acquisitions to combine operating units, thus streamlining production and saving on exorbitant research costs.

The process has already started. Recently Philips, the Dutch conglomerate, sold its microchip production divisions to Kohlberg Kravis Roberts (KKR), a giant in the world of private equity investments.

KKR are the original barbarians. In financial terminology barbarians is a term used to define hedge funds and private equity funds who are attracting huge billions of dollars from private investors giving them unimaginable financial strength in order to make friendly acquisitions. In some cases they use these funds to position themselves, even in a hostile manner, commanding significant stakes in large companies where they perceive the management is not doing a good enough job and that value can be extracted by using shareholders’ rights to push for changes that management, in their opinion, is not strong enough to execute on its own.

A typical example this week is Deutsche Telekom (DT). Their CEO was forced to resign during the fourth year of his five-year contract. US private equity giant Blackstone through their five per cent equity stake in DT, thought he was not delivering shareholder value. Blackstone were termed locusts by the former SPD government who had resisted such approach but the Merkel government saw the validity of the argument and through its sizeable shareholding blessed the change at the helm of DT, which is still a German flag carrier on the international scene.

The term “Barbarians at the Gate” knows its origin to a book (and subsequently a film) dealing with the leveraged acquisition in 1988 of RJR Nabisco, the American food giant, for a record of USD 31.4 billion, most of which was financed by debt. It remained the largest acquisition till 2006 when we are starting to see bigger figures in acquisitions due to the plentiful supply of private equity liquidity.

Barbarians refer to the heartless way in which such private equity investors move once they acquire control of a company in order to cut down its costs and recover their leveraged investments as quickly as possible.

On the assumption that once KKR made a sizeable investment in acquiring Philips microchips division they will be on the lookout to acquire similar sizeable outfits which could be merged for extraction of better value added, and considering that once this process starts four per cent market share companies will either have to downsize to satellite status or grow into a mega force through mergers and acquisitions, it is highly likely that the barbarians are already at the gate of companies like ST Microelectronics.

The French and Italian government through their shareholding are likely to resist the barbarians at the gate for some time, certainly until the French presidential elections are out of the way. But once the elections are over, it will become hard to resist the logic of consolidation for survival and thus to keep the barbarians outside the gate.

Whether this will be good or bad for the Kirkop outfit depends on the level of competitiveness and innovation housed within the plant. If, as I have the impression, the Kirkop outfit is one of the most successful and avant-garde plants of ST with considerable cost advantages, the Barbarians’ arrival at ST’s gate could well prove to be a blessing for Malta.

Cut to Size

10^th November 2006
The Malta Independent - Friday Wisdom

This week US President George W Bush was cut to size by the electorate who gave a very hard drumming to his Republican Party in the mid-term elections, causing a very significant switch of power outside the White House. The Democratic Party now controls both the House and the Senate on Capitol Hill.

This is a belated wake-up call by the American public who in fact never elected Mr Bush in 2000 and by all evidence he had snatched victory from Democratic Presidential candidate Al Gore only because the US Supreme Court did not allow sufficient time for a detailed recount of the Florida vote. On a national basis President Bush had in fact obtained less votes than Mr Gore. On both moral and legal grounds based on facts that subsequently emerged, Gore rather than Bush, should have become the 43^rd President of the US.

One could ask whether the re-election of Mr Bush in 2004 legitimised his original dubious election. Given the facts of this week my view is that it has not. In 2004 Bush was re-elected on the platform of his being a war President. He postured himself as being against national interest to change the Commander in Chief when the country was at War in Iraq and elsewhere in the famous cliché of War against Terror.

The deep sense of US patriotism worked in Bush’s favour and the American public continued to endorse their Commander in Chief. They were impressed that changing him would be interpreted as admitting defeat in the War against Terror.

But this week the same platform that re-elected the President in 2004 brought his Party’s downfall in a major shift of US political fortunes. The American people clearly have had enough with the deception that is going on Iraq and they sent a clear message that they want an honourable and programmed exit out of that theatre of war.

The US electorate voted in much higher turnout than is the norm for mid-term elections re-enforcing the clarity of the message for change. The electorate’s nervousness over the situation in Iraq can be appreciated better if examined in the context of a very strong performance of the US economy since Mr Bush re-election in 2004.

Normally domestic economic issues, which are the main contributor to general feel good factor, over-ride any considerations related to international relations. In fact President Clinton for his election in 1992 had coined the term ‘ it’s the economy, stupid’ meaning that the electorate is more concerned about economic issues that effect their standard of living rather than to celebrate President Bush Sr. ( the 41^st President) success in the first Gulf war.

This time the ‘it’s the economy, stupid’ syndrome has not worked. The feel good factor generated by above average economic growth was largely eclipsed by concern about the heavy casualties being suffered in Iraq against a background of lack of progress in moving the country towards anything resembling a working democracy.

More US military personnel have now died in Iraq than the number of casualties suffered by the Twin Tower terrorist attack of 2001. Yet Iraq remains a jungle of sectarian interests where each section imposes its views through the use of unlawful militia or underground terrorists. Every day tens and hundreds of Iraqis are killed in such sectarian warfare with the weak central government unable to take effective control of the country in spite of the support of coalition forces.

The electorate felt that the fight for peace in Iraq has become unwinnable and the expectation that a truly democratic Iraq could become a beacon for the spread of democracy in the whole middle east was an unrealisable pipedream. The US situation in Iraq has become a sure loss whatever they do. They lose if they stay and they lose if the leave, given that the country could easily fall into civil war breeding a new wave of international terrorists and increasing the influence of Iran in the region sufficiently to bring into question the stability of oil exports even from nearby Saudi Arabia.

The electorate finally realised that it has been deceived into electing a War President who waged war on false pretext and who celebrated mission accomplished when the real war of bringing order in an occupied Iraq had not even started and as it turned out was either very badly planned or not planned at all.

President Bush seems to have heeded the message enough to engineer the resignation of Defence Secretary Rumsfeld within a few hours of the election result. Rumsfeld was untouchable just a few days before. This is a good start for achieving bi-partisan support for adopting new perspectives regarding Iraq. It is not enough. If Bush means to work with a Democratic Congress he needs to do more. If Vice-President Cheney, the prime promoter of the Iraq adventure, cannot be made to go, he must be sidelined.

Smartless

5^th November 2006

The Malta Independent on Sunday

I don’t think it is very smart to announce the project when negotiations with the investors are still proceeding. Clearly, the minister felt comfortable enough to present it as a fait accomplit, when in fact it is still not so. Is this not exposing us to the risk of other locations making more advantageous offers to attract the investment to their shores? And it is obvious that by going public rather prematurely, the minister has weakened his position in negotiating the outstanding issues, as the investors know that the minister would lose political capital if he does not accommodate their additional demands.

This is a verbatim quote from my contribution of 3 March 2006 entitled Smart and not so smart published in my Friday column in the daily sister to this newspaper.

The inevitable has happened. The minister responsible had to admit in parliament that negotiations with the investors are not proceeding as smoothly as he expected and he basically gave the investors a warning that unless agreement is reached soon, the government will have to pull out of the negotiations.

Clearly this is a case where political self-serving interests over-rode national interest and to obtain short term political mileage the Minister weakened his negotiating position and had to make a volte-face in parliament in order to regain negotiating leverage. Hopefully, this will be enough to help conclude the deal on reasonable terms, but nothing is in the bag before it is in the bag, commitments are signed for, the ink has dried and the financial security has been provided.

It will be just as well to learn from this experience and remove narrow political interest from the equation when this starts conflicting with the national objective. This applies particularly to the euro project.

The Leader of the Opposition in his budget reply in parliament on 25 October announced that if Labour is elected to power before the materialisation of the euro project, basically if Labour wins an election held in 2007, despite past misgivings it will not abort the process and will, for the sake of stability, proceed with euro entry on 1st January 2008.

National interest would have demanded that the rare newly-found consensus be cultivated to make the euro project a really national affair. Such national unity would help to make the changeover smooth and help avoid inflationary impulses. An absence of such national unity could well harbour inflationary expectations, which are an assured source of real inflation.

Yet rather than grasp this quite unique opportunity, the reaction from the government side was purely self-serving for its narrow political interest. It retorted that the opposition was making another U-turn and in so doing was confirming that government policies were succeeding and delivering a strong bill of health.

The logic of these arguments escape me. Euro adoption is no certificate of economic clean bill of health. Good husbandry in public finance is not necessarily synonymous with overall economic health. The measures of overall economic health go far beyond the Maastricht criteria for adoption of the euro. It involves the size and sustainability of economic growth, the level of unemployment and overall labour participation, the stability of our balance of payments and the control of inflation to be consistent with that of our major competitors.

On all these wider economic criteria our performance leaves much to be desired. The general idea is that euro adoption can hopefully serve as a catalyst to stimulate economic growth by attracting more foreign direct investment, the achievement of higher levels of efficiency and an increase in exports, so addressing the chronic shortfall in our balance of payments.

So rather than castigate the opposition for making an effort to achieve consensus that could lead to higher indirect rewards – as we have experienced through the success of the consensus in the financial services sector – the government should have celebrated the consensus. It should have encouraged the participation of the opposition in the broad spectrum of initiatives that should lead to the adoption of the euro and the few months thereafter until we are all settled into the new reality.

We are simply not smart enough to take opportunities as they come and build on them to achieve the success that is being enjoyed by the east European countries that joined the EU with us. These countries are registering growth rates far higher than ours, even if they have put back their euro ambitions far behind us in the calendar. Maybe their priorities are more logical than ours. But what is important is not whether we join the euro now or later, but that once we achieve consensus on something, we celebrate it and build on it, rather than fight over who had to sacrifice his principles on the way to achieving the consensus.

Under-Rated Events

3^rd November 2006
The Malta Independent - Friday Wisdom

A string of four events in these last few days have been under-rated by the media. They are worth dwelling upon.

Let me start with the two local events. In his replica for the budget speech, the leader of the opposition made a very important declaration which practically was eclipsed by his other pledge to remove half of the energy surcharge on acceding to office.

He pledged that if elected to power before Malta joins the euro, ie. should elections be held during the course of 2007, he would not abort the process for Malta’s entry into the euro.

The leader of the opposition was not specific enough about the rate of conversion, given opinions he had expressed in the past that we should only join at a more competitive rate. However the evident assumption is that the process of joining the euro could only be accomplished if the chosen rate at the ERM stage will not be changed on the eve of accession. The leader of the opposition would do himself and his party a hell of a lot of good if he clarifies this point beyond doubt in the course of the budget debate in parliament.

The implications of this novelty for the outcome of the next general elections should not be underestimated. But endorsing this policy of continuity for the euro project, the leader of the opposition has removed an unfair advantage he had given to the PN who were clearly planning of making the euro entry as a key point of distinction for the next election.

With the MLP now aligning itself to the rest of the country regarding the euro, the election will be fought on real bread and butter issues which is not what the government would have preferred.

Another local event which merits further attention is the clarifications which the Parliamentary Secretary for Finance gave in this newspaper last Monday to technical queries I raised in my contribution of last week. Thankfully he clarified most of my misgivings by pointing out where in the maze of figures I could find the answer to my doubts about revenue neutrality of certain measures, without which the whole issue of budget sustainability could be brought into question.

But one important issue which was only clarified in a negative way was that the true sustainable budget deficit for 2006 is in reality well above three per cent if the extraordinary revenue from sale of land is treated substantially rather than superficially.

The point made was that the budget deficit for 2007 is planned well below three per cent without the help of such extraordinary measures, but frankly the weight of the current numbers is much heavier than that of projected ones.

On the international front, one should give much more weight to the report published by the British government on the economic cost of neglecting the problem of global warming resulting from uncontrolled carbon emissions.

A report by Sir Nicholas Stern, former economist of the World Bank, endorsed by former US vice-president Al Gore, suggests with convincing empirical research that the cost of taking preventive measures now will be surpassed by five to 20 times over the next 50 years if the problem is neglected. An increase in the average world temperatures of a mere four degrees would bring economic havoc on an international scale which Stern suggests could easily compare to the great depression of the thirties.

By framing the problem in economic terms, it is hoped that politicians who were against the Kyoto agreement, which indeed is by itself a very insufficient first step compared to the measures which Stern considers absolutely necessary, will surrender in the face of stark economic reality and accept the introduction of marketdriven measures which can sustain a global effort for a step reduction in carbon emissions.

But what takes the cake for the under-rated event of the week is the statement made by George Bush during a press conference, meant to address the damage being done to the Republican’s party prospects for retaining control of the House of Representatives and Senate in next week’s election, by the bloody events in Iraq which rendered October 2006 as one of the most casualty heavy month for US forces there.

President Bush said that over these last three and a half years since US forces have been on the ground in Iraq there has been a mixed bag of good and bad news and identified amongst the bad news the inability to find weapons of mass destruction.

This is turning history on its head and I wonder how the President was not torn to pieces about it by the journalists present.

The absence of weapons of mass destruction is not bad news. By itself really it is good news. The bad news is that the US had entered into war on false pretext and faulty intelligence which is why it is desperately trying to find new reasons to justify their staying there.

In fact one of the most raving arguments in the US campaign is whether America’s interest, now that the Iraq omelette cannot be switched back to wholesome eggs, would be best served by staying in Iraq or by withdrawing.

The Republicans justify US presence in Iraq as a success by linking it to the absence of new terrorist attacks on US soil. The cause and effect in this argument is very subjective and I would rather think that the absence of new attacks is more related to military activity in Afghanistan and the strengthening of intelligence services. If anything Iraq has been turned into a breeding ground for new terrorists that may haunt the western world for many years to come.

The argument whether US forces should stay or get out of Iraq should rest only on what is in the best interest of Iraq. Would Iraq tear itself apart if US forces leave or would the country unite to rebuild itself as Vietnam did?

Thruth with Bad Intent

27^th October 2006
The Malta Independent - Friday Wisdom

In his famous poem Auguries of Innocence, William Blake makes a stark observation.

A truth that’s told with bad intent,beats all the lies you can invent.

This saying came to mind when the disgraced, now resigned Republican Florida Congressman Mark Foley tried to defend his sexual misdemeanours within his Congressional Office by blaming it on a 40-year-old experience where he claims he was abused by a clergyman, who, as it so happened, is a Gozitan priest.

It gains little credit to a person whom life has treated well enough to offer opportunities to reach the highest levels of US politics, to justify his indiscretions by pinning them on a 40-year-old claimed victimisation about which he kept mum for all this time.

I don’t know if Foley was truly victimised by any clergyman 40 years ago. But even if, and I underline if, Foley was victimised as claimed 40 years back by a Gozitan priest, it is poor defence for his own wrong-doing and it is irresponsible towards the rest of society that he has not exposed this clergyman much earlier when he has had ample opportunity to do it. If Foley is now saying the truth it is clearly a truth with bad intent.

The budget figures presented in parliament also carry a few examples of truths, or half-truths, with bad intent. Now that I have had time to comb through the figures it is possible to pinpoint some of these.

I will side-step the issue whether it is substantially correct to consider grants, which are only available for a limited period, as normal ordinary revenue. In the Labour’s old days these were considered as financing items, but technically now it seems acceptable to classify them as revenue, although this does nothing to alter the basic underlying truth that we have to shape up our public finances to do away with such grant revenue by 2013.

However, the assertion that the 2006 deficit is down to Lm58 million and within three per cent of GDP is only half true. How can one consider sale of government land to the tune of Lm20.4 million as recurrent revenue as if the government is going to sell land to the US government for building their embassy every year? If sale of government shares/assets is considered as a financing item for the purpose of calculating the deficit, why should sale of land be considered as ordinary revenue? If only this item is written back and considered as a financing item rather than revenue, the 2006 deficit will grow to Lm78 million, equivalent to 3.78 per cent of the GDP.

Also, how can one justify taking as ordinary revenue premium achieved by issuing government stock at a rate of interest above market rate? Is this not simply taking revenue this year which has to be paid back in the form of higher interest in future years? If this is not window-dressing, what is?

Examining the projected revenue for 2007, two figures stand out showing step change increases which deserve further explanation. Revenue from gaming taxes is planned to increase from Lm12.5 million this year to Lm18.5 million next year. Domestic economic growth, better tourist traffic and expenditure shifts due to new initiatives, may explain part of this increase but they cannot be expected to explain the full 48 per cent increase. If this relates to additional gaming taxes from international gaming operations that have been attracted to base themselves here, then it is a positive development and we should make the most of it before EU regulation will deprive us of this advantage just as the US has recently done to online non-US based gaming companies.

Harder to explain however is the growth of nearly 30 per cent in excise duty revenue on petroleum from Lm29.7 million in 2006 to a planned Lm38.3 million in 2007. It is hard to explain only in the context of various assertions made that the budget is not increasing any taxes or making new ones. How can one increase excise revenue by over Lm9 million without raising taxes? By magic it is a half-truth which is more insulting than a pack of lies.

Enemalta always made huge margins in its petroleum division with which it used to cross-subsidise its electricity division in order to keep utility rates socially responsible. With petroleum importation and distribution now on the verge of being privatised, the government has taken the right precaution to increase the excise duty in order to remove the excess profits. This explains the projected steep increase in such revenue in the Budget for 2007. So far so good!

But to keep things neutral one would have expected the government to pass back this excess revenue to Enemalta in order to keep subsidising the utility rates. There is nothing in the budget which suggests this is happening, which in a nutshell means that the government is withdrawing the normal subsidy to utility services in order to increase its ordinary revenue. Clearly, the government has every right to take such fiscal measure but this does not equate with the claim of no new taxes. Withdrawal of subsidies is taxation by another name.

Another case is the absence of provision for the government contribution to the Freeport for Lm6 million to pay interest on its international bond. Suddenly next year there is no such provision. It is hard to believe that the Freeport will finance its own interest when it has privatised all its operations and has no strong revenue flows. Probably another case of window-dressing where this interest payment is being funded outside the budget next year in order to look better than we really are.

Half-truths with bad intent?

Are We On for the Euro

22^nd October 2006

The Malta Independent on Sunday

I tried to look at the Budget for 2007 presented in Parliament last Wednesday as a source of assurance or comfort that we are well on the way to joining the eurozone. After all, the projected date of entry is 1 January 2008 and therefore Budget 2007 is the financial bridge that can get us there in time and in good shape.

Conflicting signals unfortunately emerge from the budget documents. In his speech the Prime Minister, with the Opposition firmly in mind, criticised those who argue that we should not rush into the eurozone before we achieve strong and balanced economic growth. Quite rightly, in my opinion, the Prime Minister points out that joining the eurozone could be a catalyst for achieving such growth and that it is risky for our international reputation and for our ability to attract foreign investment if we start having cold feet at this stage.

Then the Prime Minister made a categorical statement “...with satisfaction I say that today everybody is saying that we are on track (for joining the eurozone in 2008)”. Who is “everybody”? What exactly this everybody is saying we are not told but we are expected to take the Prime Minister’s word for it.

Having been trained in financial analysis and credit assessment, I have a natural inclination not to accept anybody’s word for anything. I have to seek corroboration and evidence to base opinions on an array of evidence from different sources rather than on assertions from partial sources. And as future events cannot be black or white, but with a lot of shades of grey, the opinions I form are quite often flexible and thus can be adjusted to new data as it emerges until the future projected event becomes current and, consequently, definite.

The same had happened to me in the run up to EU membership. Government sources made assertions that Malta would definitely qualify for top objective one funding upon membership and in the first full budget 2007–2013. I challenged these assertions, pointing out that we were too close to the criterion for objective one funding to permit such positive conviction. As it so happened we did eventually actually qualify for such top funding but we were sailing very close to the wind. Paradoxically, the slow growth and downright contraction we had in our economy between 2000 and 2004 actually helped us to qualify, as we stayed within the 75 per cent limit of the average EU GDP. Had we had normal growth during this period, we would not have qualified, but as it turned out we were lucky to be rewarded for our failures.

So I sought corroboration from other budget documents to see what is giving the Prime Minister all this certitude to make such unqualified assertions about our being accepted to join the eurozone as planned. One has to bear in mind that last spring Lithuania was denied entry, which was okayed for Slovenia for January 2007, because Lithuania fell marginally foul of its performance on inflation when benchmarked to the Maastricht criteria for entry into the eurozone. This stipulates that our inflation (measured by a Harmonised Index of Consumer Prices – HCIP– worked out on a 12-month moving average) has to be within 1.5 per cent of the average of the best three performers of the EU25.

The latest measures we have for September 2006 shows that our comparable measure of inflation comes out at 3.2 per cent, whereas the average of the best three, Finland, Poland and Sweden is 1.3 per cent, to which adding 1.5 per cent would put the benchmark at 2.8 per cent.

We are therefore 0.4 per cent out of the benchmark and this is categorically confirmed in the documents accompanying the Budget documents and in other official economic and statistical press releases.

Now the jury will stay out till March 2007 and there may be developments that could help us bridge the gap and come within the benchmark. It depends not only on us but also on the performance of the best three in the EU. In a way this comparison is unfair in our regard. Whereas Finland, Poland and Sweden have alternative and natural sources of energy (coal in the case of Poland and hydro in the case of the Nordic countries), they also have an abundance of free potable water. In Malta we consume expensive imported hydrocarbons not only for our energy needs but also for producing our water through energy-hungry reverse osmosis plants.

But a test is a test and the rules were not bent for Lithuania just a few months back. I wonder what comfort the Prime Minister has to feel so positive about our making the grade in the short time still available to us or, if we do not, that the rules will be interpreted less rigorously in our case.

I agree that it is important to be there on time for the euro. But being a realist I cannot help but question the assertions being made by our politicians when hard economic data is giving different signals, which create doubt about our being considered euro-ready. Doubts are doubts and reality could go either way, but we have a very marginal case and there is no room for unfounded assertions. Over-confidence kills the cat. Thankfully the Governor of the Central Bank was much more guarded recently when questioned in this regard.

Frankly, rather then gratuitous assertions, we need a plan B. We need a political effort to rally support for our case even if we are marginally out of the benchmark on the inflation front. And we have to make the case that our inflation will head down if oil prices keep steady, as we are now close to running a full 12-month cycle with fuel surcharges, so the year-on-year inflation increase should moderate and this would show up with a time lag in the 12-month moving average inflation measure.