Sunday, 28 May 2006

Judging Maltacom

26th May 2006
The Malta Independent on Sunday

How should one judge whether the privatisation of government’s controlling stake in Maltacom has been a success, a failure or somewhere in between?

I propose adopting three criteria for conducting such an analysis, i.e. strategy, process and price. And in so doing one could benchmark Maltacom’s privatisation to that of Mid-Med Bank’s sale to HSBC which by all these measures has been a categorical failure.

From a strategy point of view one should examine whether it made sense to privatise Maltacom at all. I am against the privatisation of monopolies or strong dominant positions unless the privatisation itself involves the opening up of the market to further competition.

Maltacom’s strong dominance in the market relates to its fixed line network which is a declining business as it gets replaced by mobile telephony. Fixed line infrastructure is in fact being adopted to service data transmission where Maltacom has to compete with cable TV operators that can also offer such services. Maltacom’s monopoly over the international gateway for overseas telephony is now consigned to history as the international gateway has been liberalised and international telephony is now available at extremely cheap rates or indeed for free through the internet’s VOIP.

In mobile telephony Maltacom was a late entrant after Vodafone had a practical monopoly for over a decade. The fact that Maltacom has gained a sizeable market share in the space of a few years is a credit to its management. The duopoly that exists in mobile telephony has not led to oppressive pricing for the consumer and new suppliers are free to offer additional competition if they consider the necessary investment worth their while.

From a strategy point of view there was no evident reason why the privatisation should have been avoided especially as Maltacom is in full competition with private sector suppliers who operate without the administrative weight of public sector bureaucracy. Maltacom needed to be freed from this disadvantage if it is to compete on fair basis. Furthermore the sector is well regulated to ensure that unavoidable dominant positions caused by our market size are not abused of to the detriment of the consumer.

The continuous investment needed to keep refreshing the technology justified the linkage of the privatisation to a strategic partner capable of investing substantial funds in the business over and above those needed to pay for the privatisation price. We have been told that Lm30 million would be so invested and we have to assume that this will be new money invested by the new owners and not by using Maltacom’s own existent liquidity.

From a strategy point of view Maltacom’s privatisation made sense, much more than the privatisation of Mid-Med Bank to HSBC which effectively reduced competition in the market through the eventual absorption of the former operation of Midland Bank.

The process for Maltacom’s privatisation has been clear, fair and transparent. The process was widely advertised, interested parties were offered every facility to join the bidding process and the decision making process has not given rise to any claims of unfair selection. The bid selected was reportedly the highest one available even though it came in below the trading price of the free float of the minority shareholding that trades on the Malta Stock Exchange.

It has been a refreshing change from the opaque manner in which Mid-Med Bank was sold to HSBC without any bidding through private negotiations between the Minister and the acquirer. Whereas in Maltacom’s case government engaged the services of internationally renowned investment banks to advise it in the negotiations, in Mid-Med Bank’s case the Minister boasted of acting unilaterally without feeling the need to seek reliable professional advice.

So on the process criterion Maltacom scores very high marks compared to the zero which is the only appropriate mark that could be given to the process adopted for the sale of Mid-Med Bank.

Having given a comfortable pass mark to Maltacom’s privatisation on the criteria of strategy and process how does it rank on the price criterion? When I criticised the poor price obtained by government on the sale of Mid-Med Bank I had argued that this was the direct result of the poor process that lacked all elements of competitive bidding. This was certainly not the case in Maltacom’s process.

So the first implication ought to be that once the process was correct, than the price outcome was consequently equally correct, once the highest bidder was chosen.

Yet this argumentation is tempered by the fact that whilst Mid-Med Bank sale was concluded at a 7% premium on the last market price before the sale was announced, the price for Maltacom was at a substantial discount to the last trading price. Such comparisons are however unfair. Whereas the market price of Mid-Med Bank shares in no way reflected the efficiency gains expected from privatisation as effectively the privatisation was conducted behind everybody’s back, the share price of Maltacom in the free float quotation on the Malta Stock Exchange included substantial premium for such expected efficiency gains as the privatisation process was public knowledge. So much so that even after the announcement of the privatisation price the market price of Maltacom’s shares continued to trade at a substantial premium to such privatisation price.

This does not however completely convince me that from a price point of view we should not have done better, I would say considerably better. The argument that the price of Lm1.55 per share is at a slight premium to international valuation of similar companies based on profitability criteria, indicates that no premium was included in the price to take into account the substantial assets that not essential to the company’s profitability.

The most obvious candidate here is the substantial liquidity of Maltacom including substantial cash balances and receivables. Should not these have been distributed to present shareholders before the share transfer was concluded at a price that was not arrived by asset valuation but by discounting future profitability? Should other assets, not essential for the company’s core business, including some valuable real estate, have been sold before the privatisation and profits there from distributed before executing the share transfer?

So in conclusion, whilst a much better affair then the privatisation of Mid-Med Bank, Maltacom’s privatisation has its own blemishes too.

Wednesday, 24 May 2006

Managing Expectations

26th May 2006

The Malta Independent - Friday Wisdom

One of the trickiest aspects in the Euro changeover project is ensuring that the process will be inflation neutral. Militating against this objective is the natural inclination to expect an impulse of inflation from the changeover.

As often happens, unless such expectations are addressed in a long process of educational information, they tend to become a self-fulfilling. Expectations turn into reality by the very fact they give pricing power to suppliers.

If inflation expectations are allowed to take root and eventually turn themselves into real measured inflation, this could very well prejudice our credentials to proceed with Euro entry as planned in 2008. Lithuania has just been refused entry into the Euro Monetary Union next January 2007 purely because its inflation rate was minutely above the criteria laid down for this purpose in the Maastricht Treaty.

Whilst other criteria for public fiscal deficit and debt levels seem to carry sufficient flexibility in their application and should not therefore be decisive factors regarding our credentials for Euro entry, the inflation criterion is being applied with exaggerated rigidity without any allowance for the exceptional inputs caused by high energy prices.

It is therefore of paramount importance for macro-economic policies to focus obsessively on the inflation score and this can only be done if the consumer is not allowed to harbour undue inflation expectations by the same process for which contained inflation is crucial.

The only way the consumer can be trained against building undue inflation expectations is by having a long period of dual pricing to avoid suppliers building in price hikes to take advantage of the confusion caused by the changeover process.

Obviously there are problems with adopting a long period of dual pricing. The main one is that until there is final agreement with the EU about entry, which can only come this time next year, the rate for conversion remains a target not a binding commitment. And in the absence of a binding commitment the market will keep throwing up a myriad of rates for converting currencies between MTL and EUR.

There are at least five rates published officially every day, one by the Central Bank and four by the commercial banks two for buying cheques and notes and two for selling them. These range from a minimum of Lm0.4113 per Euro to a maximum of Lm0.4426 giving a spread of 7.6%. This is no small stuff considering that the central rate quoted by the Central Bank is fixed at Lm0.4294 without day-to-day risk of fluctuations.

Which means that for dual pricing to be effective as a means of education, it can only start at the point in time when the target rate turns into an immutable commitment. At that point the Central Bank would be constrained to use monetary policy during the preparation period to pitch interest rates at a point high enough to avoid anticipated conversion into Euro, encourage domestic savings, and control excessive demand but not too high to attract destabilising inflows of hot international money searching for additional interest rate returns without exchange risks.

The timing for making such a move has to be left to the final judgment of monetary authorities who have to weigh the benefits of controlling inflationary expectations through effective dual pricing campaign against the risk of stimulating undue capital flows, outward or inward, by the removal for exchange loading charges for conversion between EUR and MTL in the preparation period.

This is complicated enough on its own and need not be complicated further by introducing additional variables. One such variable that is absolutely avoidable is the risk of an election before the changeover.

The risk of electing a new government before execution of the Euro project will cause market instability that will of itself destabilise the project execution. The clear message from the government has to be that elections will follow not precede the Euro changeover date.

Another variable we ought to do without is introducing additional criteria for economic growth performance before the changeover. I most heartedly agree that this country needs at least 4% (probably more) real annual growth to keep employment stability. We need even more to accelerate the convergence with our European peers. Where I differ is the suggestion to make Euro adoption conditional on such growth.

Growth comes from efficient restructuring and new investments and both these aspects are abetted by adoption of the Euro. We need the monetary stability and recognition that come from monetary union at a competitive level in order to achieve the desired growth. One could choose to argue whether the rate for conversion chosen is consistent with preserving international competitiveness. I think we should have done more, but once a decision has been taken international competitiveness has to be sought elsewhere and not through delaying monetary union.

Friday, 19 May 2006

Portable Everything

19th may 2006
The Malta Independent - Friday Wisdom

Quality of life has improved in leaps and bounds when the human species invented easy and efficient means of mobility. The benefits of international trade would not have been possible if goods produced in one country could not be easily transported to another.

Take energy. As it so happens, natural energy sources are located in world regions far removed from the main energy users. The three industrialised blocks,
USA, EU and Japan/China in the east, need regular importation of energy supplies from resource rich regions like the Middle East and Russia. Without oil tankers, LPG carriers, pipelines and other capillary distribution networks the division of labour and specialisation which has permitted so much efficiency and growth in productivity would not have been possible.

Mobility has also facilitated trade development because people could move easily from one place to another. Barriers have been brought down permitting people to move freely within countries and regions to resettle where economic efficiency could guarantee a better quality of life.

One of the best sources of new efficiency inputs which should help the EU to catch up with the higher economic growth of the
US is the enlargement to include former communist states in central and eastern Europe which permits two way flow of economic resources. Investment moves eastwards to gain efficiency in lower cost environment while in due time eastern labour will move westward thus bringing a rough equalisation of living standards throughout the EU which will give it the same advantages currently enjoyed by the greater mobility among states in the US.
China’s stratospheric economic growth is only possible because a million or so people every month are migrating from the rural heartland to the sprawling industrial centres in the south and coastal areas.

Even where such labour mobility is illegal, one cannot deny the benefits host countries gain from the gradual integration of such new labour resources into the economic fabric. On 1 May, illegal immigrants in the
US staged a one-day “strike” to prove that without their intervention America’s economy would slow down significantly. In fact, it is clear that the most effective way to fight illegal immigration is to promote accessible channels for legal and organised migration.

Once mobility has been achieved, probably to the boundaries of physical possibilities, the concept of portability has kicked in. We do not only need to travel or relocate freely but we need to stay in touch with everyone else all the time. So while travelling, people can still reach us on our mobile phones through telecoms’ roaming services. We can phone anyone while on the move and we can access our office facilities, email networks and all, and keep working as if we were in the office when is fact we could be on a tourist coach in some distant country.

Pretty soon we will be able to watch live digital TV on our mobile phones which are more and more becoming like a hand held PC.

Again, as hard physical portability starts approaching its physical limitations, focus will shift, indeed it has started to shift already, to soft portability. People need to be freed from being locked up with suppliers through invisible mobility barriers. People need to choose the best supplier, which could change from time to time as new and more efficient players come on the market, without being inhibited by such invisible mobility barriers.

Numbers portability in telephony is a prime example. Without numbers portability, users cannot freely switch from one carrier to another as the trauma of having to inform all contacts of their changed number far outweighs the benefits that a new carrier could offer.

It is necessary to transport such soft portability beyond the telecom industry. One area that is ripe for such development is the financial services sector with particular reference to mortgages or house loans. The wide usage of house loans and their long-term nature spanning up to 40 years make it an ideal candidate for a dose of portability in favour of the consumer, i.e. the borrowing customer.

Take a young couple that takes out a 40-year house loan with one of our banks. They are locked in whatever they agreed for the whole duration of the loan and they cannot benefit from more favourable offers that come on the market from different mortgage suppliers unless they actually repay the existent mortgage and take out a new one with a different bank. The cost, the hassle and the logistics of doing this are nearly insurmountable. The client is simply locked in with his original bank come hell or high water for the whole term of the mortgage.

Is it not time to think about portable mortgages? Can’t we device legislation permitting mortgages to be given in favour of a central registry rather than in favour of a particular lender and then the central registry will keep the mortgage interest in favour of any bank that the client desires, so that the client can switch mortgage lenders by a simple letter rather than by expensive contracts and registrations?

Portable mortgages? Portable everything – if it favours the consumer.

Sunday, 14 May 2006

A Unique Opportunity

14th May 2006
The Malta Independent on Sunday

The value of notes and coins in circulation as at last December amounted to slightly more than Lm520 million. On average, each one of us, from babies to centenarians, carries Lm1,300 in our wallets or under the mattress, forfeiting the opportunity to earn interest thereon.

Obviously, the average is deceptive, as most people would hold no more than a few notes and a handful of coins for truly transactional purposes. Others, however, must be holding some relatively large amounts in the form of cash for whatever reason they consider it appropriate to do so, but certainly not for genuine small cash transaction requirements. The fact that 88 per cent of the value is composed of Lm20 and Lm10 notes emphasises this point.

If, as proposed, we join the euro on
1 January 2008, this cash will have to be converted into new euro notes in the space of the first few months of 2008.

This must be a great and unique opportunity to straighten out a few things that have gone wrong over the many long years since we acquired our own currency. So it is amazing that while preparations have been made on all fronts for the euro conversion, including the putting of religion’s face on our euro coins – going against the Gospel’s own admonishment against mixing Caesar with God – no serious thinking seems to be going on to see how to make the most of this unique opportunity.

There must be a reason why people would prefer to hold cash in excess of normal transaction requirements and in the process paying the price in the form of forfeited interest. And this reason must have something to do with the objective of keeping such cash holding unregistered and anonymous.

People are prepared to forego not less than Lm10 million in interest each year purely to preserve, in anonymous form, their ownership of such financial assets, the real value of which is eroding each year through inflation. Basically, this means that they value their anonymity more than the interest and real value they are forfeiting.

It is therefore quite reasonable to consider whether the need to preserve anonymity over a cash holding has anything to do with a greater need to avoid being exposed as being on the wrong side of the law. However, one needs to make a clear distinction between those who need to preserve anonymity due to an infringement of criminal law and those whose motivation has more to do with the evasion of fiscal law. While all infringements of the law are serious, criminal infringements are much more serious than fiscal ones.

The conversion of such a massive cash holding in such a short time presents a once-in-a-life-time opportunity to bring offenders within the net of the law by a mixture of incentives and punitive measures.

Firstly, we need to make it extremely difficult, nay impossible, for criminal offenders to exchange their ill-gotten cash into new crisp euros. It is therefore important that administrative steps be taken as of now to make all conversions of cash subject to strict identification and registration.

People need to be reminded that anybody fronting for the true beneficial owners of such cash hoards are themselves guilty of participation in criminal activities and could expose themselves to severe fines and even imprisonment. Anyone exchanging Maltese liri cash into euro cash should be made to sign a declaration that he/she is the true beneficial owner of such cash or make a full disclosure of the beneficial owner’s identity.

Before exchanging cash, banks would have to conduct strict due diligence “know-your-client” procedures, which have to be sufficiently rigorous to deter criminals from attempting to exchange cash for euros through the official system.

Secondly, the authorities need to put together some form of fiscal amnesty, similar to the various foreign investment registration schemes of recent years, for those who are holding cash for fiscal reasons, giving them an opportunity to come clean against payment of reasonable penalties.

From a macro-economic point of view, measures have to be taken to avoid having a large amount of cash, that has been lying idle for such so many years, suddenly entering the normal economy, swamping it with additional excessive liquidity, and risking further asset price explosions in addition to what we have already experienced in recent years.

One way of doing this would be to launch a fiscal amnesty scheme offering protection from tax investigations (certainly not from criminal or money-laundering offences) to holders of Maltese lira cash who transfer the balances to a medium/long term special government bond, either through payment of a percentage penalty or through the payment of sub-market interest coupon on such bond. Such a bond should not be marketable but should be repaid in graduated annual installments in order to avoid the grave inflation risk for asset prices that will be caused by currency out of circulation suddenly rushing back into circulation.

Such a transfer should only be effected after licensed institutions conduct diligent “know-your-client” procedures to exclude, as far as is reasonably possible, any risk of there being a criminal origin to such funds. Unlike the Investment Registration Schemes, no secrecy should attach to the registration of cash, given that we are dealing with nameless assets rather than registered investments that were out of view of the taxman. All registrations should be notified to the Inland Revenue, the Central Bank and the Financial Intelligence Unit. Anyone who decides to come clean with the law should have no problem with the responsible authorities getting to know about it.

Until such a system is launched, it will be necessary for the authorities to tighten up control over the channels through which cash can be converted into other assets outside the official conversion system. All such channels, like the repatriation of Maltese liri cash from foreign sources, need to be carefully monitored to ensure there is no increase in volume beyond normal transaction levels. Cash deposits by business organisations beyond their normal seasonal patterns must be watched and, where deviated from, be properly explained or subjected to further investigation.

Between now and the conversion date, cash deposits out of the strictly normal course of business should be subjected to doubly strict investigation. No discretion should be allowed to permit the structuring of deposits of cash into the banking system, which reinforces the case for an early launch of the fiscal amnesty of cash declarations in order to get as much volume out of the way as possible, as early as possible.

This will help to ensure that there are sufficient resources to handle the necessary investigations when the time constraints for the conversion of residual cash begin approaching euro D-day.

Friday, 12 May 2006

Never the Right Time

12th May 2006

The Malta Independent - Friday Wisdom

Confirmed bachelors can always explain why it is never the right time to get married.

Speculators in property and share trading can explain convincingly why it is never the right time to sell. When the prices are going down they prefer to wait until better sale prices could be achieved. When prices are going up they prefer to hold on to their assets while they are growing in value.

Following Labour’s defeat in the 2003 general elections, it was the natural time to project the unavoidable shift in party policies through new party leadership. This has not happened much to the amazement of the general public and at the expense to Labour’s credibility as it promotes new products in old wrappers.

For insiders, it was not the right time to press for change of leadership, when the incumbent leader decided to re-contest in spite of earlier pronouncements to the contrary, as the party was in trauma after the election defeat. Now it is not the right time, although an independent report had recommended that the matter should be re-visited within two years, as the next elections are too near.

The “Not the right time” argument is again being used by Labour regarding the government’s plan to join the euro in 2008. This is a complicated issue as there is a long lag between the timing of the decision and its implementation. During such time lag various economic variables are in play. The government decided to join the ERM II mechanism in May 2005, leaving a period of more than two-and-a-half years until actual monetary union, if it really happens in January 2008.

During this waiting time, we have to bring ourselves in line with the official criteria for joining the euro, about which the EU seems to be adopting a rigid attitude.
Lithuania could be denied entry to the monetary union as planned next January because its inflation rate has marginally deviated from the standards set for entry. No allowance is being made for inflation caused by high oil prices.

And to complicate matters for
Lithuania, no allowance is being made for the fact that the reason why it deviated slightly on the inflation front is because the calculation of the benchmark includes low inflation Sweden, which is itself not a euro country. Logic should dictate that the benchmark should be drawn only on countries already participating in the monetary union and should exclude Sweden, Denmark and UK, who so far have opted out of it.

Labour is suggesting inclusion of a further criteria for the timing of our euro entry, that of having real economic growth of four per cent per annum. Once at it, why not include as well other tests like having a surplus in the balance of payments current account or having unemployment rate less than the EU average? Individually, all these tests make sense but collectively they would complicate the process so much that ultimately it will never be possible to join the euro.

One has to make a distinction between the ideal scenario, that hardly ever materialises, and the practical scenario that makes it possible to proceed with one’s plans and then continue aiming for perfection or idealism along the way.

For me, the issue of joining the euro was decided when we took on that obligation upon accession to membership. A small country like ours, exposed to international trade, has immense benefits in having a stable rate of exchange policy that is perceived credibly by trading partners and foreign investors. Nothing can achieve this better than a monetary union with our major trading block partners.

The timing should be the shortest possible one to come in line with the conditions of monetary union without sacrificing economic growth or causing undue disruption to the country’s social cohesion.

The big decision for the euro project was at what rate of exchange level should we make the docking into the monetary union. In the past, I expressed myself liberally that we ought to have chosen a lower rate than the one we did. At the same time, I was against gradual adjustments that can only give rise to instability, capital leakages and consequent erosion of foreign reserves.

Once the decision to join at the rate chosen was taken this time last year, I laid down my arguments as energies had to be devoted to other economic variables which have to be adjusted to preserve and promote competitiveness both in the run-up to and after the monetary union.

To a large extent, we are already in a monetary union. The fixed parity chosen means that our interest rate decisions have to shadow those of the ECB even in the preparation stage. So why wait beyond 2008 (unless one wants to re-open the level of exchange rate docking into the euro) denying the economy the benefits of monetary union while carrying all its obligations?

As to the dual pricing argument, I feel that a long period of dual pricing is necessary to avoid abuses of price rises on the changeover date. But it is illogical to conduct such dual pricing exercise unless the banks participate by offering a fixed central parity exchange facilities during the dual pricing period.

The relatively small amount of profits from exchange that banks will forfeit is a small price to pay for smoothening our entry into the euro and would be a gesture against those who keep arguing for the imposition of windfall taxes on the banking sector.

Friday, 5 May 2006

A Tribute to Galbraith

5th May 2006
The Malta Independent on Sunday

John Kenneth Galbraith, who passed away last Saturady at age 97 was an influential American Economist of the 20th century. He was a Keynesian and a leading proponent of US-style 20th century political liberalism and progressive politics. His books on economic topics were bestsellers in the late 1950s and during the 1960s.

Galbraith was a prolific author, producing four dozen books and over a thousand articles on various subjects. His most famous works were perhaps a popular trilogy of books on economics, “American Capitalism” (1952), “The Affluent Society” (1958), and “The New Industrial State” (1967). He taught at Harvard University for many years. Galbraith was also active in politics, serving in the administrations of Franklin D. Roosevelt, Harry S Truman,John F kennedy and Lyndon B. Johnson, and among other roles served as U.S. ambassador to Inida under Kennedy.

He was one of the few two-time recipients of the Presidiential Medal of Freedom, receiving one from President Truman in 1946 and another from President Clinton in 2000.

Galbraith is best remebered for his quotable quotes which carry drops of wisdom that would often take lesser mortals a whole book to express themselves with unmatching clarity and impact.

In a speech as Ambassador to President Kennedy in March 1962 Galbraith said “politics is not the art of the possible. It consists of choosing between the disastrous and the unpalatable.”

We have a living experience of how true this is through the works of the present administration. Following several years of irresponsible housekeeping of public finances where the money no problem culture was all persavive and where all problems were avoided, rather than addressed, by simply writing a cheque drawn on the exchequer’s account, this administartion has to choose between the disastrous and the unpalatable. The disastrous in not an option as thankfully the EU is imposing on us external discipline which no longer permits us to continue irresponsibly wasting resources to avoid unpalatable but necessary medicine. The unpaltable is unavoidable; but while this may please economists, financial analysts, credit rating agencies and central bankers, it jars with the electorate who instinctively tend to associate the sour medicine with the stern doctor that has to do the dirty work for predecessors who through lethargy and default to easy solutions, have caused the malady in the first place.

In other counties this works through change of administration where incoming incumbents can administer the medicine in the first half of the legislature free from the guilt of ownership of the inherited problems, and in time to deliver in popularity terms when seeking to refresh the electoral mandate.

Typical of this is President Lula of Brazil who is cruising to reconfirmation on the basis of an economic miracle which seemed impossible four years ago when Brazil was on the brink of defaulting on its foreign obligations.

The fact that remedial action in Malta is being taken by a government from the same political stables that created the problems in the first place, makes it impossible for the administration to esculpate itself from the pain which is being felt through the unpalatable measures. Add to this the fact that the first year of this administartion was lost by preparations to join the EU and by the change of Prime Minister, meaning that crucial time was lost which could well put the gain resulting from the pain well beyond the next electoral dividing line. Top this up with oil at USD 75 per barrel that gives an extra sour dose to the unpalatable measures and one can well understand why this government is unpopular and why there is a growing perception that Labour could well win by default the next time round.

In America also there is building a strong sense of disgust at the extraordinary profits being made by the major oil companies when the consumer is having to pay record high prices for energy and utilities. There is a growing chorus of demand for the government to levy windfall taxes to neutralise these exceptional profits and pass these taxes back to the consumers who are paying them in the first place. There is an equally growing chorus of economists and oil industry lobbyists that say that windfall taxes will reduce the capacity to invest for increased oil supply and will thus lead to more shortages and further higher prices. However this argument is weakened by the excessive pay packages of oil companies executives who are rewarded for profits that the were made by market movements rather than personal initiatives.

John Galbraith once said “ The salary of the chief executive of the large corporation is not reward for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself”. Long live the spirit of Galbraith!