Hello September

10^th September 2006

The Malta Independent on Sunday

August has come and gone. This week, many operators returned to their desks, the holidays over and facing the reality of the economic sector, which in the end is the foundation for our quality of life, holidays included.

And it was a return with quite a bang. In the US, following the Labour Day holiday on Monday, the big operators returned to their desks to discover that quite atypically for August, while they were away, leaving behind thin trading markets, equity prices edged up significantly, particularly in the technology sector. It is difficult to square this with the general feeling that the US economy is slowing down, interest rates have stopped rising and the bond markets are indeed already pricing interest rates cuts for next year, as they anticipate that the economic slowdown, particularly in the housing sector, will force the Federal Reserve not only to pause its interest rate hike cycle started in June 2004, but to start cutting them back in order to avoid a housing crash.

The returning big players immediately started to talk the markets down forcing a reflection on whether the August advance was overdone and waiting for clearer signals from the economy to see if the slowdown will in fact materialise and if the US consumers will continue spending regardless even when losing the comfort of increasing equity values in their immovable residences.

In the UK where the economy is still sailing impressively forward at a consistent speed without the imbalances inherent in the US economy, we had an explosion on the political front. A mini-revolt in the ruling Labour party has forced Tony Blair hands to set a one-year time frame for his departure as party leader and Prime Minister.

Blair had gone on record before the third successive election victory of May 2005 that he would not contest another election. However he never gave the exact date of his departure. On the contrary, recently he has gone on record stating that he regretted committing himself the way he did, as this took away moral authority from leadership in this third term. Loyalty gravitates round the prospective incoming leader rather than the present incumbent with a short expiry date of tenure Tony Blair found out.

Now that he has been forced to put a one-year time frame for his departure, it is not inconceivable that pressure will mount further, arguing that once he has to go it would be better to do it sooner rather than later to give to his successor time to reorganise the troops for the next election.

A comparison with the situation in Malta is hard to resist. Tony Blair took over the British Labour Part leadership in 1994, just two years after Alfred Sant won the MLP leadership. They were both New Labour flag carriers and both won their first electoral test in 1996 in Malta and 1997 in the UK. There the similarities end.

While Tony Blair is still in power after two full terms and after winning a mandate for the third successive term currently being executed, Alfred Sant could hold on for less than half a term and has since lost two successive elections. How different are the British genes from the Maltese genes? After three electoral wins, Tony Blair is being forced to quit while still in the role of Prime Minister, whereas in Malta, despite Labour losing two consecutive elections, following its inability to complete the mandate of the only election won when he was still a relatively unknown quantity, Sant still rules the MLP unchallenged. This despite evidence that he is the only stumbling block between Labour and the next government, with personal popularity ratings below that of Prime Minister Gonzi in spite of the PN floundering all over the place.

September has also returned with a raft of statistics and other news about the state of our economy. It started with bad news on the inflation side, which shows that we are travelling well above the relevant strict EMU criterion for euro entry, and that unless there is a sharp correction in the next six months there is great probability that the euro entry date of 2008 will have to be postponed in the same way Lithuania was forced to do earlier this year. International rating agency Fitch was quick in issuing an opinion that 2009 was a more likely date for Malta’s entry into the euro monetary union.

It might seem no big deal if we make it in 2009 rather than 2008, but in reality it is. In between there is an election which could bring in a new government with different policies for euro entry, if not in the final destination, but certainly in the timing and in the appropriate level at which the Maltese lira is to be exchanged for euro on accession date.

Government finance statistics continue to show progress for ending the year with a deficit under the three per cent of GDP necessary for euro entry. But for those who can look beneath the surface, as those who have to decide on our euro adoption will certainly do, this is being done only due to postponement of capital expenditure payments and through the booking of unrepeatable grants from foreign sources. Basically, rather than safely cruising toward an ultimate budget neutral position, our fiscal position is being artificially suppressed to meet a particular criterion, building up pressure which will be released after we are judged for euro entry by June next year.

Balance of Payments statistics for the second quarter show that the deficit on current account is still increasing and during the first half of the year it still amounted to 12.5 per cent of the nominal GDP, a truly unsustainable figure by any standard.

GDP statistics show that during the second quarter of the year the real rate of growth slowed down from 3.1 per cent in the first quarter to 2.2 per cent in the second quarter, giving an average of 2.7 per cent for the first half of 2006, which is not impressive but better than the 1.1 per cent projected at last budget. However the composition of the GDP growth gives little room for comfort. All the growth is explained away in inventory build-ups equivalent to a real constant 2000 money value of Lm18 million in each quarter while the value of the overall growth averaged Lm14 million per quarter. Somewhere in the economy, increased production is resulting in an inventory build up rather than increased sales.

These are flash figures subject to revisions and more detailed allocations; however, experience on the ground cannot but suggest that there is an impressive inventory building of unsold housing stock. The strength of the construction sector seems to suggest a strong pipeline of new housing stock that is not finding a comparable increase in demand is leading to a rapid build-up of inventories, which is impacting positively the GDP figures as if they are being sold normally. Any lending banker can tell you that rapid inventory building is ominous of inability to find markets for production and will eventually, if it persists, have to be revised in write-downs to a discounted price at which the market can be stimulated to increase demand and offload inventories.

The holidays are truly over and September brings us back to face the reality we have to grapple with during the crucial year of 2007, which will be a decisive year for the next election and for the adoption of the euro.