Predictable

 20^th October 2006
The Malta Independent - Friday Wisdom

 

They say that the only certainties in life are death and taxes. Probably we can add a third. The budget for an election year is loaded with measures that would benefit as wide a section of the electorate as possible. It is loaded with mantras of reaping the fruit of the hard work and sacrifices of the past and basically promising a never-ending spring from that point onwards.

In this respect the budget just announced for 2007 has met all these expectations, and while it is not excluded that the government may slot in a further “goodies” budget before next election if readings from the field still indicate that people need more persuasion to forgive past tax oppression, the government is clearly keeping its options open that this could well be the last budget before taking the plunge.

This is not meant as an accusation. It is just pointing out that all governments in the democratic world try to influence the economic cycle to hit a bottom in the mid-term of their mandate and a peak in an election year. So people are generally oppressed more than is necessary in the first years of a legislature and they are rewarded with what was unnecessarily taken away from them towards the end of the legislature.

The government has two main objectives for 2007. Firstly, it aims to start a momentum of feel good factor that could serve as a sound platform for its re-election bid. Secondly, it needs to meet the Maastricht criteria to pass the euro test so as to be able to join the monetary union on 1 January 2008.

Past budgets which created so much “feel bad” factors have laid a good platform for meeting the necessary credentials to meet the Maastricht fiscal criteria for joining the Euro. The deficit is now within the three per cent of the GDP and heading for a neutral position towards the end of the decade. The debt to GDP ratio, while outside the 60 per cent limit, is heading towards it and the rules allow sufficient flexibility in this respect.

So by relaxing the fiscal pressure, the government feels confident it is not compromising its fiscal credentials for euro membership. Having said that, however, there remains the inflation criteria which is becoming the greatest obstacle for euro entry. However, this inflation criterion is not directly controllable through fiscal budgetary manoeuvring and considering the delayed impact on inflation of any budgetary measures, there is pretty little now that can be done fiscally to aid or compromise our bid for joining the euro in 2008.

Through loosening the budgetary screws however the government is leaving disposable income to the tune of some Lm20 million in the hands of the electorate to make them feel better. Revision of tax bands, increase in allowance for private school fees, increased allowances for child care expenses, subsidy for acquisition of energy efficient household appliances (aren’t they all energy efficient these days?), halving of the departure tax and other social security trimmings all add up to give a step change improvement in the disposable income of the average Maltese family.

This is only possible without compromising the euro entry credentials if the economy continues to grow at a healthy rate so that the tax take of the government continues to increase at a healthy rate in spite of the rebates given. Technically this is referred to as SSE (supply side economics) where it is argued that lower tax rates would generate more tax revenues as lower taxation permits higher economic growth so the lower rates would apply to higher tax bases producing an increase in tax revenues in absolute terms.

Whether this would work the way it is planned is a gamble which, if things go wrong, would have to be corrected in post-election mode, a replica of what happened in 1996, not coincidentally another election year.

Yet the government is planning a real GDP growth rate of 2.5 per cent for 2007 which is slightly less than the rate being registered this year if the flash figures till end September 2006 are anything to go by. I am confident that we have the potential to register much higher growth rates for 2007 and my projections would indicate a growth rate more in the region of 3.5 per cent - 4.5 per cent.

We will be registering 2.6 per cent real growth this year even though we have practically contracted in tourism. With the European economies growing much faster than anticipated and planned to overtake the growth rate of the US economy in 2007, our manufacturing sector, mostly geared to the EU markets, should do better next year.

Tourism can hardly do any worse and the introduction of low cost airlines should produce some noticeable improvement both in volume and in earnings terms. Financial services have growth momentum and the tax measures announced for 2007 should give a boost to consumption and thus to retailing and domestic services. Some relief could also be expected from the international price of energy as a structural downward shift seems to be in the making.

So we can get to this time next year being told that growth has exceeded the forecast, that we have passed our euro test and with the government assuming that the electorate would have forgotten or forgiven the pain it went through between 2003 and 2006.

Is there a fly in the ointment? There always is. We are dangerously sailing too close to the wind on the inflation front and we could fail the euro test on this inflexible criterion. Should this happen we may introduce an element of big uncertainty in the economic equation which could blow away all the expected growth.