26th October 2007
The Malta Independent - Friday Wisdom
This is what Jack
Nicholson told Tom Cruise in the movie A few good men when Kaffee (Cruise) was interrogating Colonel Jessep (Nicholson) in a court marshal trial of two marines
who obeyed orders to administer a code red (unofficial punishment) on a
colleague who was not capable of physically performing up to the expectations of
the colonel.
It is this quotation that sprung to my mind as I continued
to dissect the budget for 2008. It feels that this government is telling us, the
governed electorate, that we cannot handle the truth and that we have to be fed
a few good lies and half truths in order not to get hurt by being tempted to
elect Labour in government come next elections.
Let me start with the
COLA increase of Lm1.50 which is Lm1 more than what should have been paid under
the tri-partite COLA mechanism in operation since 1990. Would this have happened
if this was not an election budget? And perhaps more importantly how sensible it
is to continue with this out-dated system of legally enforced across the board
COLA increases when we are entering the rigidity of a monetary union? We are
giving up the economic tools of monetary, interest rate and exchange rate
policies and government has pretty little room to manoeuvre within fiscal policy given its commitment to
balance the budget by 2010.
As has been repeated ad nauseam, we can only
remain globally competitive if we continue to restructure, and without the
economic tools that will be sterilised by the monetary
union, such restructuring has to take place directly in the real economy. But
how can this happen if we continue to legislate across the board COLA increases
totally unrelated to productivity? Or are we still thinking that monetary union
is some free lunch?
Why can’t we be told the truth that in the context of
a monetary union wage indexation, that is legally enforced
irrespective of productivity, is a recipe for disaster? This is so
especially when we are joining in the monetary union a currency that has become
irrefutably and fundamentally overvalued against all major currencies, not least
the US dollar, Japanese Yen and dollar pegged currencies of emerging countries
in Asia and
South America including
China,
India and
Brazil.
How else are we
being denied the truth we are presumed unable to handle? Consider this. Income
tax revenue in 2006 was Lm598 million. Income tax revenue projected for 2008 is
Lm728 million. An increase of Lm130 million in income tax revenue over two years
when in each of these two years the government has increased tax allowances to
the value of Lm12 million i.e. Lm24 million forfeited income tax revenue over
two years. So added to the increase of Lm130 million, this is really a gross
increase in the tax take of Lm154 million which is 26 per cent of the 2006 tax
base.
Even the most optimistic “Supply Side” economist will question the
realism of such an increase in the tax take when the economy is growing by less
than four per cent per annum in real terms and six per cent per annum in nominal
terms, which at best may explain about half the projected increase in the tax
revenue. Where is the other half, a whopping Lm77 million coming from and what
contingencies are being made in case this fails to realise itself?
We have been here before. Roll back
your memory to another election budget for the year 1996 when the government
again made very generous income tax concessions in expectation of substantial
increase in indirect tax revenue through the then newly introduced VAT system.
The expected increase in revenue from VAT proved to be overly optimistic and the
result was a harrowing actual 1996 budget deficit which we continue to nurse
till this very day. Now that we are seeing the budget deficit reduced to
sustainable figures, the government, for pure electoral exigencies that have no
place in good financial housekeeping, is again making optimistic assumptions for
tax revenues to justify distributing the goodies before the bacon is
delivered.
Is this 1996 all over again? 11 years ago to this very day a
Labour government was elected to find that a projected budget of Lm32 million
was in fact running in excess of Lm100 million without a single word of warning
being uttered about it in the election campaign.
Is the government once
again gambling the stability of public finances, gained the hard way over more
than a decade of oppressive tax increases, for the sake of political
convenience? Does this contain the unbelievably selfish argument that if this
works the PN will be back in power with a five-year term to patch things up and
if it does not work they will ensure that a new Labour government will find it
tough going having to nurse public finances back to health and thus being unable
to deliver on the many promises being made on the basis of inheriting a strong
public finance situation?
I wrote this piece before I had the opportunity
to examine the Opposition Leader’s criticism of the budget. Dr Sant once defended himself from some politically
inconvenient truth I had mouthed saying that I tend to reason like a banker not
a politician.
I don’t regret it and presumably that’s why I did not make
a career in politics. But Labour is no less guilty of avoiding the economic
truth. Too little too late may be politically convenient but economically it is
a non-starter. It sounds not merely gambling but doubling the odds.
Can’t
we be trusted to face the truth that it is too risky for our own good to upset
public finance stability in the context of a monetary union rigidity and that
tax credits should not be given before we are reasonably certain that the
projected inflows will in fact materialise? Can’t we
be trusted to handle the truth?
19th October 2007
The Malta Independent - Friday Wisdom
You really would have to
struggle to try to analyse the budget for 2008
presented this week in parliament out of the immediate context of the impending
general election. Out of 93 pages of the Budget speech booklet there is only one
page that attempts to put this Budget in a longer term context until 2010. All
the rest speaks of performance so far, performance expected till the end of this
year and measures to be applicable for 2008.
With a general election due
in all probability somewhere in February next year, it is politically compelling
for government to tailor the budget with the election in mind. Measures
announced have been costed as putting an additional
Lm21 million in consumers’ pockets and they have clearly been designed to
address the laments of wide and narrow sections of the electorate that have been
breeding discontent and sending signals of their readiness to switch their
vote.
A second round of tax band widening is clearly addressed to reduce
the tax burden of the middle to high income families that have been hit in
previous years through fiscal measures such as fringe benefits taxation. The
granting of the full cost of living allowance to pensioners meets a demand they
have been making year in year out for as long as I can remember. Extension of
the benefits under the children’s allowance scheme rolls back restrictions which
had been gradually introduced rendering the application of the children’s
allowance very narrow. Through the announced measures it has been extensively
widened. A middle income family of four could find itself better off by about
Lm7 a week through the cumulative effect of the budget measures.
Other
specific measures have more telescopic impact although collectively they amount
to considerable feel good generation. Exemption or reduction of VAT on selective
sports and cultural activities, tax exemption of subscription fees to children’s
sports club, measures aimed to ease the hardship of sick and handicapped
irrespective of means testing cost little but mean a lot to those who start
benefiting there from.
How all these measures are being financed without
new tax measures and while continuing to reduce the budget deficit could
initially be mistaken for some classic example of supply side economics. This is
the economic credo of those who maintain that lowering taxes does not
necessarily lead to reduction of government revenue as the reduction in taxes
could generate economic growth leading the application of lower tax rates on a
wider base resulting in a larger tax take for the exchequer.
A closer
look at the revenue side of the budget however shows this is hardly the case.
Ordinary tax revenue is scheduled to increase by 5.3 per cent well above
economic growth rate and evidently contains a measure of better enforcement.
Recurrent expenditure, including all budget measures is scheduled to increase by
3.3 per cent indicating substantial freezing of government operational
expenditure to allow room for the funding of the announced measures from the
projected tax revenue growth.
What has largely gone unexplained is the
increase of revised estimates of Income Tax revenue during the current year 2007
which is projected to exceed the original estimate by Lm30 million. This
increase in 2007 additional income tax revenue can by itself finance all the
measures announced in the budget for 2008.
Government has been very scant
in explaining this growth of income tax revenue. One liner stating “additional
revenue is expected on various taxes on income” is hardly sufficient to explain
more than 12 per cent increase in income tax revenue in 2007 over 2006 which is
more than three times normal economic growth and this at a time when tax
allowances were given by way of widened tax bands.
More detailed
explanation is merited lest we start suspecting that there is an artificial
exercise of shifting revenues across yearly divides purely to strike a
pre-determined bottom line figure.
In the comments I heard following the
presentation of the budget, there has been little or no effort to give
significance to the long term context of the Budget; how will it lead to higher
economic growth so that we can continue to enjoy improved standard of living
based on real earnings rather than debt.
Our economy has grown by 3.6 per
cent which though better than the 3.2 per cent of previous year is still the
lowest of the new EU countries with the exception of
Hungary. We have grown because
Europe, our main trading
partner, has grown. There are no measures in the budget which can make us
optimistic that we can accelerate our growth to the same tempo of other new
entrants. On the contrary there is total disregard of problems facing loss of
competitiveness of important manufacturing units that with the strengthening
Euro versus the US dollar are being forced to consider relocating fully or
partially to dollar based economies in the Far
East.
Mandatory cost of living increases payable in advance could
in fact accelerate the pace of such relocation. This COLA business has grossly
outlived its purpose and needs scrapping sooner not later except for its effect
on the minimum wage. The unions must regain their role of negotiating one
increase across the board with each employer taking into account efficiency
gains that vary from workplace to workplace. The COLA is indiscriminate in this
regard and could send a few industries to their grave prematurely.
It is
healthy that in the medium term budgetary figures till 2010 government is
planning to reduce its recurring expenditure from the current 35.1% of GDP to
32.2% of GDP by 2010. It is not so healthy that government is freezing the
capital vote at current level during all this time. We need to continue
investing in our infrastructure to render our economic outfits more competitive
to withstand the challenges of a strong Euro we have de facto already
adopted.
12th October 2007
The Malta Independent - Friday Wisdom
As we enter the final
stretch towards D-day for the adoption of the euro, I cannot help noticing a
measure of premature exuberance, celebrating an achievement which has not yet
been achieved and risking slip ups through over-confidence at the most crucial
time of execution.
It is as if
Italy started celebrating
winning the FIFA World Cup 2006 two months before the event when they beat
Holland 4-1 in a friendly
encounter.
The euro adoption project does not consist solely or primarily
of the administrative steps needed for its adoption. Indeed in the long run of
things this will be a relatively minor part of the project.
This is not
to say that the National Euro Changeover Committee has not done an excellent job
in administering efficiently the change over process. The praise they have been
showered with even from foreign authoritative sources is well deserved. Their
job has been facilitated by the political consensus that has surrounded the
project. This has permitted the NECC to brand it with a national imprint so
necessary to obtain acceptance and cooperation from a very wide cross-section of
the population.
But we should not deceive ourselves into believing that
this is what the adoption of the euro is all about, and that the good work of
the NECC is enough to guarantee the success of the project.
The real
success or otherwise of the euro project can only be assessed and measured a
posteriori after the actual adoption. There will be two tests that have yet to
be overcome. The first one is to ensure that the changeover will not bring about
any noticeable increase in prices, neither of a one-event nature and certainly
not a spiral of price increases feeding on itself.
I don’t think that
enough is being done to ensure that from an inflation point of view the NECC
will live up to its motto that only the currency is changing but the underlying
prices should remain, all things being equal, the same as if no currency
changeover has happened. In a few words if a product was being sold at LM1
before the changeover it will be sold at EUR2.33 after the changeover and there
will be no rounding up to 2.35, 2.40 or 2.50.
What else can be done in
this regard? We need an intensive educational process of managing expectations
of price stability. The consumer has to be trained to challenge price increases
caused by the rounding off effect from currency changeover. The anchoring of
such no price increase expectations has to be very deeply ingrained in the
consumers. In business, merchants sell their products and services for the
highest price consumers can take. If merchants perceive any readiness on the
part of consumers to accept price increases due to the rounding effect of the
currency changeover, rest assured that they will use this pricing power to the
detriment of the consumer.
Next Monday is budget day. It is tempting for
the government facing an election that will probably be held within two months
after euro adoption, to score some political points by offering a financial
one-off reward in advance for any price increases resulting from the changeover.
What’s more effective to sway voters’ opinions than sending them a cheque in the post during an election campaign?
This
will go diametrically opposed to the need to anchor expectations of no price
increases and will practically give a license to merchants to round up prices on
changeover.
I don’t agree with muted suggestions about imposing temporary
price freeze. Apart from the extreme difficulty of policing such price freeze,
the price increases will at best be postponed and not avoided. What is needed is
correct and easily available information which consumers can use to their
advantages in policing directly unjustified price increases. The voluntary price
freeze agreements being signed with private sector operators are good and
welcome in so far as they go. But who is going to ensure that they are honoured where it matters ie, at
the retail end to the delivery chain?
In days of ICT revolution, it
should be fairly easy to enforce dissemination of information by forcing
retailers, wholesalers and importers to file an official price list with the
NECC or Consumer Affairs office at the end of each month between October 2007
and March 2008. This information should be pasted up an on appropriate website
where consumers can search by VAT Registration number shown on their fiscal
receipt to know whether prices are being unfairly rounded up or indeed increased
beforehand in anticipation of the currency changeover. Information is the best
tool for consumers to protect themselves from price exploitation.
In the
longer term, the success of the euro project will be measured by how much our
economy remains competitive to export to the rest of the world and to attract
foreign direct investment. Before we joined the ERM mechanism in May 2005, I had
argued that we could suffer from loss of competitiveness by locking in at a rate
which I perceived as fundamentally overvalued. Once the decision to lock in at
just under 43 cents per euro was made I rested my case
and worked for competitiveness to be achieved by restructuring in the real
economy.
Two and a half years later and just on the D-day threshold, I am
pleasantly surprised that our competitiveness has not suffered and that
restructuring kept pace. There is no doubt that the euro project itself served
as a catalyst for acceptance of an accelerated pace of re-structuring, but we
should also thank our lucky stars that the world economy has been experiencing a
very glamorous period of economic growth, not perceived likely in May 2005,
which has eased the pain of restructuring and helped us to regain
competitiveness without resorting to exchange rate adjustments.
The
restructuring cannot be considered as having reached its destination on Euro D –
day. It must continue relentlessly if we are to keep winning in a competitive
world. With very limited or no room for manoeuvre in
the monetary, exchange rate and fiscal policies, the restructuring has to be
made in the real economy, where after all it is most effective.
This is
no time for irrational or premature exuberance. It is time to focus more
determinedly to the need to achieve a smooth price changeover without any
inflationary impulses and to ensure that euro adoption will continue to be
catalyst for accelerating the pace of restructuring.
5th October 2007
The Malta Independent - Friday Wisdom
The Northern Rock is
melting. Confidence had turned sand into a rock. Lack of confidence in the
UK financial system is
causing the rock to crumble back into sand. Soft confidence can do or undo what
hard sledgehammer tactics fail to scratch.
This might be of little
relevance to us in Malta given that we have a
very solid and overly liquid banking system and there is not even a remote
possibility of the inter-bank money markets seizing up as they did in
UK. But given that we adopt
a similar regulatory regime as that adopted in
UK, it should interest us
to watch and analyse how effectively this regulatory
regime has performed when put to real test of financial stress.
In
Malta, as in
UK, there is separation
between the monetary policy and financial stability oversight duties adopted by
the Central Bank from the banking regulation duties adopted by the financial
regulator (MFSA in Malta and FSA in
UK) that actually licenses
and regulates banks at the institution level.
The purpose of this
separation was meant to ensure that the Central Bank is and is perceived to be
totally autonomous in the conduct of monetary policy without being influenced by
the stability of individual institutions.
How has it worked out in
practice in the case of the Northern Rock crisis? Not very well I must say. With
this first hand experience of how the system works when put to the stress test,
it might just as well be that we need to review the whole structure of
regulation, financial stability and monetary policy execution.
Northern
Rock was a mutual building society that converted to commercial bank status
being fully licensed and regulated by the FSA. Its business model involved
operating as an important niche player in the
UK mortgage market with
very limited branch network for raising retail deposits and instead funding its
mortgage loan book by short-term funding on the inter-bank markets and the
wholesale commercial paper market.
No one has in any way accused Northern
Rock that it has adopted irresponsible lending practices or that it is suffering
any material deterioration of delinquency ratios of its loan book. On the
contrary, regulators went on record stating that they are completely satisfied
of the robustness of Northern Rock loan book and that the illiquidity problems have been caused by extraneous sources
of systemic disturbance. Mortgage problems in the US and direct and indirect –
as yet unquantified – exposure of some of the UK bank
players to such problems and the general and sudden investors’ attitude shift
from one of strong risk appetite to one of substantial risk aversion, forced the
wholesale and inter-bank money markets to suddenly seize up.
Without the
working of an efficient and liquid inter-bank market, the business model of
Northern Rock went through the shredder. While the Bank of England was adopting
a hands-off approach interpreting the problem as being specific to Northern
Rock, depositors started lining up demanding instant return of their deposits.
The confidence foundation built over decades and decades of central
banking tradition in acting as a lender of the last resort for preserving the
integrity of the banking system was thrown out of the window in a couple of days
by what appears to be lack of co-ordination between the FSA and the Bank of
England. This lead to some under-estimation that Northern Rock was melting down
due to a systemic freezing for reasons beyond its control and unconnected with
their integrity of doing business.
Then when it was too late for
confidence to escape unscathed there was a vault-face by the Bank of England.
Not only did they suddenly give all the necessary credit lines and liquidity for
Northern Rock to fund all the deposit drain in process but when this was not
enough to reinstall confidence, they forced the Chancellor of the Exchequer to
take the unprecedented step to guarantee all deposits of Northern Rock, and by
implication of all banking institutions that might find themselves in its same
position.
I dare suggest that this would not have happened if the Bank of
England was directly responsible for licensing and regulation of individual
institutions as the Bank of England would have had first hand ongoing experience
of the problems of Northern Rock. It would have either not approved Northern
Rock’s business model in the first place or would have provided liquidity more
promptly without causing systemic seizing and without tarnishing the confidence
foundation on which all of our financial systems are built.
Now with
this first hand experience of how well or otherwise the new separation of duties
between regulation and monetary policy has worked in practice, we can pass some
judgement. Which is the more damaging? The risk of
monetary policy execution being contaminated by the moral obligation to save a
regulated institution or the risk of lack of coordination between the various
regulatory players leading to a systemic failure causing the near collapse of
licensed institution for reasons that are totally extraneous to their
operations, causing hardship to individual depositors, leading to anxious queues
outside branches right in the City which floats on financial confidence, and
forcing the government to take on the obligation of the insurer of the last
resort.
How are MFSA peer institutions in the euro area countries going
to increase their coordination with the ECB to ensure that the Northern Rock
experience in UK is not repeated
unnecessarily in the euro area we are just about to join?