Friday, 30 November 2007

Creativity Overdose

 30th November 2007
The Malta Independent - Friday Wisdom

It is turning into a creativity overdose. The strategic plans published by both the government and the opposition for the development of the Valletta harbour and surrounding zone, is matching the anything-you-can-do-I-can-do-better game of promises about goodies to be dished out by each side if elected.

At least we are being told not only how to spend it, but also how to earn it. The problem, however, is that both parties are setting dead lines for execution which stretch well beyond the next legislature.

The PN puts the arrival date on their time line as 2015, meaning they need two legislatures to deliver, giving them almost uninterrupted tenure of office, stretching 28 years. Labour on the other hand give their dateline delivery year as 2020, meaning they would need three electoral terms to complete the project.

I have nothing against long-term planning. But in a fast changing world it is often of dubious value to make plans stretching so far into the future. The political parties would be more credible if they publish which elements of their plans will get priority for execution within the next legislature, as, after all, the electorate will choose a government for five years. No one should assume re-election down the line.

And of the greatest priority, I hope, would be a very promising initiative in Labour’s document about the City Gate bus terminus. Quoting verbatim this reads: “This project will also include the transfer underground of the City Gate bus terminus …creating a pedestrian area from the
Malls Gardens right to the City centre”.

If we do anything, we have to do this project. The present bus terminus and surrounding kiosks are an insult to the World Heritage Site that is
Valletta. Irrespective of whether the existing City Gate is appropriate or not for a walled city, what is certainly inappropriate is having its main pedestrian access point a perfectly organised confusion, with pedestrians criss-crossing among moving buses. The kiosks, with merchandise overflowing onto the pavement and often covered or protected by wind breakers – more appropriate for fields rather than for retailing outlets in a prime area – are a display of shabbiness and proof of poor standards.

I just returned from
Salzburg where I could admire the cute wooden stalls erected in perfect order side by side to create a temporary Christmas Market in the city centre. For a market lasting a handful of weeks, Salzburg organises perfectly designed and uniform stalls. For kiosks being used day in day out in our City entrance, we have no power of persuasion or measures of discipline to impose a uniform and organised approach.

Less appealing is Labour’s proposal to develop the Royal Theatre site into an office building for financial services, to create a financial district in the area comprising the Stock Exchange and the Central Bank.
Valletta is appropriate to be a city for the citizen, not for business. A financial district attracting international business would have little inter-action with either the Stock Exchange or the Central Bank. More likely their interaction would be with MFSA as regulator, located on the Mriehel by pass.

It makes little sense to load further traffic and parking stress on
Valletta, by adding business traffic to the private commercial attractions which draw huge crowds to Valletta each day. If we succeed in attracting business to form an international financial district, then its ideal location would be the site presently occupied by the Marsa power station, due to go out of business by 2015. On the SmartCity model it should be possible to attract PPP interest to develop this site and give a soul to the inner harbour area.

The Royal Theatre site ought to be developed into a project which meets the needs of the residents and tourists that daily throng in
Valletta. Primarily for tourists, especially the cruise line visitors who are here for only a few hours and have no real opportunity to get to know us, it would be ideal if we could mount a visual display of our unique collection of prehistoric temples and cultural treasures there. The purpose would be to whet their appetite for a longer visit.

Rather than house complete government departments like the Inland Revenue, as Labour propose, this site should embody customer service points of the various government departments and national entities, giving us a single building where people can get a complete service without having to go from east to west and north to south. With Social Services department just across the road, a building servicing passports, ID cards, income tax enquiries and education department services would go a long way in offering a focused service point releasing many other buildings to house more appropriate cultural and commercial activities. I would even tolerate the housing of the parliament building here if it released precious space in the Presidential palace for more appropriate touristic and cultural uses.

Before spreading ourselves too thin in a multitude of projects stretching over several legislatures, we need to focus on the urgent work needed to give
Valletta the pedestrian access it deserves and to render it a city for the people.

Friday, 23 November 2007

Cash Piles

23rd November 2007
The Malta Independent - Friday Wisdom

We had two different types of cash piles in the news this week. The one closer to home was discussed at the general meeting for the shareholders of Maltacom plc, now officially renamed GO plc, where the shareholders rightfully queried the company executive what it plans to do the some thirty million liri of liquidity sitting in the company’s books for which there is no evident purpose.

Given the very low level of market price at which the shares of Maltacom have been trading on the Malta Stock Exchange, some 12 per cent below privatisation price on the sale of majority shareholding to TECOM which of itself was some 25 per cent below the last trading price before the announcement of the acquisition price, shareholders rightfully demanded why the executive should not put their money where their mouth is and start buying back the company’s own shares on the market. This would be a very powerful signal to the shareholders that the executive considers that the market is seriously undervaluing the company and could kick start fresh demand for the Company’s shares which would drive the price to a more realistic level.

Rather than accept such suggestion as a practical way of returning funds that the company does not need for its own development to its shareholders, the Chairman was reported as defending the holding of such excessive liquidity to finance overseas projects being eyed by the company.

I would not wish to enter into the merits of how appropriate it is for Maltacom to give priority to such foreign acquisitions over returning capital to shareholders as obviously I have no access to information on how attractive such foreign investments could be. However I know that there are not many acquisition targets with a price tag of thirty million liri. On top of that I feel that shareholders never invested in Maltacom to finance foreign acquisitions. Given that the majority shareholders ought to have no problem to finance their acquisitions themselves outside the Maltacom framework it is prudent to give Maltacom’s small shareholders the final say as to whether they want their executive to use the company’s excess liquidity to finance foreign acquisitions or to return capital to shareholders.

However this brings home another important point that I had raised at the time of the sale of a majority stake in Maltacom by government to Tecom. Given that the share price was arrived at on the basis of estimation of future operating cash flows from the core Malta operations rather than on the value of present assets, why did government not distribute the excess cash, surplus to operational requirement, to the shareholders (itself included) before the transfer to TECOM?

This is an enigma that was never satisfactorily explained or answered and together with the failure to transfer out of Maltacom the valuable Qawra land before sale to TECOM, makes this one and only privatisation under the Gonzi administration a failure. Whether it can be justified in a wider context on the basis of TECOM’s investments in
Smart City remains to be seen even though the government had itself insisted that the two matters are not connected and each deal had to stand on its own two feet.

The other cash pile in the news is the foreign reserves in the hands of the oil exporters and emerging markets economies, including
China, India, Russia and Brazil who among them are now holding 75 per cent of the global foreign exchange reserves. This is a far cry from the Asia crisis and Russia default of 1998 when such countries had very thin foreign exchange reserves to withstand the sudden outflow of hot money from their economies.

The US dollar keeps falling and comes within a whisker of a landmark of 1.50 for every Euro. The argument is being heard more insistently whether the USD still has the merits to remain the principal reserve currency of the world and the unit of account for pricing international commodities such as oil, metals and wheat amongst others.

As the US economy slows down under the weight of its housing crisis and seems to be moving closer towards the edge of a recession, the outlook for the USD, at least in the short term, remains poor. If the Federal Reserve has to cuts
US interest rates still further to protect the economy from a recession, this will continue to devalue the external value of the USD and will give rise to continued concern to emerging economies about the wisdom of continuing to accumulate such USD amongst their foreign reserves.

With the Euro just about to celebrate its ninth year of existence its fate of becoming a reserve currency with comparable weight to the USD seems to be materialising much earlier than anyone could have imagined especially when just 5 year years ago the Euro was trading at some 80 cents for every USD. It has nearly doubled its value against the USD in just over five years.

The status of reserve currency brings much greater responsibility as well as considerable pain at the adoption stage as the rate tends to overshoot causing problems of competitiveness for domestic producers. But if this is accepted as a challenge of creative destruction, i.e. the replacement of non competitive units by new investment in higher value-added competitive units attracted by the reserve currency status, then the long term benefits from the switch the cash piles of emerging countries from USD to Euro could be enormous.

Friday, 16 November 2007

Lost Composure

16th November 2007
The Malta Independent - Friday Wisdom

Ever since the Prime Minister decided not to go for a general election on this side of Christmas I perceive a certain loss of composure and self-confidence on the PN’s side diluting the boost they had received through the impact of the Budget novelties.

The decision to hold the election after the Euro changeover date should have been a sign of confidence by government in its ability to engineer a smooth changeover without any abnormal inflationary impulses due to the rounding up of prices upon conversion of the currency.

Yet government suddenly seems to have been gripped by fear that it has allowed itself hostage to fortune, as it is practically impossible to avoid some rounding up price pressures. Though insignificant in the grand scheme of things of how inflation is measured, such price pressures coming during an election campaign could be quite powerful points of criticism in the hands of the opposition and could very well prove a useful tool to discredit the image of a safe pair of hands that the PN wants to portray upon their leader.

Reality is that prices increase all the time. It is unrealistic to expect zero inflation and indeed such a hypothesis could be economically dangerous as it could tilt the economy into a depression, i.e. a general level of price reductions which would kill off demand in the economy as people will wait to buy tomorrow at a cheaper price what they can buy today at a higher price. The European Central Bank has an official inflation target of below but close to two per cent.

What must be avoided as much as possible is a widespread process of rounding up of prices as a direct result of the currency changeover. Government could have passed a law to prohibit price increases but given that we have a market economy and given the difficulty in policing and enforcing such law, government opted for something more effective and more practical. The voluntary agreements for price stability until March 2008 are not intended to ensure eternal price stability. They are merely intended to ensure that suppliers voluntarily bind themselves to keep prices stable over the currency change over period; to ensure that the consumer is given time to adjust to the new currency regime. Of course price increases after March 2008 are possible and indeed probable. But by then the consumer would know that these are price increases in the normal course of things and not price increases through abuse as a result of the currency changeover.

The best safeguard against price increases is free market competition and easily accessible information where the consumer can compare prices. After March 2008 we will have the same price policies based on the free market concept as we had in every March of recent years.

Government seems to have lost its confidence to explain such simple things and is somehow allowing the virtue of price stability agreements to be changed into a perceived vice of possible price increases after March 2008 without effectively explaining and defending its totally rational position.

Another sign of government losing its composure is the pitiful reply which the Prime Minister gave to a Super One journalist about the expected completion date for the Manwel Dimech bridge project. This project is celebrating its quccija these days.

It should have been completed by now, yet work is still proceeding on the St Julian’s Bay side of the bridge. The work on the Swieqi side has yet to start. The Prime Minister simply refused to be committed to a completion date for the project.

The obvious answer should have been that the contractor involved has been committed to finish the project by such and such a date and failure to do so would involve penalties which the government will invoke with rigour.

Yet the Prime Minister’s obstinate refusal to commit his government to a definite completion date shows he is not in control things and that is hardly typical of a safe pair of hands.

I have no idea what made the Prime Minister discard the idea of seeking a refreshed mandate on this side of Christmas.

Maybe the hope and expectation of a Christmas laden with feel-good factor, a smooth currency changeover and tangible result of budget – measures which will be included in the January pay slip – has persuaded the PN that it stands a better chance in February than in December.

They are possibly under-estimating the perceived, not necessarily the real, inflationary effect of the Euro and may be they are expecting lasting gratitude from the electorate for the economic boost families have been given by the Budget measures. Possibly the PN have under-estimated the reality that novelty wears out quickly and budget measures quickly solidify into a given and the electorate would be more impressed by fresh election campaign novelties rather than by yesterday’s news.

The PN could possibly soon regret their decision not to go for a 2007 election. On the other hand, they could find some comfort that their faux pas is well matched by Labour’s misplaced criticism of the quality of health services being provided at Mater Dei instead of focusing their criticism on the gross absence of value for money in this project.

Friday, 9 November 2007

Boring Bankers

9th November 2007
The Malta Independent - Friday Wisdom

Central Bankers are generally very boring people. They have more independence than most other national organisations, an independence almost at par with that of judiciary outside Pakistan. They are tasked to keep the value of money stable but the only tool they have to do so is a very blunt one. Central banks are in charge of monetary policy which in simple language seeks to control the level of interest rates in the economy.

As the theory goes, if an economy is growing more than its potential, the excess demand will translate itself into rising prices so the Central Bank tightens monetary policy by raising interest rates to convince people to consume less and save more and thus bring back demand to within the economy’s potential. If on the other hand the economy is growing very slowly and below its potential causing excessive price stability or deflation through price reductions, central banks tend to lower interest rates to stimulate demand and kick start the economy.

Central banks get into a quagmire when they are faced with an economy with low real growth and high inflation as any attempt to stimulate the economy by lowering interest rates to stimulate demand could complicate an existing inflation problem. On the other hand, if they raise interest rates to address inflation they could throw a low growth economy into an outright recession.

When faced with such stark choices of conflicting objectives, central banks in developed economies that enjoy true independence from the executive are generally expected to give priority to the inflation objective. Quite often this would irk politicians whose objective time frames are generally as short as the date of the next elections. This is the reason why central banks cherish their independence which is the corner stone of the euro monetary system.

Changes in interest rates, unless of a draconian nature in the Paul Volcker style in the early 1980s, would only have an effect on the real economy with substantial time lag and this is why central bankers, boring as they may be, are expected to stay ahead of the economic curve and model their interest rates decisions to pre-empt problems rather than to address them. Otherwise interest rate changes decided today will have their real effect in 12 or 18 months down the road when the problems may have changed. So unless central banks stay ahead of the curve they could be prescribing a medicine unsuitable for the malady.

This could explain why for example presently there are people who query whether the US Federal Reserve is fuelling inflation by cutting interest rates too soon and by too much while others are arguing whether the European Central Bank is asphyxiating growth in Europe by not cutting interest rates and letting the Euro appreciate too much.

If central bankers are boring people, Maltese central bankers should be doubly so. They will no longer have monetary policy to administer as of 1 January and given that they have already lost banking regulation to the MFSA and exchange control to history, I sympathise with those who might think that our central bankers will be quite relaxed, outside their economic research department, as from next year and hard put to justify the use of their current resources, both human and physical.

So it is quite amazing that on the eve of joining the euro our Central Bank seems to have entered into an argument with the government about release of excessive foreign reserves to pay off part of the national debt. What’s more funny is that this duel is being made with the Times of Malta who are acting as an unofficial proxy for the government so that the latter avoids giving the impression that it is challenging the independence of the central bank.

Leaving technical issues aside, as these could be quite complicated, the crux is whether the excess reserves that are not required to cover the currency in circulation component under the new euro regime should continue to be administered by the Central Bank or released to government to pay off the national debt.

Those who argue that this will save us millions in interest servicing costs of the public debt seem to forget that this will be neutralised by lower profits by the central bank which in the end would flow back to the public exchequer. So we will lose on the swings what we gain on the roundabout.

Personally I would prefer to see these reserves stay with the Central Bank if for nothing for the avoidance of the possibility of giving this and future governments capacity to rebuild the public debt and still stay within the euro rules. On the other hand the Central Bank has to start practicing what they preach and explain what measures they would be taking to improve their efficiency given their reduced workload. They should also be more transparent about their performance in the management of foreign reserves.

Small fry investment services operators entrusted by their clients with portfolio management are under the new MiFID regime expected to report performance every quarter against a declared benchmark. Why should our professionals at the Central Bank avoid measuring their performance publicly against a benchmark given they are handling pretty high figures with several zeros behind the digits?

There is another enigma with the business of central banking. When things are going well central banks target their monetary policy to keep retail prices under control but take very little interest in asset price inflation. For example the Central Bank never pitched their interest rate policy to control the real estate price explosion of recent years. When things turn bad, as is happening presently in the
US housing market which inevitably spills itself into the financial markets and possibly on the general economy, central banks start cutting interest rates aggressively in order to stabilise the economy and create a cushion for a soft landing.

But something is wrong somewhere. What applies to the downside should also apply to the upside which can only be done if central banks include asset price inflation in their monetary policy stance and if they have direct regulatory control over the markets not only in the banking sector but also on its periphery that contribute to asset price inflation or outright asset price bubbles. The whole regulatory regime needs to be re-engineered in the light of the 2007 experience.

Friday, 2 November 2007

Budget (non) Vision

2nd November 2007
The Malta Independent - Friday Wisdom

If anything stands out clear from the budget debate it is that both the government and the opposition are on political trip of fiscal patchwork that sees no further than the next election. The short-termism is palpable.

To my point of view the objective of a budget ought to be the delivery of sound fiscal policy that stimulates operational efficiency and long-term sustainable economic growth to develop the economy to its full potential.

To achieve such objective a budget has to carry as proximate targets the need to keep marginal taxes low enough to stimulate economic activity and promote tax compliance by making it more economic than tax evasion. It also has to minimise transfer payments as these serve to bloat the government’s share of the economy and leads to inefficiencies as the government takes money from taxpayers with one hand and gives it back to same taxpayers with the other hand without adding value. It just adds inefficiencies as the government takes our taxes and gives us back part of our own money in children’s allowances.

The budget fails to generate such vision. It effectively does the opposite. Marginal tax rate is kept at 35 per cent, which is high by today’s standards when many competitor countries are working with flat tax rates at around 20 per cent or less. There is no vision to continue with the shift of fiscal impact from earnings to expenditure and instead leaves the economy to operate with marginal tax rates that are high enough to make evasion more economic than compliance.

Furthermore we continue with the social blasphemy in our fiscal laws where the fruit of labour is charged at a rate (35 per cent) higher than the fruit of capital (15 per cent in case of withholding tax application on investment income).

The opposition proposal to exempt overtime from income tax further complicates matters as it creates distortions in the composition of pay packages and discriminates against white collar middle income employees who are not paid overtime. It also discriminates against blue collar and junior white collar employees who in the absence of overtime opportunities at their main employment supplement their income through part-time jobs.

Our fiscal structure needs a total overhaul. It certainly can do without pre-election patchwork which puts some sugar on the front end and makes the long-term overhaul that much more difficult.

Our objectives should be twofold. To reduce marginal tax rates to the same level of the VAT rate so that we will have one common rate throughout the economy applicable to all marginal income, whatever its sources, and to all marginal expenditure. This rate will be low enough to make compliance more economic than evasion as the experience with withholding tax on investment income clearly indicates.

The second objective should be to reduce transfer payments so that the individual interacts with the government at only one point i.e. through taxation which could be positive or negative. The only other point of interaction would be in payment of contributory benefits like pensions the arrangements for which will remain intact.

Such a system would ensure that all government departments, with very few exceptions like justice, law enforcement, foreign affairs and the revenue departments, would operate on a strict commercial basis with as wide competition as possible to ensure maximum efficiency. The government would retract itself to become the enforcer of standards and consumer protection and will reduce its role even in delivery of services that can be delivered by market forces even in the field of infrastructure and maintenance, education and health.

This is not a vision that could be implemented through a single budget in a big bang method. But each budget has to make a contribution towards this destination. Regrettably the 2008 budget takes us in the opposite direction and proposals from the opposition do not help either.

We have lost our vision which needs to go much further than optimistic hopes of balancing the budget by 2010. We have to target growth, real growth at our maximum potential. We have to extend the limits of our potential and we have to economise on the use of resources by giving a huge impetus to efficiency by changing the way we do things around here. That which in MBA programmes is commonly referred to as the culture.

Electoral exigencies conditions politicians to fiscal patchwork. Let’s hope the newly elected government will focus of fiscal restructuring that deliveries the bacon over a medium term so that we can continue to earn an enhanced standard of living in a very competitive world.