5th October 2008
The Malta Independent on Sunday
This was the week when hidden
contradictions were exposed.
Take the proposal presented by the government for the introduction of a new utility rate tariffs effective 1st October. This is meant to be a consultative process. But how can it be so if at the same we are informed that the new rates will become effective retroactively from 1st October 2008.
How can households run their budgets if they do not know the cost of electricity they are consuming? How can commercial organisations price their products and sign contracts if the rate of a cost input as important as energy is still up in the air and will take effect retroactively?
It is clear that too many problems were swept under the carpet in the run-up to the election, and it is seems that after taking a long summer holiday that government is now presenting society with very unpleasant fait accompli(s) which have to make up for extensive hiding of reality in order to facilitate getting re-elected.
Between October 2007 and June 2008, the surcharge on a hedged basis should have been, on average, 100 per cent. In fact it was 50 per cent and the government had committed itself to keep it at that level till June 2008. The government knew it was under-recovering actual cost but electoral convenience demanded that social aspects take precedence over economic ones. Now we are being presented with the real bill. Now we are told that utility rate setting should be merely an accounting exercise for recovery of costs incurred including not only direct cost, operational expenses and overhead recovery, but also a margin to provide for recovery of past investments and a new investment programme of €451 million over the next four years.
No wonder government proposals are under attack from practically every quarter – traditional friends as much eternal adversaries. Presenting these proposals without an analysis of its social and economic impact is an act of gross irresponsibility. Presenting them with the intention that they would have retroactive effect is an act of gross arrogance. Presenting them without explaining what sort of direct subsidies government can provide is the job of an accountant not of a government that has social and economic responsibility for the whole country.
This week also exposed an acute case of contradiction embedded in the set up of the Euro Monetary Union (EMU). When it was designed its founders knew that history was not on their side while trying to create a durable single currency for a group of individual sovereign States that are not underpinned by a political union. In the past, similar attempts were short-lived and ended in disintegration.
The euro founders must have been hoping for one of two things. Either that EMU would itself be a catalyst for the gradual formation of a political union to underpin it, or that the constituent sovereign States would closely co-operate and align their fiscal and financial policies to make them resemble the policies of a single State.
Such assumptions can only be validated when the system is under severe stress. And after 10 years of relatively stress free performance, we have now suddenly precipitated to the point where the financial stability of the constituent sovereign States has come under stress as US financial instability is exported to Europe, especially since Lehman Brothers filed for bankruptcy on 14 September.
The European Central Bank (ECB) is responsible for a common monetary policy for the whole euro area and statutorily is only responsible for keeping stable and low inflation with little or no responsibility for economic growth. Obviously, to achieve such inflation objectives it needs stability in the financial markets. It cannot perform in a situation where banks lose their credibility and depositors and investors prefer to keep cash under the mattress rather than in the banking system. But all the ECB could do to achieve stability at times of turmoil is to pump liquidity to keep the banks floating when their problems is one of illiquidity. It can do pretty little when the problem is one of insolvency caused either by the misfortune or mismanagement of one particular institution or by systematic failure caused by external shocks.
The responsibility for financial stability in such cases rests with the individual States, or in case of banks working across borders, with a group of such States. This week we have accordingly seen the Benelux countries salvaging Fortis with a direct equity capital investment, Belgium and France salvaging Dexia, Germany salvaging Hypo Real Estate, and Ireland giving a sovereign guarantee for all retail deposits held by Irish banks worldwide as well as foreign banks in Ireland holding Irish deposits
With this measure the Irish have released a bull in a china shop. They put pressure on other countries to offer similar sovereign guarantees, as otherwise there would be a shift of deposits towards Ireland at a time when the situation in most euro countries is unstable enough. Greece has already followed in the Irish footsteps and the big countries are meeting over the weekend to see whether they can come out with a co-ordinated response that would include all euro countries. Meanwhile, Italian Prime Minister Berlusconi promised no one would lose a euro of deposits in Italian banks, effectively giving an informal blanket state guarantee.
So what will happen now? Will all euro area deposits be covered by a State guarantee, or will a supranational organisation be set up to harmonise such matters without having one country gaining unfair advantage over the others? And what if the guarantee would need to be exercised? Like an insurance policy a guarantee is only reliable if it can be cashed when validly claimed. How will the Irish government make good for a guarantee for a value more than twice its GDP and still stay within the Maastricht criteria? Is it not an oversight that these criteria make no rules for the quantity of contingent obligations EMU States can take on their books?
The weekend summit is crucial for the future of the euro and for the stability of the European banking system. Without a broad agreement for setting up a common fund for recapitalisation of European banks to a more comfortable level that can withstand the severe stress of current financial turmoil, each country will have to fudge along on its own, adopting beggar thy neighbour policies more typical of the 1930s than of a monetary union of the 21st century.
Yet our government thinks now is the right time to have us bear the full brunt of the energy prices because EU rules do not permit subsidies, cross subsidies and unfair competition among its members. While other countries are bending the rules to protect their economies from these financial external shocks, our government thinks that in the midst of all this turmoil it is the right time to shock the economy further by the abrupt removal of energy subsidies with retroactive effect. Truth is that the government has lost control of public finances and is desperately trying to paper over the cracks without considering the long term consequences of its actions.
The financial turmoil has now damaged the international economy making a rather prolonged recession a near certainty. When the price of oil is heading down to more comfortable levels as a result of less demand due to the impending recession, our government is proposing to jack up internal market prices for energy to recover past shortfalls tolerated for its own political convenience. And in the process it takes cover by claiming that EU rules are forcing its hand when reality is that the EU is much busier putting out much bigger fires elsewhere.
Let's get serious!
Take the proposal presented by the government for the introduction of a new utility rate tariffs effective 1st October. This is meant to be a consultative process. But how can it be so if at the same we are informed that the new rates will become effective retroactively from 1st October 2008.
How can households run their budgets if they do not know the cost of electricity they are consuming? How can commercial organisations price their products and sign contracts if the rate of a cost input as important as energy is still up in the air and will take effect retroactively?
It is clear that too many problems were swept under the carpet in the run-up to the election, and it is seems that after taking a long summer holiday that government is now presenting society with very unpleasant fait accompli(s) which have to make up for extensive hiding of reality in order to facilitate getting re-elected.
Between October 2007 and June 2008, the surcharge on a hedged basis should have been, on average, 100 per cent. In fact it was 50 per cent and the government had committed itself to keep it at that level till June 2008. The government knew it was under-recovering actual cost but electoral convenience demanded that social aspects take precedence over economic ones. Now we are being presented with the real bill. Now we are told that utility rate setting should be merely an accounting exercise for recovery of costs incurred including not only direct cost, operational expenses and overhead recovery, but also a margin to provide for recovery of past investments and a new investment programme of €451 million over the next four years.
No wonder government proposals are under attack from practically every quarter – traditional friends as much eternal adversaries. Presenting these proposals without an analysis of its social and economic impact is an act of gross irresponsibility. Presenting them with the intention that they would have retroactive effect is an act of gross arrogance. Presenting them without explaining what sort of direct subsidies government can provide is the job of an accountant not of a government that has social and economic responsibility for the whole country.
This week also exposed an acute case of contradiction embedded in the set up of the Euro Monetary Union (EMU). When it was designed its founders knew that history was not on their side while trying to create a durable single currency for a group of individual sovereign States that are not underpinned by a political union. In the past, similar attempts were short-lived and ended in disintegration.
The euro founders must have been hoping for one of two things. Either that EMU would itself be a catalyst for the gradual formation of a political union to underpin it, or that the constituent sovereign States would closely co-operate and align their fiscal and financial policies to make them resemble the policies of a single State.
Such assumptions can only be validated when the system is under severe stress. And after 10 years of relatively stress free performance, we have now suddenly precipitated to the point where the financial stability of the constituent sovereign States has come under stress as US financial instability is exported to Europe, especially since Lehman Brothers filed for bankruptcy on 14 September.
The European Central Bank (ECB) is responsible for a common monetary policy for the whole euro area and statutorily is only responsible for keeping stable and low inflation with little or no responsibility for economic growth. Obviously, to achieve such inflation objectives it needs stability in the financial markets. It cannot perform in a situation where banks lose their credibility and depositors and investors prefer to keep cash under the mattress rather than in the banking system. But all the ECB could do to achieve stability at times of turmoil is to pump liquidity to keep the banks floating when their problems is one of illiquidity. It can do pretty little when the problem is one of insolvency caused either by the misfortune or mismanagement of one particular institution or by systematic failure caused by external shocks.
The responsibility for financial stability in such cases rests with the individual States, or in case of banks working across borders, with a group of such States. This week we have accordingly seen the Benelux countries salvaging Fortis with a direct equity capital investment, Belgium and France salvaging Dexia, Germany salvaging Hypo Real Estate, and Ireland giving a sovereign guarantee for all retail deposits held by Irish banks worldwide as well as foreign banks in Ireland holding Irish deposits
With this measure the Irish have released a bull in a china shop. They put pressure on other countries to offer similar sovereign guarantees, as otherwise there would be a shift of deposits towards Ireland at a time when the situation in most euro countries is unstable enough. Greece has already followed in the Irish footsteps and the big countries are meeting over the weekend to see whether they can come out with a co-ordinated response that would include all euro countries. Meanwhile, Italian Prime Minister Berlusconi promised no one would lose a euro of deposits in Italian banks, effectively giving an informal blanket state guarantee.
So what will happen now? Will all euro area deposits be covered by a State guarantee, or will a supranational organisation be set up to harmonise such matters without having one country gaining unfair advantage over the others? And what if the guarantee would need to be exercised? Like an insurance policy a guarantee is only reliable if it can be cashed when validly claimed. How will the Irish government make good for a guarantee for a value more than twice its GDP and still stay within the Maastricht criteria? Is it not an oversight that these criteria make no rules for the quantity of contingent obligations EMU States can take on their books?
The weekend summit is crucial for the future of the euro and for the stability of the European banking system. Without a broad agreement for setting up a common fund for recapitalisation of European banks to a more comfortable level that can withstand the severe stress of current financial turmoil, each country will have to fudge along on its own, adopting beggar thy neighbour policies more typical of the 1930s than of a monetary union of the 21st century.
Yet our government thinks now is the right time to have us bear the full brunt of the energy prices because EU rules do not permit subsidies, cross subsidies and unfair competition among its members. While other countries are bending the rules to protect their economies from these financial external shocks, our government thinks that in the midst of all this turmoil it is the right time to shock the economy further by the abrupt removal of energy subsidies with retroactive effect. Truth is that the government has lost control of public finances and is desperately trying to paper over the cracks without considering the long term consequences of its actions.
The financial turmoil has now damaged the international economy making a rather prolonged recession a near certainty. When the price of oil is heading down to more comfortable levels as a result of less demand due to the impending recession, our government is proposing to jack up internal market prices for energy to recover past shortfalls tolerated for its own political convenience. And in the process it takes cover by claiming that EU rules are forcing its hand when reality is that the EU is much busier putting out much bigger fires elsewhere.
Let's get serious!
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