Still Can`t Get It

16^th November 2008

The Malta Independent on Sunday

Try as I may, I still can’t understand what the government is trying to achieve with Budget 2009. I was hoping that the Prime Minister’s reply to the criticism of the Opposition would somehow illuminate, but really the Prime Minister seemed to be talking about something far removed from the Budget his Minister of Finance presented to Parliament on 4 November.

There are two major issues which remain an enigma and for which I can’t find any explanation using a minimum of economic logic.

The Prime Minister, echoing his minister’s original presentation, placed great emphasis on the international economic gloom, which acts as a threatening background to our economic fortunes in 2009. He is right. None can dispute that our major trading partners are speedily slipping into a serious recession the length and depth of which remain highly uncertain. Dysfunctional financial markets could make the current recession much more damaging and painful than an ordinary cyclical one. As the financial system is constrained to de-leverage, credit is bound to become scarce and expensive notwithstanding desperate efforts by central banks to push down short-term interest rates. Without properly functioning credit markets, consumers will be forced to retrench their spending and businesses will be constrained to abandon their investment plans.

Lack of global demand will have unpleasant consequences on an open economy like ours, which depends on foreign demand for our manufacturing exports and for success in our tourism industry. The government’s estimates of real growth of 2.5 per cent for 2009 seem optimistic. Its expectations to increase the tax take by eight per cent bear no justification by normal economic growth, which even at nominal level will struggle to exceed five per cent.

So it is understandable that the Prime Minister in his reply put great stress on the economic need to use the budget to give an economic stimulus to compensate for the expected drop in foreign demand. So far so good! The problem is that the Budget 2009 provides no such stimulus. On the contrary, it caused a shock, indeed a series of shocks, which will reduce domestic consumption demand without providing additional demand on any significant scale through additional investments. Was the Prime Minister referring to the same Budget presented in Parliament, or does he have a Plan B we know nothing about?

To be considered as an economic stimulus, a Budget has to have two attributes. It would have to leave more spending power in consumers’ pockets to stimulate consumption demand. And it would have to increase the capital investment budget to mop up idle resources and build infrastructure that supports future growth.

The Budget 2009, taken in tandem with the revision of utility rates, has shocked consumers and takes away, rather than increases, their spending power. How can the Prime Minister speak of a fiscal stimulus if the deficit is expected to fall from e200 million in 2008 to e99 million in 2009. Arguments that the 2008 Budget has special items related to the shipyards’ early retirement schemes and energy support measures amounting to e99 million, do not alter the fact that in 2009 consumers will be left with e101 million less in spending power than in 2008. Even if for argument’s sake the special items are knocked off the 2008 revised deficit, is the adjusted deficit of e101 million of 2008 still projected to fall marginally to e99 million in 2009? So where is the economic stimulus? There can be no short-term impact economic stimulus without an increase in the deficit. That’s the stark reality the government seems oblivious to.

Even when it comes to the capital budget the government is planning a spend of e348 million. The government regularly under-spends this budget by some 20 per cent, principally due to our inability to handle the EU co-funding process with the necessary speed. If, as is typical, we spend about 80 per cent of the amount voted, the actual spend will be about e280 million, which is roughly on the same level of the 2008 spend. So where is the economic stimulus?

The other thing I just can’t get is why we are the only country in the world raising fuel and utility prices at a time when the cost of international energy is dropping like a rock. The Prime Minister made two arguments to try and explain this. Both are feeble and unsubstantial. He said that the price of refined oil is not falling as fast as the price of crude oil. This could well be so, but though prices of refined oil products do not move in perfect harmony with the prices of crude oil, both shadow each other closely and it is only a matter of time that refined oil prices will reflect the fall in the price of crude. Fuel prices at the pump in the US are already half of what they were at their peak.

Secondly, the Prime Minister said, and rightly so, that energy supplies are contracted forward and we are currently burning oil bought at high prices. Certainly, we should take the opportunity to buy or hedge forward at current prices so that we can average down the acquisition price to smoothen excessive price changes at retail level.

There is something sinister about the new utility rate system. Why is the structure being changed now? Is it to make it difficult to compare future reductions with prices under the present system? Now that we should expect a reduction in the surcharge due to the falling price of international energy, why are we being denied the transparency to make comparisons with the applicable surcharge of previous years?

Consider this. When the surcharge was fixed at 50 per cent in August 2007, the average price of crude oil was US$70. When this surcharge was revised in July 2008, the price of crude was peaking at US$147 and the surcharge was fixed at 95 per cent. However, we were warned that without subsidies and hedging gains the surcharge would have been fixed at 160 per cent. Going forward it is fair to assume that with the world in the throes of a recession the average price of crude oil in 2009 could stay within US$70 (currently it is US$58). So logic would suggest that rather than increase the 95 per cent surcharge further, it should soon go back to 50 per cent (or say 60 per cent to take account of the strengthening of the USD since last year).

The only reason why government is moving away from its own past logic is that it is changing the rules of the game without being open and frank about it. We have subtly moved from a long held model where profits from sale of petroleum products subsidise recurrent and investment costs for the generation and distribution of electricity, to a new model where generation and distribution of electricity should become commercially viable on its own merits.

I question the new logic. We are competing with countries who get their supply of water free from nature and who have economies of scale in the generation and distribution of electricity. What is wrong in cross subsidising Enemalta’s electricity division to remove disadvantages we have vis-à-vis competitors?

I am afraid there is a hidden agenda. We are privatising importation and distribution of petroleum products and in the process we are privatising assured profits previously used to subsidise electricity costs. Obviously, without this cross subsidy the consumer will have to bear the brunt not only of full recovery of recurrent costs for generation and distribution of electricity, but also to fund capital investments. Costings published in fact include a charge of e25.5 million being 6.61 per cent on capital employed of e386 million. This huge figure includes past as well as future investments.

In layman’s language, we have embarked on a regressive model where we are privatising profits and socialising losses. So much for social solidarity! And now that we are about to privatise the gas division, which will involve the removal of all subsidies and give yet another shock to the consumer, it is fair to question if the further increase, unjustified as it evidently is, in electricity rates is meant to favour the private operator of the gas division that needs expensive substitutes to maintain and increase the consumption of unsubsidised gas.

Or is all this part of scheme to put as much pain as possible at the beginning of the legislature to amass space for easing up in the run up to the next election? Once I can’t get it, I search for reasons beyond what is immediately obvious.