The Challenge is Now

  

9^th January 2009

The Malta Independent - Friday Wisdom

 Two years ago almost to the day I had titled this column ‘The challenge comes after’. There I had stated that:
“The true challenge for making success of the euro will not be 2007. It will have to be a few years down the road when we can draw some conclusion about the success or otherwise of our euro project. Unlike what many might think, the euro challenge is not the preparations for smooth changeover, which will be largely forgotten a few weeks after the event. It is the process of the unfolding years after the event that will decide whether the euro has enabled us to accelerate the restructuring in order to preserve our competitiveness.

2007 is pretty much a transitory year. Being the last full year before the latest date for holding fresh elections, governments tend to go soft on the restructuring process. Such issues like restructuring of the health services and a thorough overhaul of our fiscal system will have to wait till after the next election.

All in all, therefore, 2007 will be a cruising along year. The real challenge comes after. Making success of our joining the euro depends on our determination to continue restructuring to avoid waste, as is currently inherent in our public services, and accepting that there is no such thing as a free lunch.”
By extension of this argument, the real challenge of the euro is now. How are we shaping up to face it?

Many have made the argument that our being in the euro monetary system has protected our banking and financial system, and by implication our general economy, from Icelandic type of financial disasters and has spared our government from any need for significant intervention to stabilise our banking system.

I find these claims exaggerated, if not inappropriate. While being on board a stable large ship adds comfort when the sea turns stormy, the real comfort is not being caught in the eye of the storm. Ireland is a founder member of the euro system but because its regulators allowed its banks to take imprudent over-exposures, it practically had to re-nationalise its banking system. Even Germany itself had to intervene to save its regional banks that had sought additional yield on their investment portfolio and in the process had built exposure to the US sub-prime mortgage market.

I maintain that what has preserved stability in our banking and financial systems, rather than our being euro members, is our thrift culture and our conservative banking system where all bank investments and lending are financed by retail deposit with money to spare over and above legal reserve requirements. This priceless endowment should be protected and cultivated.

I am developing cold feet seeing foreign financial institutions using the freedom granted to them by the EU single passport rule, plugging aggressively into our savings pool by offering attractive rates on deposit products written in man-sized digits on billboards. Local authorities should conduct meaningful information dissemination on the difference in rating of the deposit institutions pitching for local deposits and the extent and limits of the deposit protection insurance offered for such products by foreign regulators under whose licence it is possible for such non- Malta registered banks to compete with locally regulated deposit institutions.

Arguing that our economy has been spared from international financial turmoil is wishful thinking. Being the open economy we are, there is no way that we will not be affected adversely by the recession taking hold internationally. Our tourism numbers have been sinking since October and the outlook for 2009 appears grim especially from the UK market where EUR based holidays have become too pricy in GBP terms given the sharp fall in the foreign exchange value of the Pound Sterling. Our factory order books are getting shorter and price competition will seriously erode trading margins. Our property market has cooled down and unless given some macro-economic stimulus could well slip into a dangerous coma.

The challenge of the euro is therefore ahead not behind us. When things around us are getting tough, it is those who have restructured that stay competitive enough to win even in a shrinking market. Italy, Greece and Ireland are suffering as their unit labour cost has increased by 20-30 per cent since their euro entry whereas Germany through its successful restructuring has achieved efficiency gains large enough to keep its unit labour costs on the same level it was in 1999.

Since we joined the Euro we have done little or no restructuring. 2008 was an election year and this inevitably slows down any restructuring process. The only real change we have seen is the phasing out of subsidies on energy and bread and indeed in the case of energy government has probably gone from one extreme to another and will hopefully right the pendulum in the middle during the course of 2009.

But we have seen no real restructuring to render our expensive health services sustainable. We have had no overhaul of our fiscal system leading to a reduction in marginal tax rates moving hand in hand with solid improvements in tax compliance. We have seen no serious attempt to cut the waste in our public service employment. These are the real challenges which could make our euro experience a real success. I finish off just as two years ago: “The euro is certainly no free lunch. It is a veritable challenge”.