Friday, 27 March 2009

GO Greek

 27th March 2009
The Malta Independent - Friday Wisdom

Normally I would not comment on the financial results and individual share performance of any public company quoted on the Malta Stock Exchange. On the rare occasions where I comment on local financial investments, I tend to restrict myself to the general market rather than focus on any particular company.

The financial results announced by GO plc last week merit an exception. Rarely have I seen a set of financial statements where what you see, at least at first glance, is not what you get; where you really have to make many mental adjustments to pass objective judgement on the company’s performance and still you are left gasping for more information to form a reliable opinion on the company’s future prospects.

If you start with the bottom line it is easy to get shocked. GO switched from a profit before tax of E28 million in 2007, to a loss, yes a loss, of e1 million last year. How can a company which returned steady profits in the region of e30 million each year before full blown liberalisation took effect, switch so suddenly from a substantial profit to a loss situation?

Further analysis shows that a series of one-off items are making first glance results extremely misrepresentative of the underlying performance from normal operations. 2007 results were flattered by a one-off credit of e9.6 million from a VAT case decided for the company. On the contrary 2008 results are penalised by an exceptional charge of e12.9 million related to pension obligations resulting from a court case decided against the company. These two items on their own explain e22.5 million of the e28.9 million variance between the bottom line results of 2008 compared to 2007.

2008 results are also penalised by another non-ordinary operational charge of e15.5 million related to booked losses on an investment which GO is making in a Greek operator licensed for fixed line, internet and media services. GO’s directors’ report issued with the financial statements emphasised that such losses were in line with expectations as the Greek investment is still maturing and consequently the impression one gains is that this should be a one-off charge. Indeed the directors’ report prompts an assumption that such losses should not only be reversed, but translate into positive new sources of profits in subsequent years as the Greek investee company reaches maturity.

Adjusting for these one-off charges it results that the Malta underlying business operations of GO improved by 14.6 per cent from e23.3 million in 2007 to e26.7 million in 2008. This is no mean feat considering that in 2008 the Company had to contend with EU price restrictions on mobile roaming charges, had to continue to register continued decline in its legacy fixed line services, and had to fight increasing competition in broadband and media services.

How then can one justify the dim view being taken by the market in marking down so heavily the value of the company’s share price? Last week the share price of GO closed at e1.40 which is 20 per cent down year-to-date following a 44 per cent loss last year, much worse than the overall index performance on both measures. At e1.40 the price is 33 per cent below the first IPO price of 1998 (at e2.10), 61 per cent below the privatisation price when government’s 60 per cent stake was sold to current majority owners, and 82 per cent below its all time high price.

Given that the company will soon achieve more room to manoeuvre additional cost cuts as the three year no-forced-redundancy provision expires, the share price should reflect the improving and potential core operational performance of the company, unless one of two things is happening.

Either investors are judging the book by its cover rather than by its contents in which case GO is failing in making its case properly in the eyes of investors and in keeping them properly informed of its strategy and its successes; or the investors are voting down the company’s foray in the Greek market, considering it a serious deflection from its core business, a risky investment exposing the company to further losses in future years and jeopardising recovery of the huge loan of e89 million which GO made to its overseas investment company.

This investment is nearly 50 per cent of the entire equity base of the company after distribution of proposed dividends from past reserves (there were no profits to distribute in 2008 so the proposed distribution of e12 million dividends will erode past reserves) and has not only drained away the comfortable cash resources of the company but has forced the company to leverage its balance to finance such investment through an external loan of e50 million.

I made informal contacts with some active investors in GO, investors who vote to elect directors on the board of the company, to enquire how much they were aware of GO’s Greek foray. The feedback I got from different sources was that the directors elected by the minority shareholders were as enthusiastic as the directors of the majority about this overseas investment and that there is still full confidence that this will turn out to be a very important investment for GO’s future profitability. I was further assured that the majority shareholders made no pressure on their local offshoot to undertake this investment and that the investment was made with the unanimous approval of the board.

On the other hand passive investors knew next to nothing on this large Greek exposure by their company and some even expressed surprise as they maintain that they invested in GO’s local operations and were at best hesitant about seeing their company take such significant stakes in overseas ventures.

Frankly I think that one of the reasons the market is punishing GO’s shareholders more than the index is that the company is not working as actively as it should to keep its investors informed enough to enable them to understand more deeply the strategy it is following under its new ownership. With deep pocket majority owners who have no interest in cashing out their investment, the market price of their shares may not be of great interest to them. But for the small investor the share price is important.

Even if the Greek investment were to be merely neutral and just provide recovery of the losses booked in 2008, the share price of GO deserves to be in another planet from where it is presently languishing.

Given the significant size of the Greek foray, GO’s management has a duty to explain to small investors what their expectations from this investment are, as this information could well change the Greek investment from a discount force to a premium force on the company’s share price. In due course GO should also consider placing such overseas forays in one holding “international” subsidiary and list it separately so that investors who consider such overseas ventures too risky for their liking will have an opportunity to exit such risk without having to exit their investment in GO’s domestic operations.

China has the Power to Reduce the Dollar`s Dominance

Financial Times

Sir, If the Chinese want a system reducing the dominance of the US dollar as a reserve currency and instead have a more diversified reserve system (`China`s plan to end the dollar era`, Editorial, March 25), they have the means to do it.

They should let their own currency float, stimulate domestic demand to switch from a balance of payments surplus to balance of payments deficit, and in the process supply the world with a sizeable volume of freely convertible renminbi.

Their currency would then gradually find its place as an alternative reserve currency reflecting the shift of economic power from west to east.

In the process they would render the international financial system much more stable and they will stop worrying about losses on their dollar reserves after absorbing a one-off adjustment. Structural trade and payments imbalances, whether positive or negative, are the source of the current turmoil.

If the world leaders in their upcoming Group of 20 meeting cannot agree on anything substantial, they should at least agree to increase the resources available at the International Monetary Fund and to empower the IMF to act with corrective measures on structural surplus countries as vigorously as it addresses structural deficit countries.

If this symmetry in IMF`s operation is not achieved, the solution to the current problems will be the seeds for the next one.

Sunday, 22 March 2009

Not There Yet


22nd March 2009 - The Malta Independent on Sunday

March is a fantastic month for mid-week holidays as they can easily be extended to weekend breaks. With a public holiday last Thursday, many will go to work tomorrow refreshed from a weekend break lasting four days. The following week the same will happen with Freedom Day falling on a Tuesday, permitting another four-day weekend before returning to work on April Fool’s day. Quality of life doesn’t get much better than that.

But the point I wish to muse about is whether it still makes sense to have so many mid-week holidays, and whether in this challenging world we can afford to have time off to enjoy religious holidays devoid of any international validation or local tradition (19 March, the feast of St Joseph); whether the time has come to show political maturity to streamline the five national holidays and focus on one or two national days.

We can never claim to have reached an acceptable level of political maturity as long as we continue celebrating national day events in tribal traditions. It is opportune to discuss this matter this year when we will soon celebrate the 30th anniversary of the closure of the military base (Freedom Day) and the 45th anniversary of Independence in September.

In tribal tradition, Labour will hijack Freedom Day festivities just as much at the PN will hijack the festivities of Independence Day. Foreign observers will be forgiven for deducing that we have a Cyprus-like division between the Turks and the Greek communities. And if these two dates are so crucial to our political operators, do we really need to celebrate another three national days on 7 June, 8 September and 13 December?

To my mind, the events we commemorate on 7 June and 8 September are stages in a process that led to independence on 21 September 1964. While independence comes at one particular point in time, celebrating that particular point in time anniversary involves celebrating the whole process leading to it. We can’t afford a holiday for every important stage.

The same can be said about Republic Day. Changing from a foreign monarchy to a republican constitution is more a matter of form than substance and we cannot afford to celebrate every time we change the Constitution.

So it should be possible with goodwill on all sides to strike three national days off the holiday calendar. It is up to the government and the MCESD partners to come to agreement about whether this loss of public holidays is to be compensated by an increase in vacation leave or whether it should, at least in part, strengthen our efficiency by reducing such holidays without compensation. But at least, by reducing the five national days to two the disruption of mid-week holidays is alleviated.

These days are inter-linked. Independence gave us a sovereign birth even though the conditions attached to it negated the proper evolution of our newly acquired sovereignty. It did however give us the instruments with which to dismantle these conditions, leading to their renegotiation providing for gradual phasing out our dependence on the military spending of a foreign government. Independence gave us the birth date to exist; Freedom Day marked the graduation of our statehood to a level of economic sustainability without dependence on former colonisers. One would have not been possible without the other.

Twenty years ago I ended a public speech I made in a conference to commemorate the 20th anniversary of Independence as follows:

“In my opinion, just as a young man on his birth date celebrates his birth whatever the circumstances in which he was born, so should Malta commemorate appropriately the anniversary of its political birth. We should however reserve the right of those who complain about the performance of those, who blinded more by the form than the substance, brought our sovereign birth on a bed of thorns when with more astuteness, wisdom and love they could have had our birth on a bed of straw if not on expensive cotton sheets.”

I still feel the same way today. We should celebrate Independence Day as our primary national day, as it is the day when our sovereign statehood was born. In doing so we would not be celebrating the ceremony that took place on 21st September 1964 or the Independence constitution that came into effect on that date. We would be celebrating the whole process that brought us to such statehood from the first expressed desires by Mikiel Anton Vassalli in the 19th century, Manwel Dimech in the early 20th and Mintoff and Borg Olivier in the post-war era.

At a distance of 30 and 45 years we should be able to overcome the prejudices of the individuals who were directly involved in the events and pass an objective assessment on the significance of the events well beyond the role played by individuals concerned at that particular point in time. To put it more clearly: Mintoff could never accept 21st September as a national day, as for him it was a betrayal by Borg Olivier for accepting harsh conditions rather than hold out for a better deal. In many ways Mintoff proved his point when he came to power seven years later and renegotiated the Defence Agreement.

Mintoff could not overcome his prejudices because for him celebrating 21st September was celebrating Borg Olivier’s incompetence. For us, at a distance of 45 years, free from the prejudices of those directly involved, celebrating independence is not celebrating the particular agreements negotiated by Borg Olivier. It is celebrating the process spanning centuries that led first to political independence in 1964 and by natural progression to economic adulthood and political maturity in 1979.

It is time for this country to move on to a new level of political maturity. It is time to accept Independence as our official national day and Freedom Day as an important national landmark, and for these two important days to be truly celebrated on a national not partisan level. It is time to remove the farcical arrangement of five national days. It is time to move on because we are not there yet.

Friday, 20 March 2009

Show us the Money

 20th March 2009
The Malta Independent - Friday Wisdom

There is nothing outside sex that can produce instant pleasure more than receiving a tax refund. For some time I used to overpay my provisional tax bills for the joy of receiving a tax refund cheque at Christmas time. It’s strange because it was my money after all which I would had advanced to government interest free; but still, opening a tax statement with a cheque appended at the bottom made the joyful experience worthwhile.

So it is understandable that the prospect of recovering VAT paid on the past purchase of a car would appeal to many thousands of people who decided to queue up to join the class action which Labour will be bringing against government in local courts to be followed up as necessary through the EU judiciary system.

There seems to be growing conviction, running across party lines, that technically government was incorrect in charging VAT on the registration fee and that there is good possibility of government being forced to refund if the class action case is pursued through EU channels.

Such cases could take several years to work their way through the full process and with Labour having committed itself to give the refunds if were to be elected at the next asking, there may well be a case for Labour strategists to include this financial obligation in their fiscal plans as they may well have to foot the bill either through a Court decision nearer to election date or through execution of an expensive electoral pledge. If this issue is still pending by next election Labour will be asked to ‘show us the money’ to explain how they intend funding the e50m involved in honouring this pledge.

Given that the government seems quite isolated in defending this case on its technical grounds, my idea is to argue the merits of this case on more broad economic and moral views.

What is good for the individual may not be good for the whole economy. This is like Keynes’ paradox of thrift. While it is good for individuals to save for the future, if everyone were to adopt a herd mentality and cut spending and increase saving at the same time, they could well throw the whole economy into a serious recession. While it is good for the individual to claw back tax ‘overpaid’, if this spreads to several thousands involving millions of euros, what is good for the individual will not be good for the general economy.

After all, the government has no money of its own. It administers funds which belong to us all, mainly funded by current taxpayers or by borrowing which would be a burden on future taxpayers. So if the government is forced to refund tax to a selected few thousand who purchased a car since we joined the EU till the system was corrected in the Budget for 2009, then the benefit to these few would be a burden on the many. Is this a case of inverted socialism?

The EU framework provides for fiscal policy to remain subordinated to national jurisdiction with limited EU- wide regulation related to the application of VAT. Even if it is accepted that government was adopting a technically incorrect fiscal measure by applying VAT on registration tax, the core fundamental issue remains that these car buyers were fully aware of the bottom line price they were paying for the car they were acquiring and that government could have corrected the technical VAT issue and kept the same bottom line price purely by adjusting the excise duty or registration tax applicable on such purchase.

So while the government could have been technically in the wrong, it was fundamentally in the right whereas those who are technically correct in demanding a refund are fundamentally in the wrong as they liberally bought their car for a bottom line price they were fully aware of. This is nothing like the airport departure tax which applied discriminately against local residents and did not apply to visitors. This applied universally to all.

Even from a moral perspective, the class action struggles to find a justification. Government needs tax revenues to operate effectively and a good slice of this tax revenue has to be expenditure based. Putting undue weight on income based taxes would lead to high tax rates killing the incentive to work and leading to economic decay.

One of the most effective tax sources is indirect taxes loaded on to the price of big ticket items, especially those which have a discretionary element attached to them. Car purchases fit squarely into this category. On this traffic congested island 17 by nine miles, tax measures which apart from generating revenue also discourage excessive use of personal means of transport, make perfect sense. Should we upset this sensible tax orientation purely to exploit technical defects in past application of taxes that may not have been sensitive enough to the new technicalities introduced by EU membership? There is no moral justification for doing so.

It is a sad political reality that a party in opposition, free from the immediate burdens of administering the public purse, could score quite a few points of popularity if it hooks its fortune to a handful of issues which find mass appeal irrespective of their eventual consequences on the macroeconomic shape of fiscal responsibility. The risk is that if it pushes its luck too far pursuing such crusades, Labour risks being perceived as a party that functions more effectively in opposition than in government. And surely this is the last message that Labour would want to project on themselves from the point of view of the electorate.

So Labour could score well if this is a one off exception but should be careful not to search or attach themselves to other similar issues which in the end could lead to potential victories that can break the public purse and force additional tax burdens on future car owners. In substance I think this issue was better suited to individual MEP’s to show they have learned the EU ropes enough to bring government to the book, rather than to be used by Labour as a broad national issue which could come back to haunt them. Really this could be a case of be careful what to wish for!

Labour, to my eyes, are projecting themselves as much more appreciable government material in presenting their 20 point illegal immigration action plan. This is a subject I always kept considerable distance from because I have no specialisation on the matter, because it involves the life and death of fellow mankind, and because it is an issue where everyone is right and wrong at the same time.

Labour’s plan seems a fair effort to develop a national strategy which could unite us to present our strong plight before the international community which in many instances is just washing its hands off an issue which is its responsibility as much or much more than it is ours. We have never been colonial masters in Africa and we never appointed or removed despot dictators in African countries which cultivated the poverty culture that is forcing so many innocent souls to risk their lives to free themselves of their bondage.

To my mind it is imperative for a national immigration strategy to be achieved by consensus. The EU, and the world beyond the EU, will then know that we mean business and that their criticism about our detention centres not being shiny enough will not be taken seriously. For those who criticise us so unfairly
our curt reply should be ‘show us the money’.

Friday, 13 March 2009


13th March 2009

The Malta Independent - Friday Wisdom

In last week’s article I said that “the minister, and government generally, are exhibiting a whiff of undue optimism, based more on hope rather than reasonable expectations, that our economy can get through this international financial turmoil and consequential recession, with mere superficial damage”.

When I read it I said to myself that I made an under-statement. It is more than a whiff. It breaks your nose.

Let no one have any doubts. This international recession is not like anything we have been through before in our lifetime. This is not just a deeper cyclical recession. This is a global banking crisis and before the banking crisis gets fixed, the economy cannot recover. On the contrary, starved of credit it will continue to spiral downwards.

I happen to belong to the school of thought that believes that only mass nationalisation of banking systems in countries that suffered the credit crunch, the US and UK in particular but not exclusively, can restore the banking system to anything like normality. Only nationalisation can offer the possibility to clean up the banks from their toxic assets, re-sanitise them with strong capital and render them capable of being re-privatised to start sending a normal flow of credit through the financial plumbing system of the world. Only nationalisation can deliver a strong and clean banking system with the necessary speed before the recession turns into an ugly depression.

I am not suggesting that governments should become bankers deciding the allocation of credit, although frankly it is difficult to do a worse job than investment bankers did these last three years. Governments should stick to the business of governing and privatisation should be a top priority for nationalised banks. But it is governments’ duty to clean up the banks with speed and determination and it is their duty to regulate banks to ensure that they operate in a manner which does not endanger the whole system. No bank should be considered too big to fail and if a bank ever gets too big to fail, governments have to penalise such bank with high taxation to ensure that the taxpayer is compensated for offering an implicit guarantee against failure.

Cleaning up the banks, however, is only the start of what needs to be done to get ourselves out of the economic woes which have engulfed us once consumers’ and investors’ confidence were blown away to pieces with the collapse of Lehman Brothers last September.

The ultimate cause of these economic woes was the structural imbalances that were allowed to accumulate in the global payments and trade system. The ultimate cause was that America has over consumed and China has over saved. America’s over-consumption has enabled many Chinese to get out of poverty but this could only work as long as China was willing to lend their surpluses at cheap rates to the Americans so that they can spend it all over again on Chinese goods manufactured by people who were pulled of rural poverty into urban jobs in China’s new cities. That could not go on forever. The poor cannot finance the rich forever! And now that it has collapsed, health can only be restored in a sustainable manner if there is a reversal of past excesses.

We need a global deal whereby the Chinese start consuming and Americans start to save. China has to spend its accumulated surpluses and in so doing become a net importer to stimulate the economies of the West without the latter having to resort to more consumption and more debt. If excessive debt has actually gummed up the US financial system, more debt cannot possibly produce a lasting solution.

China needs to be persuaded that it is in its own interest to stimulate consumption in order to keep its own economy growing at the double digit rates they were used to and that Chinese authorities themselves consider necessary to maintain social order and sustain the process of economic enrichment. They can no longer depend on the US consumer to stimulate such growth. They have to stimulate their internal consumption by building a social network to persuade Chinese workers that they can safely reduce their savings and spend more on their current wellbeing. China domestic consumption can only be spurred if they abandon their policy to peg their exchange rate to the US dollar and so let their currency appreciate to external value that reflects their efficiency gains. It is in their interest to do so if they are to switch from being net exporters to net importers.

This will not be without consequences on the US side. Without the Chinese readily financing their deficits, the US will have to finance their own by promoting less consumption and more saving. So US economic recovery can no longer depend on consumer demand and has to switch to export demand which is the other side of the coin of the shift in China from export-led growth to domestic-led growth. For this purpose we have to see a sharp reversal of the strength of the US dollar seen since the financial turmoil began.

If you want a marker of whether there is progress being registered in resolving this crisis, the value of the US dollar is a good marker. If the US dollar keeps strengthening it means that things are getting more serious. If things stop getting more serious we will see the US dollar weakening, eroding the strength it has artificially accumulated these last six months, giving a chance for the US economic engine to shift from consumption mode to productive mode.

It is good that we are going to have a G20 meeting in London next month where the major economic players can discuss, agree and hopefully implement a coordinated response to get us out of this crisis. But the force of the numbers shows that the core of such a strategy has to be based on Chimerica i.e. China and America. Unless these two economic giants somehow agree to a coordinated approach which basically unwinds the excesses they worked out between themselves in the past, it does not matter what the others do. Japan, Europe and other invitees for the G20 meeting do not have the force of numbers to work their way out of this mess, if China and America do not lead this effort in the coordinated way indicated.

So tiny Malta is at the mercy of the global players and there is pretty little we can do to repel the consequences of an international recession, other than show a deep sense of solidarity to ensure that the adjustment pain does not fall only on those that get directly affected and to undertake sensible investments, in the physical and human capital, to ensure we are ready to maximise our potential as soon as the recession reverses.

It is for this reason that I maintain government is being capriciously optimistic in expecting we can get out of this recession with mere superficial damage. There are no easy solutions but it is definitely not a solution to play down the economic troubles about to hit our shores. The crisis offers opportunities to be exploited for the long term but this does not diminish the adverse impact in the short term.

We should be thankful that our deep-rooted culture of thrift has protected us from the immediate consequences of the international credit crunch and has kept our banking system working in a perfectly normal manner. I write off street complaints that local banks are unduly tightening their lending standards as appropriate measures to cool down the over-supply in the property market which would have been necessary even if there were no international credit crunch.

We should be thankful that our public accounts, unlike the experience of other major countries and trading partners, have not been put under pressure by crisis demands to recapitalise the banking system.

But nothing suggests that we will be spared the consequences of a deepening international recession consequential to the credit crunch. It is only a matter of time lags. Credit crunch consequences are felt instantaneously, international recession consequences are felt with a time lag varying between six and 12 months. The absence of credit crunch consequences should not give us any false sense of security that the consequences of the international recession can be escaped. They cannot and we will know it soon enough as spring turns into summer, unless Chimerica raise up to their responsibilities to save the world.

Sunday, 8 March 2009

All Those Zeros

8th March 2009
The Malta Independent on Sunday

It is hard for many people to really appreciate the huge quantitative difference between a million and a billion. For most these are just big numbers starting with a different letter. Reality of course is much different. The three zeros tacked on to the million’s six zeros make a hell of a difference.

To put it in perspective that can be better appreciated, a billion seconds take nearly 32 years to tick away. So when a person is billionaire one would really have more riches than could be spent in several lifetimes. When you hear that governments are spending hundreds of billions, and in the case of the US more than two thousand billion (voted so far) to stabilise their financial structures and to stimulate their slowing economies, then we are talking about serious money.

So it is obvious that people would ask where all this money is coming from. The short answer is governments borrow it, tax it or, as a last resort, print it. That in simple non-technical language is what governments are or will be doing in order to finance the various initiatives they are being constrained to launch to protect their financial systems from collapsing and their economies from falling into a depression.

In normal circumstances, governments finance their expenditure from taxation. From time to time they have to borrow, particularly to finance non-recurrent infrastructural and social investments that are designed to augment the productive capacity of the economy for the longer term. However, such borrowing is generally contained within a few percentage points of the country’s GDP. Developed economies try to keep such annual borrowings to within three per cent of the GDP and to balance out the Budget over an economic cycle, i.e. when the economy is performing at its optimum and the government has high tax revenues and low social unemployment payments, the budget has to balance or go into surplus to leave space for deficit spending when the economy turns down. Developing economies with a lot of infrastructural investment yet to be financed tolerate larger annual deficit until they reach maturity stage. But in all cases accumulated debt is generally kept to within 60 per cent of the GDP and if this level is exceeded in the development stage it will be brought down at the maturity stage.

These however are not normal circumstances. Far from it! Governments cannot raise money from taxation given that present soft cyclical stage reduces the tax take and increases the social spend on unemployment benefits.

Raising taxation now would continue to flatten the economy rather than re-invigorate it. So governments have to resort to borrowing.

Reducing interest rates makes the burden of additional borrowings more manageable but the quantity of money that needs to be borrowed is so huge that it goes beyond the capacity of the individual countries to find the necessary savings to finance such borrowings. Especially in countries like the US and the UK with a traditionally low savings culture, domestic markets have limited capacity to finance governments’ exploding borrowing requirements. Resorting to foreign borrowings is inevitable but given the low rates on offer even this may not be found in the quantity required.

Which leaves basically one source to finance government’s borrowing requirements. If all else fails the government may need what politely are being referred to as “non-conventional measures”, and what has technically been coined with the confusing term of “quantitative easing”.

In normal everyday language this is nothing other than mere creation of money by printing it, or in these electronic days by merely having the central bank buying government and private sector bonds and paying for these by newly created money, which are merely IOUs on the central bank.

This is a truly extreme measure that central banks only resort to in extreme circumstances. Outside Japan, this is the first time such measures are being resorted to in the post-war era.

Does this mean that the USA, UK and Japan, which are being forced to resort to such extreme measures, will become just like Zimbabwe where money has lost its value due to hyperinflation measured in millions of percent per annum? Is not this free printing of money what caused two hyperinflation experiences in Germany in the first half of the 20th century?

No, it does not mean that, at least not unless the central banks sleep at the wheel when the economy recovers eventually. Japan had used quantitative easing in the nineties, yet it is still in depression mode. Of all the problems with the Japanese economy, inflation is not one of them. By adopting quantitative easing, the central banks of USA, UK and Japan (and who knows, quite soon they may be joined by others in a global co-ordinated response involving also the ECB) are in fact trying to create some inflation to avoid the world economy from falling into a depression where prices are entrapped into a spiral caused by falling demand leading to unemployment, further price falls, and further destruction of demand.

Central banks in developed countries are having to create and literally print money in order to stimulate demand to fill a slack in the economy where supply is not finding sufficient demand leading to inventory build-up and unemployment. Money has simply stopped circulating as people save more due to fear of an uncertain future. Therefore, a much larger quantity of money is needed by the economy to maintain the demand level as close as possible to the supply capacity. This is quite different from Zimbabwe style inflation where money is printed to meet excessive demand just when supplies run short due to an economy that stops producing goods due to malfunction, or due to allocation of productive capacity to non-consumer goods (for example, Germany’s spending to build up the war machine).

Where does the risk of inflation lie? It is certainly not an immediate risk, as in fact central banks are trying to create not control inflation. It would become a problem if central banks actually succeed in their efforts to stabilise the economy by creating some inflation and re-stimulate demand. If at that point money starts circulating at a faster pace, central banks have to be very agile and quick in reversing the “quantitative easing”, i.e. selling back the bonds they are now buying and demonetise the money they are now creating. Unless they eventually do this in an effective and timely manner, inflation would then, two or three years down the road, really become an issue.

One thing is sure however. Having come to the point where central banks have to adopt non-conventional measures to try to create inflation is of itself indicative of the gravity of the economic morass in which the world is engulfed. It’s tough being a central banker these days. It’s tough for the consumer to find the necessary confidence to defeat “the paradox of thrift” explained by Keynes. While saving is needed for the long term, for the short term the world needs consumers to save less and increase consumption to avoid falling into a depression.

All those zeros are confusing enough. But if we allow the world to fall into a depression it will be simply painful. Better a confusing solution than a simple defeat!

Friday, 6 March 2009

To Stimulate or not to Stimulate

6th March 2009

The Malta Independent - Friday Wisdom

This week we had a vibrant argument between one school of thought urging the government to stimulate the economy to protect it from being damaged by the imported consequences of a harsh international recession, and another school of thought that argues that across the board macro-economic measures will stimulate demand for imported products and thus will offer little lasting protection to the domestic economy.

The first school of thought is mostly driven by the Opposition and allied groupings as well as private sector business organisations representing varying sectors. The second school of thought represents the government official policy line.

I do not think that this is a black or white issue, a clean cut between a decision to stimulate or not to stimulate. In fact government has offered help and support at micro or sectarian level but without resorting to expensive grand schemes. The argument that given the openness of our economy, macro-economic packages to stimulate demand will likely leak into imports with little value added to our own GDP was forcefully made by the Finance Minister during a business breakfast meeting last week.

However, I could not help noticing that the Minister, and government generally, are exhibiting a whiff of undue optimism, based more on hope rather than reasonable expectations that our economy can get through this international financial turmoil and consequential recession, with mere superficial damage.

Optimism is a virtue if kept within reasonable limits. If relied upon excessively it could turn the virtue into a vice, causing havoc to those unprepared to face the problems when eventually they arrive, proving too large to overcome with mere optimistic talk.

I fully concur that across the board consumption based stimuli would do little for protecting our economy from recession. But not all stimuli have to be related to boosting internal consumption demand and there is ample space for government to take protective measure to stimulate investment demand and external demand for our products.

Let’s start with the latter first. Stimulating our tourism package would attract an increase in foreign demand and help to avoid having a disastrous tourist season this summer. Government is taking steps in this direction already by boosting MTA’s marketing budget and by offering subsidies to airlines to roll out new routes to replace those that have been lost through retirement of existing operators. It can do more!

Reducing VAT rate on restaurant services and car hire from 18% to 5% is something worthy of consideration. Car hire is predominantly a tourist product so any increase in demand will totally reflect foreign demand as the product is rendered more price competitive.

Restaurants are used by locals and tourists alike and it is not easy to distinguish one from the other except when the board is pre-booked with the accommodation. But the service has a very high content of local value added (being mostly service based) so it could keep the restaurant sector going by boosting local demand without significant damage on the balance of payments side.

Another sector which requires some sort of government stimulus intervention is the property sector. This sector was already experiencing slowdown independently of the global recession but the latter will no doubt further complicate things and could precipitate them if as is likely, there will be a collapse of foreign demand for local real estate.

There exists a huge over-supply hangover of properties at a time of shrinking demand as buyers await prices to fall before plunging in. The consequences are being cushioned by the dramatic fall in interest rates engineered by the ECB as this makes the carrying of unsold inventory by developers less painful, delaying downward price adjustment needed to bring the supply and demand equation into balance.

Furthermore given that this sector suffers from long lead times in supply there is additional overhang in the form of projects still in development, further accentuating the structural imbalance and making the price adjustment eventually needed to bring demand in balance even more damaging to the whole sector.

The property sector and the construction sector associated therewith, have been an important component of our recent economic growth, and given the wide culture of home ownership, have positively affected households’ balance sheets to a very considerable extent. A sharp disorderly drop in property values will have wide consequences well beyond developers carrying unsold inventory facing reduced demand.

Stimulating demand for property acquisition will cause no balance of payments leakages if this is applied temporarily to run down the inventory over-hang. It need not adversely impact fiscal budgetary calculations as it could generate supply-side mechanisms generating more revenue through higher volumes at reduced rates. It would however liquidate a lot of dormant inventory and will help the banking sector avoid being loaded with a perilous increase in non-performing loans as developers start finding difficulty to continue servicing interest costs if sales remain at current low levels.

Government would do well to consider temporary removal of the five-year time limit for the opt-out by vendors from the 12 per cent final withholding tax of sales. In the context of a dull property market this measure will soon force many developers to pay withholding tax on profits they have not made. Furthermore government should consider a one –year removal or reduction of the five per cent duty on documents payable by purchasers for a maximum value of e250,000 per unit.

Measures also need to be taken to keep workers, suffering short work weeks or outright redundancy, employable through retraining to up-grade their skills. The argument should not be whether to stimulate or not to stimulate. It should be how and when to stimulate.