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.


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