Sunday, 25 September 2011

Start of the Silly Season

25th September 2011
The Malta Independent on Sunday

Minister Austin Gatt has kicked off the silly season leading to the next election. This being the penultimate PN organised Independence Day festivities before the next election, the opportunity could not be missed to start the election campaign with arrogance, eternal gratitude and expectations asserting that the PN would stay in government for another 20 years!

Why 20, not 15 or 25, is hard to fathom but really it is meaningless as what matters in politics, where a week could be a long time (ask Mubarak, Ben Ali and Gaddafi) is whether the local electorate, which was forced to resist political change in the last two elections by the EU/ Alfred Sant factor, will still reserve inhibitions to go for the change it is naturally hoping for, now that the EU/Alfred Sant factor is no longer there.

In political campaigning, as in war, truth is the first victim. And the truth is that Minister Gatt has no predictive power to say who will win the next election let alone the three after that.

In truth, the PN campaign had started softly quite a few months ago when in tandem with its allies, it started a campaign to try to force Labour leader to move on from pure criticism and to be more forthcoming with detailed policies on how Labour proposes to carry this country forward if it should become the next tenant of Castille post 2012.

Cell after cell in the power network that prefer to have Castille permanently inhabited by the PN leader, have been putting pressure on Muscat to show his hand even though he is not expected to start playing the game for the next 21 months.

Muscat has learnt from the mistakes of his predecessor, who used to delight the PN with detailed policy formulations that could be exploited and turned to their political advantages by a well-equipped PN strategy team. While generic policies have universal application, detailed measures for policy execution invariably have negative effects on certain sectors that can be exploited by political adversaries.

If Alfred Sant had simply said that under his leadership it would be a priority to render the country more competitive internationally, that would not have been controversial and would have carried no political risk. However, explaining that in the pursuit of such objective measures to devalue the national currency (since subsumed into the euro) were to be contemplated opened up a whole plethora of contentious argumentation.

Muscat’s tact in keeping to the general objectives without exposing his hand on particular measures is clearly unnerving the PN strategists who are short of issues to kick up in order to hide the general disappointment of the electorate with their overstay in office.

It is concentrated arrogance to expect the Opposition to explain its policies in detail, which they can only implement in 21 months’ time when the situation could be hugely different from what it presently is, and then government gives no detailed explanation of its here and now policies.

Take the Moody’s credit downgrade. It is clear that the government was not expecting it. The problem is that the government believes its own propaganda and that is very dangerous. Moody’s downgrade is a wakeup call for government to look reality in the face and take measures to address our weaknesses immediately rather than continue to feed the electorate with illusions and distractions.
The government wants us to believe that the budget deficit is nicely floating downwards to 2.88 per cent of GDP this year and public debt is 68.80 per cent of GDP. It seems to believe that itself even though there is manifest evidence that both these figures are unreal, that they are fabricated to hide the unpleasant reality.

Let me start with the annual deficit. Out of the budget we provide about € 17 million Contribution to Treasury Clearance Fund (TCF) Advances. Vote number 7189 for those who want to check it. This means that in the past expenditure was incurred and suspended in the TCF and now this is being amortised annually through the Consolidated Fund. No information on the balance left in the TCF is available anywhere, though the Auditors General Report for 2009 lists €117 million loans to the shipyards which will have to be repaid from the Consolidated Fund. But there are other advances that will never be repaid, such as loans to Freeport, loans to various employees’ foundation and, hold your breath, loans to the Hellenic Republic of Greece under the euro rescue fund agreement. I suspect that other expenditure is going through which is being suspended in the TCF e.g. Air Malta rescue funding. So basically, the deficit in the Consolidated Fund is a managed figure not a real figure. If you take €117 million shipyards loans written off and probably at least another €60 million Air Malta loans that have to be written off plus other exposure, making a total of at least €200 million loans in the TCF to be written off through the consolidated fund, that is three per cent of GDP.

Take the public debt. At 68.8 per cent, it is above the Maastricht 60 per cent criteria, but not worryingly so, and with good housekeeping it could be gradually brought down. But is it real?

According to the latest Auditor General Report for 2009, there are €893 million in bank loans to various public entities which are guaranteed by government. This is up from €774 million in 2008 and €673 million in 2007. The upward trend is indicative that government, in an attempt to keep the official national debt low, has resorted to funding through commercial credit channels against government guarantees. When John Dalli was Minister of Finance, he had declared in a budget speech that this would no longer be tolerated. €893 million is 14 per cent of GDP.

So the figure of 68.8 per cent public debt to GDP is a manufactured figure. Eighty-five per cent would be closer to the truth and we still have to account for expenditure still going on, like the City Gate project, which is not funded through the Consolidated Fund.

You cannot solve a problem unless you admit its existence. We have to accept that the true level of our national debt is more like 85 per cent of GDP and that there is a huge amount exceeding one billion euros (that is one thousand millions) that sooner or later will have to be passed through the Consolidated Fund and reflected in the official national debt.

Taking this reasoning, which a government in denial cannot see but which Moody’s can easily account for, the downgrade should have come as a surprise to no one and the negative watch is a clear warning that unless we are going to take measures to increase the growth potential of our economy, further downgrades are to be expected.

So before indulging in the silly season and before expecting the Opposition to do the government’s job and expose itself to unpopularity with the electorate, who cannot be expected to vote for austerity when the government has been duping itself that all is fine, it would be much better for it to forget the election and do the job it has a duty to do here and now. The election campaign should be no more than five weeks, and that’s a long way away.

Alfred Mifsud

Friday, 16 September 2011

Whither euro? Whither EU?

16th September 2011
The Malta Independent on Sunday

The euro system is under severe stress. This weekend the EU finance ministers will meet in Poland and they will have a special guest in the person of US Treasury Secretary Tim Geithner. The topic will be whether to continue bailing out Greece or to cut it loose. The cost of bailing out Greece is pretty clear and given its size, quite affordable

The cost of cutting Greece loose is much less certain and Mr Geithner will no doubt sound a stern warning about taking such risks, having been burnt by the Lehman collapse just three years ago; an event that unleashed a financial crisis of global proportions.

Many economists warn that a dirty default of Greece on its sovereign debts will unleash a financial turmoil which will make Lehman look like a walk in the park.

A lot is at stake this weekend. The existence of the euro, the sustainability of the EU in its current format and the endowment of 60 post-war years of free trade, political cooperation and economic well-being in peace and prosperity is what is at stake. If politicians stick to their introspection and forego their wider pan-EU responsibilities, we are doomed. Markets will not wait and will take cover wherever they can seek it if they perceive that EU leaders and national politicians cannot agree how to put out the fire inside the Euro house. Investors will stampede to run out of the small door and consequences would be unpleasant, possibly disastrous.

I have been writing about this for two-and-a-half years now. On 13 February 2009, I wrote in my erstwhile Friday Column an op-ed titled ‘Will the euro survive?’. Many thought I had lost it, asking questions that should not be asked. On 10 June 2010, I wrote a piece titled ‘Plan C for the euro’.

I asked: “So what future is in store for the euro? Plan A, built on hope rather than realistic expectations, sees austerity in errant countries bringing order for the euro to continue as it did during its first decade of existence. Plan B is just to muddle through somehow from crisis to crisis as the austerity measures cause instability and greater disharmony within the euro club. The ECB had better think of a Plan C!”

We have tried Plan A. It has not worked. Democracy has a limit on how many rounds of austerity it can accept without blowing up before it delivers the intended benefits. The risk starts taking shape that under crushing sequential rounds of austerity, democracy elects demagogues bent on sowing anarchy.

Plan B is also not working. Only last 21 July the terms of the second Greece bailout were approved and here we are again. Not only the market judged that what was agreed then was insufficient but the EU has severe problems even to implement what was agreed. Netherlands wants the creation of an EU budget Tsar as a condition to approve the deal. Finland wants collateral security which if given would force default on Greece through infringement of negative pledge clauses in its sovereign bonds. The German constitutional court insists that each disbursement has to be approved by parliament. The Slovakia government coalition will table a deal for parliamentary approval only after all others have approved it in the clear hope that someone else will abort it before as it is doubtful whether the Slovak government coalition can stay together to vote the deal through. Greece itself is falling behind in its privatisation schedule and tax collection plan on which the deal is conditional.

Faced with this indecision, the markets are solidifying their opinion that in the EU there are many leaders but really no one is in charge. The markets are demanding catharsis and they are demanding it now. Chancellor Merkel can fool herself thinking that she will not be bullied by the markets but she would be well advised to consult James Carville, President Clinton’s advisor, who famously articulated how he was stunned by the power the bond market had over governments: “I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.”

So what Plan C can the EU leaders put together over the next weekend to give the market the catharsis it is demanding?

Before answering this crucial question it is worth considering what the default position would be if no Plan C is reached. A dirty Greek default on its sovereign debt will set in motion a chain reaction which could force many EU banks into bankruptcy leading to their nationalisation. Investors hurt by Greece’s default will shun sovereign exposure to other EU governments perceived in distress, including Italy, Spain and maybe France. These countries would find it difficult or prohibitively expensive to borrow to recapitalise their banks so that financial confusion will be the norm, leading to gummed up financial markets and to breakdown of the euro as the problems would be too big for the ECB to handle. When a tsunami hits, even solid buildings cannot stand in its way.

The break-up of the euro will force countries back to their domestic currencies, or to much smaller currency groupings (e.g. Germany, Austria, Finland and Netherlands). Such currencies will shoot up in value rendering exports uncompetitive just as most of the markets of countries in distress disappear through devaluation of their domestic currencies, trade barriers or outright reduction in demand caused by the financial collapse. Unemployment and consequent social unrest will bring back memories of the great depression of the 30s.

Can the EU survive in such a scenario? I doubt it. The risk of 60 years of post-war cooperation being flushed down the drain should not be under-estimated. Wars will re-enter the European dictionary. From trade wars, to economic wars, to cold wars and God forbid military wars. Countries in distress will inevitably form alliances with existing or upcoming super-powers. China and/or Russia will forge strategic alliance with some countries in distress putting Europe back to a cold war scenario.

This stark reality must be borne in mind by European leaders as they make their choices this weekend. Chancellor Merkel in particular would do well to read a research published this week by UBS top economists where they estimate that the cost of bailing out Greece, Ireland and Portugal together would amount to a little over €1,000 per person in a single hit, whereas the break-up of the euro will cost a single hit of between €9,500 to €11,500 per person and an annual hit of between €3,000 to €4,000 per person.

So what Plan C can EU leaders put together? Given the problem in getting any fiscal measure approved by 27 or 17 national parliaments, in order to remain within the realms of practicality, the solution will have to be spearheaded by the ECB as a monetary measure. The ECB is the only pan-EU organisation that can act autonomously with a speed to match the market.

The ECB has these choices:

       Continue acting as the bond buyer of the last resort for countries in distress. This is okay as a temporary measure but it offers no long-term solution as persistence will render the ECB, supposedly an anchor of solidity, as a mega bad bank where sovereigns borrow cheaply to avoid market discipline. This apart, even this temporary measure has already created deep divisions inside the ECB with resignation of two prominent German exponents from the governing council. It is not healthy to have an ECB divorced so drastically from the old Bundesbank tradition.
       Fund a substantial bank rescue operation on the basis of the US TARP programme, to recapitalise the EU banks which take a hit on their capital by marking sovereign bonds to market.
       Concurrently with such bank rescue, organise a voluntary debt exchange mechanism to offer deep haircuts to sovereigns in distress on their debt exposure to give an incentive of light at the end of the tunnel for persisting with the austerity of adjustment policies to restore their competitiveness.
       Loosen monetary policy, if necessary through quantitative easing measures, to keep markets liquid as well as to reduce the overvaluation of the euro on the foreign exchange markets in order to render EU products more competitive with the rest of the world, especially the US and China.
       Renegotiate the euro rules to create the EU Budget tsar that will give substance to enhanced discipline of the Stability and Growth Pact.
       Start a political process for an EU treaty change leading to an EU Treasury, co-ordinated fiscal policy and eventually the launch of eurobonds to replace separate sovereign borrowings.
This might not be a perfect recipe but any real lasting solution cannot wander too far from it.

Alfred Mifsud

Sunday, 11 September 2011

Caught between Scylla and Charybdis

11th September 2011
The Malta Independent on Sunday

Homer’s Odysseus had a choice between either navigating close to Scylla, a six-headed monster of a rock, or close to Charybdis, a dangerous whirlpool, when taking the passage through the Straights of Messina. He decided to take the passage closer to the sea monster because the risk of losing some sailors was considered less than the risk of the whole vessel being swallowed up by the whirlpool.

This is not dissimilar to the situation in which Malta is trapped with regard to the future of the euro and our obligations to continue funding rescue mechanisms for eurozone members in distress. Financing serial bailouts is becoming horribly expensive and risky. Lending money to Greece & Co. at nominal low-digit interest rates when, for the same risk, when can get high double-digit rewards in the capital markets, is a show of solidarity – not of business sense.

On the other hand, refusing to participate in such rescues could be the spark that starts a fire that could burn out the euro system, with consequences of a Charybdis financial whirlpool.

Let’s put our credentials on the table when negotiating with our euro partners. When we joined the euro, we did so with a set of rules that clearly stated that members had to be responsible for their own financing and that no bail-outs were allowed.

Events have proven that, following the financial crisis of 2008, the euro rule-book had to be put aside, if not completely discarded. Countries like Ireland and Spain that had a property bubble – partly due to euro interest rates being kept low in the good years to accommodate German integration – suffered harsh economic destruction and a substantial fall in government revenues leading to a fiscally unsustainable deficit. Countries such as Greece and Portugal, who used easy funding in the hay days of the euro to finance their inefficiencies rather than restructure for competitiveness, found that financial markets were no longer willing to offer funding except at astronomical interest rates.

Big countries like France and Germany had to intervene by setting up euro-wide rescue mechanisms to offer Greece, Ireland and Portugal the funding, at highly subsidised rates, that capital markets were denying them. In doing so, France and Germany were as motivated to protect their flagship banks (from existential threatening losses resulting from sovereign default), as much as to save the euro system from the blushes and lack of credibility if its constituents defaulted on their sovereign obligations. The pain of adjustments, beyond the subsidised funding, was thrown fairly and squarely on the countries in trouble, causing social unrest and crushing recessions as Greece, Ireland and Portugal purge the poisonous waste and inefficiencies from their system.

In fairness we are involved in this like the Maltese ‘Pilatu fil-kredu’. Our banks have no significant exposure to the sovereign debts of Greece, Ireland or Portugal. We have played by the market rule book and never had to seek assistance from anyone to finance our development.

So it is only fair that we ask why we should be involved in all this when we did not cause it, when we have no banking exposure to protect and when we only joined in 2008. Such arguments are also being made by Slovakia and Finland, in different formats but going by the same principle. There is a good case for our country to seek exclusion from euro burden-sharing, especially considering that we have found very poor support for the burden-sharing requests we have made, as in the case of illegal immigration.

Still we cannot ignore the consequences of a total implosion of the euro system or if we contemplated reversing our euro entry.

The euro is like Hotel California – “you can check out – but you can never leave”. Even if we were to overcome such legal constraints and negotiate our way out of the euro, we can never go back to the Maltese lira. At most, we can envisage a currency board with a Maltese euro at par with the euro. The problem with such an approach is that negotiations take time, would need to be approved by the other 26 members of the EU and in the meantime the insecurity would scare off investment, especially considering that it is doubtful whether a government that leaves the euro can expect to remain a fully functioning member of the EU.

Our best hope to negotiate our way safely between Scylla and Charybdis is persuading our euro partners that we are too small to matter, that we are totally harmless in this debacle, that to protect our fiscal sanity we cannot continue participating in such rescues and that we merit exemption there from while maintaining our euro membership. Easier said than done, but still worth a try!

* * * * * * *

How pitiful and childish for our political parties to try to tar each other as being Gaddafi’s better buddy. Probably the depths were plumbed by Dr Simon Busuttil MEP insisting on full disclosure of any financial assistance Labour could have received over the years from Gaddafi sources. I fully support this request if concurrently it is accompanied by full disclosure from all sources, including business lobbies that paid the piper so that they could call the tune.

Busuttil’s PN have been in power for a quarter of a century and had all the time in the world to bring some order to the financing of political parties. They did not do so and have no credentials to teach anyone anything about such matters.

* * * * * * *

Moody’s downgrading of Malta’s credit rating, the switch to negative outlook, and its assertion that that the country’s debt metrics are still not at the level consistent with the downgraded A2 rating are problems for the whole country, not simply for the government.

Whilst in the context of a deteriorating international economy, given the openness of our economy, a downgrade from A1 to A2 need not be considered a tragedy, the negative outlook and the implication that the A2 rating is still generous, given our debt metrics, send worrying signals that further downgrades are possible unless we take appropriate steps to prevent deterioration in our national balance sheet.

Moody’s are not convinced that the declared improvement in our net fiscal position as presented in the Budget is accurate or sustainable, given the reliance on continuous one-off measures. I would add, although Moody have not said it, the pseudo government debt hidden outside the consolidated fund structure, like never, never loans at commercial banks guaranteed by government and other debts being amortised through the Treasury Clearance Fund.

Obtaining the improved debt metrics without painful adjustment measures requires economic growth and foreign investment, which tend to become scarce in the context of the prospect of international double-dip recession. But that does not mean we can do nothing about it. Better tax enforcement, and a phased programme for continuing the shift from direct to indirect taxation and from taxing earned income to taxing unearned income, would be a good place to start.

Alfred Mifsud