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!

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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.

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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

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