MediaToday
George M. Mangion| Wednesday, 29 October 2008

Requiem for a recession

The international scene is riveted by bad news of a US recession linked to the unprecedented bankruptcy of Lehman Brothers and the massive bail-out of two national mortgage icons Freddie Mac and Fanny Mae.
It was not a sweetener that a massive $700 billion was carved out to bail out toxic debts in US banks.
Concurrently, it pours and it rains as banks in Europe are paying the price for lax controls on dubious lending traits and giddy profits.
In Britain, what started the landslide in consumer confidence was the Northern Rock bank saga.
London faced long queues of depositors withdrawing their savings. The inevitable global squeeze on inter-bank credit is choking commerce while central bankers dither on how much tax-payers monies can be spared to buy out toxic debt or should partial nationalisation be the cure.
Are Malta banks teflon coated and thus cocooned from this malaise?
Will this financial turmoil hit us this coming winter?
It looks like our banks will not be suffering directly from the credit crunch since as a matter of policy they are liquid having a healthy ratio of about 65 per cent.
Such a healthy state of affairs reflects the resilience and prudent lending policies of our banks. This does not mean that foreign portfolios of local banks will be immune from a severe drop in value. More will be revealed this winter as financial institutions and insurance companies file their results and disclose impairment charges on income statements. Will local banks be pushed to impose heavier charges on consumers as a ploy to balance losses? Will our banks need bailing out?
Not likely as they rank 10th soundest in the list published by World Economic Forum.
On a positive note, with prudence and being nibble our banks may even attract millions of foreign deposits from eurozone countries suffering chaos in banking circles.
Sadly the same happy stance cannot be said of the manufacturing sector. This is already manifesting early signs of fatigue from lower order books.
Both Trelleborg and Toly Products have reported reduced sales while others may follow.
Naturally, coupled with the removal of the cap on electricity some factories may struggle to justify a full payroll. But every cloud has its silver lining. Oil hit a low of $63 per barrel. How low can it go? Nobody can foretell with certainty but it is all linked to a number of variables not least the upswing in dollar value. Will this impact positively on our energy tariffs and fuel costs?
Oil imports are a substantial drain on our taxes and logically any gains next year can help to balance our budget. Imagine the drop in cost of energy if oil prices back down to $50. Nobody can tell. Only a few months ago politicians were bracing us for a cold winter consequent to a hike in oil forecasted to reach $200 a barrel. The vagaries of the oil market are devious, yet a number of analysts predict much lower prices this winter. Food prices are expected to drop as well.
This is a mere consolation linked to the austere measures in store for recession plagued oil importing countries.
So is there an easy antidote to reverse the gloomy days ahead. Not so easy.
EU governments are busy drafting stimulus packages which include taking partial control of ailing banks and making sure credit flows freely to small and medium sized enterprises.
The tool kit includes tax breaks wherever governments can afford them based on their respective debt levels.
To find the extra revenue for a stimulus package there are two avenues-either borrow or tax more.
Hot on the heels on electoral pledges that our economy is rock solid then more taxes is not an option.
This is always an emotive issue especially reminiscent of electoral promises to introduce lower tax bands. The Nationalists blew the trumpets of a lower 25 per cent top rate levied on managers and middle-income groups.
Now the penny dropped and we discovered a mid-term deficit which exceeds projections by €100m.
To top it all redundances in Drydocks meant a cool €55 million for our exchequer. The minister of finance is on record to predict a drop in corporation tax because of lower bank profits. Next year, there will be an inevitable slide in tourist income particularly from the British sector.
Clever figure juggling is expected in the next budget if we clamor to maintain our standard of living and an ever-increasing health care cost.
Buffeted by unprecedented financial turmoil, emerging economies such as ours face the difficult challenge of fighting the twin evils of high inflation and slower economic activity.
But not everything is doom and gloom.
After peaking at around 10 per cent of gross domestic product (GDP) in 2003, the deficit decreased significantly under our EU induced fiscal consolidation programme, reaching 2.6 per cent in 2006.
Last year saw our best ever 3.8 per cent growth in GDP. This is almost double the EU average and unfortunately will drop this year.
NSO reported improved tax takings underpinning a vibrant economy. Total tax revenue last year amounted to €1,889.2 million, a cool rate of 34.9 per cent.
Revenue during 2007 increased by €169.0 million, or 9.8 per cent over 2006.
Indirect taxes, at €825.4 million, made up 43.7 per cent of total tax revenues. This included VAT, import duties, excise and other specific taxes on services, and on financial and capital transactions. Total revenue from VAT amounted to €420 million, whereas direct taxes such as income tax and wealth plus capital taxes and other current taxes increased by €117.2 million, to €741.6 million. This hefty jump was essentially brought about by an increase of €112.6 million in revenue from corporate tax. Revenue from social contributions increased by €7.2 million, totaling €322.1 million, and this invariably represents higher employment. To conclude there is no quick fix or antidote to see us through the financial quagmire.
Certainly politicians were caught with their pants down and did not anticipate the severity of the banking sub-prime debacle.
Stoically, the US rescue fund offers no less than USD 140 billion in the form of reduced taxation and subsidies to the poorest households in an unprecedented effort to boost the SMEs.
Expect interest rates to be slashed further.
The bubble burst because of defaults on loans given at giddy interest rates to property buyers without adequate collateral and dubious repayment prospects.
So is there a solution in sight to stem the tide of this global tsunami?
Cynics retort that IMF should make as its main focus the surveillance of the global economic and financial system. In Europe we expect a tough time ahead this winter unless the credit crunch is resolved by a concerted effort of all governments using the best monetary tools available. As for tiny Malta in our budget proposals we must do as others have done and launch a no-frills stimulus package.
Perhaps now is not the opportune time to rush in balancing our budget even though it formed a pivotal part of the pre-electoral promises.
Consumers woke up to the grim realisation that they need to pull up their socks in order to buttress the effects of a recession which has started to grip some countries currently taking our exports.
With unemployment looming in the manufacturing sector and a weaker tourist season, it is not wise to implement any austerity measures.

George Mangion
Partner at PKF – an audit and business advisory firm
[email protected]

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29 October 2008
ISSUE NO. 556

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