Many can be excused to think that social and economic progress experienced in the past two decades has filtered through seamlessly and without its attendant cost. Yes, we have forgotten the old parsimonious days when the government of the day opted for an infrastructure of a second hand grade and the water taps did not always fill our kitchens with running water. Power cuts were regular while the telecoms industry was still struggling with outdated analogue technology. A new dawn had appeared over the horizon when the Nationalists regained power twenty years ago and commenced in earnest to modernise the infrastructure. But there was no money to do that and while new taxes were introduced, the only avenue to finance growth was to revert to borrowing. The Keynesian school of economic management was then the flavour of the month and gradually voters started appreciating better schools, quality telephony, import liberalisation and a planned dismantling of exchange controls. The notorious surcharge tax which topped 65 per cent was halved and personal taxation was simplified. The philosophy of taxing consumption rather than labour found favour with the electorate. It is not without merit that the new policy initially released more purchasing power to the people. The reform consisted in lowering personal taxes and simultaneously gave way to disband high import duties. All this in a grand scheme to pave the way for taxing both services and products under the awesome tax called VAT. Put simply, if you add value to a product or a service then the government would like a slice of it. The more you consume, the fatter will the VAT coffers grow. In 1995, when VAT was introduced, it exempted many products such as food, printed material, medicine, education and other essential items branding them at a zero rate. Over the years the net widened and more products and services became subject to VAT at 15 per cent. A 20 per cent hike in the vat rate was levied in 2006. This increase was expected to create a separate fund to help support health sector expenditure. With this rhythm of liberalisation and reforms in commercial laws, politicians started dancing merrily around the Maypole to the tune of a new tax and spend mentality, (an alleged money no problem mantra).
In recent days, though, we’ve listened to brave statements from several politicians and policy-makers suggesting that reality is piercing through our Mediterranean style of easy living. Sadly, a contraction during two consecutive quarters led to a technical recession. The prospect of a sluggish recovery is a blow to the 2010 budget, which is relying on Malta returning to growth of at least 4.5 per cent by 2011 to help repay the growing national debt and a pension time bomb. The need to rein in the budget deficit set to reach 4.4 per cent of gross domestic product this year adds to the obstacles in the fight against the unemployment. To break the camel’s back, the European Commission has set 2010 as the deadline within which Malta has to balance its books. It is not surprising that the IMF said the Maltese authorities had to act fast “to remove the bottlenecks that have so far held back EU fund absorption”, cheekily suggesting this is to be entrusted to a high-level inter-ministerial committee.
Back to the debt issue. It is true that the tax reforms have yielded a richer stream of revenue. Yet, in spite of this source of revenue the budget was chronically running a deficit and not since the last twenty years have the government borrowed so much so quickly. When compared to the end of March last year, the total outstanding government debt went up by €325.7 million and amounted to €3.7 billion.
This level of debt has caught the beady eye of the IMF inspectors who at their latest annual report commented on the critical cash flow difficulties facing the island. It is undisputable that the economy was expected to contract by two per cent this year, hopefully followed by a modest recovery in 2010.
Banks had weathered the initial stage of the financial crisis and emerged “relatively unscathed” but not so the hotel industry which so far has faced severe drops in profitability and a bleak winter.
Our borrowing over the past two decades has landed us in servicing costs which are almost equal to the cost of medical services. It is unbelievable but the IMF mission was so concerned that the debt factor is high that they even recommended that the government should not tolerate late tax payments from companies with cash flow difficulties. True this is an ungodly punishment to administer and one may comment that it is like throwing out the baby with the bath water. Maybe in the last attempt to sell off the remaining heritage of the so called “family silver” we should heed IMF’s advise and seek strategic investors for Bank of Valletta. It is no consolation that past privatisations did not reap enough to wipe out debt while one is realistic that the €800 million sunk in dockyard subsidies will not be fully recouped from docks privatisation. Yes this may be unpalatable, but difficult times call for difficult remedies. This is particularly true when the IMF said determined action on expenditure was needed because the spending structure hindered adjustment to shocks and suggested that forthcoming negotiations on the public sector collective agreement should set a conservative benchmark for the private sector. Any cutting down in government induced costs such as the charges levied by various government agencies to the public will start cooling down the spiraling inflationary pressure.
Paradoxically, a recession it begs the question on why we cannot afford to borrow more to beat the downturn. As can be assumed, the alarming trajectory of debt has put us under the scrutiny of the European Commission, which is asking us to pull our socks up by December next year. Over the next budget, we can only walk a tight rope as the finance minister must evoke clear principles on how the national deficit is to be shrunk. Pledging to cut expenditure during the thick of a recession is counter productive although it is true that cutting waste and duplication of jobs in the general service can yield marginal gains. A sudden fit of fiscal austerity will jolt the patient and is not recommended. A spokeswoman for the GRTU said more could be done to facilitate ways for retailers (suffering from plummeting sales) to apply for some relief offered by Malta Enterprise.
The antidote to recovery is the unexpected rise in inflation which is regrettably is all home-grown. Something is distorting our dysfunctional pricing structure when imported inflation is four times lower then ours. The ugly duckling is the apologetic story of imposing higher tariffs altruistically issued to prop up Enemalta, the energy monopoly. Can anyone blame the minister in charge when the utility badly needs an injection of working capital? But not everything is doom and gloom. One credit rating agency, Standard and Poor’s, appears to be showing confidence in Malta too. It has come out confirming that the island’s stable outlook balanced expectations of a fiscal consolidation in the medium term against the challenges of economic reform and the relative high debt burden.
Again, it is no great elation to remind the public in general that by and large, each family inherits the dubious legacy of circa €35,000 in public debt.
IMF is predicting that by 2013 public debt would reach 70 per cent of GDP, yet our valiant efforts to tackle our servitude will lead us to salvation rather then tear us apart.
Partner at PKF - an audit and business advisory firm