George M. Mangion | Wednesday, 04 November 2009

Budget to straddle a €4 billion deficit

It is not surprising that next week there will be a deep sense of deja-vu when the Budget for 2010 is announced. A lot is expected by citizens but realistically, very little can be delivered. The government is under pressure from the European Commission to regularise its deficit by the end of 2010.
This is unfortunate, when one bears in mind that other EU member States like Britain, Spain, Italy and Germany are opting for a higher deficit this year in a bid to stimulate their economies.
The Commission’s directive works negatively at this critical juncture. Our budget officers would no doubt prefer to maintain the deficit at around the 5 per cent mark to allow the grass shoots to nurture.
However, it seems that the Commission is strong with the weak and weak with the stronger members.
Just take into consideration our fellow EU member State Latvia, which is not only running a high deficit but had to be bailed out by the IMF, and yet they are still able to run heavy deficits.
Back to Malta, in last year ‘s Budget, government tried to sugar the pill of recession, but in my opinion it badly backfired.
When considering our open and fragile economy it was pretty obvious that we were not immune to the virus of recession, although we may try to camouflage its symptoms. This political ploy to ‘hoodwink’ the citizens, reminds us of King Canute pretending to stop the tide. While economists say that it had a boomerang effect on us because it came when we least expected it. The stark truth now is that the economy is in recession; period.
Malta has witnessed four consecutive quarters of negative economic growth since the third quarter last year. We were foolish to dream that our spring will not turn into a winter and put aside the umbrellas only sadly realising that we were ill prepared for the stormy weather that was yet to come. To compound the issue while all EU countries were witnessing a drop in inflation matched with a severe cut in interest rates, our banks bulked the trend with high interest charges and naturally inflation prospered.
Just watch how one of the main banks has recently announced to have doubled its profit when the economy has officially registered negative growth. This is a paradox at a time of higher unemployment not to mention the EUR 37 million lost in shipyards as revealed in an investigation run by a top four audit firm.
Recession resulted in a €80 million drop in tax revenue due to higher unemployment and lower consumption. This does not make for a happy conclusion, except that it leads to a ballooning of the exchequer debt to nearly €4 billion.
However, with all this borrowing, there is no extra money to solve the root cause of the whole problem with our public finances. Can we blame such a structural deficit to loss making entities and a bloated civil service which stops for three months on half day summer routine and employs over 8000 retirees as consultants?
If the government omits to bite the bullet, the structural deficit will act as a mill stone round the necks of the
productive sector.
All this translates to a budget hiding a heavy cost of governing a tiny island with its 80 local councils and burgeoning bureaucracy.
Unemployment will fall at a slow rate unless tough measures are taken to stimulate the economy which in the short term will justify more borrowing.
Unattended unemployment will cause huge economic and social hardship for people and may force some to emigrate. Consequently, it is blindingly obvious that any unprecedented rise in unemployment, will exacerbate the twin evils of higher welfare payments and lower tax revenues. It is equally obvious that creation of sustainable employment in the productive sector is the main solution to the problem.
However, from a budget perspective inaction is a ‘loose-to-loose’ scenario.
It appears that the policy to boost consumer demand by reducing VAT is not on the cards.
The preferred route is for the finance minister to target specific industries and inject direct assistance (with no strings attached) which of course has a more direct effect on sustaining present employment but may be criticised that beneficiaries have no obligation to maintain employment once the funding stops.
So there is a solution in sight to attract investment and new jobs.
The budget is expected to come with an answer.
To start with, in the eyes of many, banks are seen as fat cats purring in the background.
The perception is that they are hell bent to expand their grip on the domestic market by aggressively pushing retail products such as investments, pension plans and credit cards.
On the international front - apart from the improved services offered by Malta Enterprise - there is little encouragement from the State and even less from the two main banks to promote foreign direct investment. The feeling is that while there is a recession in Europe it is wasted money if you go there to attract new business.
This is a fallacious and self destructive policy. In a downturn, one must intensify his or her presence in the world particularly searching for opportunities in niche markets.
Without appearing to be blowing our trumpet, PKF has invested a lot of its scarce resources to market the island abroad in the fields of e-commerce and financial services.
Bank executives all greet us with big smiles but manifest deep pockets. This needs to change, and the budget proposals must do something to intervene with the banks to start caring for the social and economic welfare of their customers. This especially during in a recession.
The banks are not lending as they used to before. So is there room to negotiate with banks to toe-the-line or perhaps do we need to set up a state economic development bank ? ( this begs the question why we sold MidMed?)
While Banks furtively chase the upward drive in their p/e ratings, the two main banks can dig deeper into their pockets to assist the business community.
Back to tourism one expects a number of hotel closures in winter and recovery much depends on how fast the recovery is made in Europe.
In the manufacturing sector, we need to attract more high value added entities to replace closures.
SThere are many areas which Malta’s ideal tax structure and moderate regulation can create thousands of jobs ahead of the world recovery.
The opposition is unrealistically calling for a generous budget to compensate for unprecedented high inflation while the unions want a 10 per cent cut in personal top tax rate.
A list of ten proposals was recommended by the opposition to be included in the budget. This included a welcome proposal for a freeze on all government tariffs and licences which avoids the anomaly that while the budget is tax neutral new tariffs will be announced through the year.
Can this happen when the government’s financial deficit widened by €75.5 million in the first nine months of this year to reach €333.9 million?
Really and truly with a ballooning national debt approaching the €4 billion mark, the finance minister must apply urgent surgery to reverse the rut in public finances. We all wish him well, but this time only magic can do the trick.
There is a hole in bucket since 80 per cent plus of total expenditure is practically untouchable. This comprises payroll, social,health and pension costs. If that’s truly the case, spending reductions will have to be on a scale never undertaken before in previous budgets.
Paradoxically , the government is determined to start the Piano project for a €80 million rebewed Valletta City Gate and new parliament building. It is true that capital spending, enhances a country’s long-term productivity, aids an eventual recovery and acts in its own way as a form of fiscal stimulus, but the choice should fall on productive options such as Cirkewwa terminal and better roads infrastructure.
What went so wrong in the 2009 projections is not impossible to explain but this is all water under the bridge and is best left for opposing politicians to argue it out in parliament.
The essential issue is that the bureaucrats have over shot the budget and nobody is falling into his or her sword to claim responsibility.
If the national budget was being administered in the private sector heads will roll unless early remedial action is taken by the captains of industry.
So at best we can expect a budget underpinning a fragile economic recovery next year.
Finally, please cut the rhetoric and make sure to avoid “shock therapy” measures in this budget.

George Mangion
Partner at PKF – an audit and business advisory firm



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04 November 2009


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