Currency worm-eating

Government is determined to join the eurozone come January 1, 2008. It has worked indefatigably to control the budget deficit; its plans are really on track, and there is no doubt that its target of lowering it below the three per cent threshold will be successfully achieved.

Revenue has substantially increased through more efficiency in tax collection by limiting tax evasion possibilities and increased taxation on the one hand and reduced government expenditure on the other. Thus, Government has succeeded to put its finances in better order.

But this is only one side of the coin. Joining the eurozone is not limited to containing the government deficit; it is only one of the five tests that are required to join this exclusive monetary club. In its eagerness to reach targets and control the budget deficit effectively, Government has appeared to contribute indirectly to the creation of more obstacles in its path by increasing costs through taxation.

These costs have percolated throughout and landed on the final consumer. In fact, the National Statistics Office has reported that the consumer price index (CPI) for March has risen to 2.92 per cent.

Admittedly, Government should not be blamed entirely for this state of affairs. Extraneous factors, particularly the recent persistent increases in the price of oil, have played an important part. In fact, the oil price has surpassed all records and it is expected to reach the $80 milestone in the coming weeks if the biggest oil consumers do not taken drastic measures.

These new energy costs have caused havoc to many economies as they have fuelled inflationary tendencies. In our case, these new exorbitant oil prices may cause Malta to overstep the EU limits for inflation rates.

Oil price increases have been partially passed on, through Enemalta Corporation's fuel tariff, to all energy users, including the manufacturing industry and tourism. Businessmen normally pass on their additional costs to their clients to ensure real profit levels are maintained.

Thus the final consumer is lumped with household fuel tariffs and the increased costs on consumable goods purchased, making the real household income lower.

If the energy tariff system is maintained, tariffs will have to be increased further, thus fuelling even more inflationary tendencies. It does not only create more hardship among the population, lowering even further real income, but it will encourage trade unions to ask for wage/salaries increases, making Malta less competitive and ultimately increasing hardship through potentially higher unemployment rates.

Were Government to contain these oil price increases, the consequences would be that its budget deficit projections could be adversely affected. It appears that Government is in an odd position.

The message is clear: concentrating on the budget deficit through augmenting government-induced costs will not obtain the desired results; ultimately, price orders will not achieve the desired results.

Government's best option appears to be economic growth through the export sector, including the services sector that provides inflows of foreign currency. An important consideration in this respect is to find ways to create an atmosphere of less dependence on oil for Malta's energy needs.

Failing to embark on this path will result in the likelihood that Malta will fail the inflation rate test. The normal EU measure of inflation used is the rate of increase in the harmonised consumer price index for EU members. EU rules stipulate that, for the new EU members to be admitted to the eurozone, their inflation rate should not vary by more than 1.5 percentage points of the average of the three EU countries with the lowest rates.

Clearly, the indications are that, unless immediate policy changes are implemented to forestall this inflationary trend, while still maintaining strict control on the budget deficit, Malta will find it hard to pass the EU inflation test.

Naturally, inflation creates conflicts not only to Government's policy targets but also within the entire economy. There are people who may gain and others who lose through the erosion of the currency.

Business people are in a position to change their prices to maintain their profit levels. In this respect, however, they have to be extremely careful not to charge prices that are too high as they may easily lose their competitive edge.

Investors in fixed assets, like land and buildings are likely to benefit from inflationary tendencies because the value of their property rises in a higher proportion than inflation rates.

Wages too can be adjusted through trade union power; in Malta's case, when trade unions are competing for new members, the demands tend to be immediate and negotiations are likely to be extremely tough.

Here too, trade unions should be wary of the fact that their demands for wage increases will not contribute to their members losing their employment. The only people who really suffer because of inflation are those who have a fixed income, notably pensioners.

Higher inflation rates mean to these people a lower standard of living if they are not in a position to fall back on their savings.

These distributional conflicts within the economy are well explained in a book entitled Distributional Conflict and Inflation - Theoretical and Historical Perspectives, written by Richard C.K. Burdekin and Paul Burkett.

They opined that "controlling inflation is not just a matter of technical manipulation of fiscal and monetary instruments, but also hinges on the degree of (implicit or explicit) distributional consensus among the major income claimants.

"Moreover, the factors determining the feasibility of consensus themselves go far beyond the purely technical realm insofar as the degree of conflict versus consensus is an endogenous outcome of socio-economic and political struggles among classes and other major groups in the private and public sectors."

In Malta a new problem surfaces as one asks whether it is possible to obtain national consensus on the subject of controlling this worm-eater of the Malta lira.

Government has declared entry into eurozone as a policy priority and the Opposition is already suggesting that entry should be postponed, showing divergence of opinion.

Of course, both Government and Opposition will present the reasons for holding their respective points of view. But this attitude only buttresses the divergences.

When national issues are at stake partisan politics should be sacrificed. It is terribly important that these higher inflationary tendencies should be arrested and both sides of the political spectrum should provide the means to tackle and solve this problem as the consequences are dire to everybody, including the political parties.

Instead of emphasising divergences, they should concentrate on common points and expand on them for a potential convergence to be reached.

The situation is not easy because vested interests have to be ignored. The problem of inflationary tendencies is not an easy one to solve. But a combination of will power, technical tools and national consensus among political and constituted bodies will help us arrive at our desired goals.

Latin American countries, the Germany of the Twenties, and Western European economies before the introduction of the euro, all suggest attempts to stabilise prices on exchange rate pegs, and either wage/price freezes or indexation and, perhaps a combination of both.

It is observed that if the underlying socio-economic perspectives of consensus are not taken into account, all policies are likely to be doomed.

Malta cannot afford failure at this extremely sensitive period of its history just to ensure partisan political success. It will be a great pity that the sacrifices the people have been asked to make will not achieve the desired positive results.

Social and economic forces together can kill this worm that is eroding our currency.

Dr Borda is an economist specialising in the economic development of small states.