It was a pleasure to have been among the invitees for last week’s business breakfast organised by HSBC Bank Malta plc. Many were evidently fascinated by the simple but very effective presentation delivered by HSBC’s senior global economist Karen Ward. Her presentation entitled “The World in 3D: Debt, deflation and deleveraging” is very topical and dealt with the recent economic developments across the world which we have been following with trepidation almost daily.
Ms Ward provided the background to the economic woes of the recent past. The housing crisis is where it all started and this came about as a result of the huge levels of household debt mainly in the UK and the US. While the dangers of this personal debt situation were overlooked as asset prices were increasing, the decline in house prices, which started in 2007, led to a vicious chain reaction across the globalised world. Many borrowers were unable to continue servicing their mortgages and this led to the start of the banking crisis. Ms Ward quoted a recent statistic that nine per cent of mortgages are still not being serviced in the US and, with continued abundant levels of housing supply, this crisis in the US property market could be a major long-term problem for the US economy.
As the housing crisis escalated and banks (especially those exposed towards sub-prime lending), suffered huge losses, the banking crisis gathered momentum peaking in the second half of 2008 with the bankruptcy of Lehman Brothers on September 15 of that year. At that point, the inter-bank market was shut as banks across the world stopped trusting each other. In order to avoid a series of similar situations to that of Lehman Brothers, governments around the globe had no choice but to bail out some of the largest financial institutions.
Gradually, confidence in the banking sector improved as the system stabilised following the unconventional capital injections by the state. However the massive capital injections by the governments (mainly in the US and the UK) to avoid another Lehman bankruptcy inflated the sovereign debt problem. Coupled with this, economic growth declined rapidly leading to lower revenues for governments and hence widening budget deficits. This was the start of the sovereign debt crisis which is still hitting international headlines every day.
The debt levels and deficits of some major governments such as the US and the UK increased to unprecedented levels at a time when the economic recovery remains fragile and unemployment levels are at multi-year highs. Within the eurozone, the state of public finances is mixed with the periphery countries of Portugal, Ireland, Greece and Spain alarming investors amid widespread concerns of a sovereign default. In the most extraordinary case, the IMF and the European Central Bank needed to bail out the Greek government through the injection of €110 billion in May.
Ms Ward delved deeply into the differentiating factors behind the concerns for the US and UK public finances compared to those of the eurozone nations. She explained that the US and the UK are able to finance their deficits cheaply, despite their economic problems and high deficits. This is being done through quantitative easing, which is simply the printing of money by the US Federal Reserve and the Bank of England. The increased supply of US Dollars and Sterling in the financial system, Ms Ward explained, is what is forcing both currencies to decline in value against the euro. Over recent weeks the USD and the GBP declined by 7.9 per cent and 6.2 per cent respectively against the single currency.
On the other hand, due to the monetary union, financing the large deficits in Portugal, Ireland, Greece and Spain is more problematic since the central banks in these countries cannot simply print money as this is entrusted to the European Central Bank. With the ECB limiting the amount of quantitative easing, the governments of Greece, Ireland, Spain and Portugal are finding it difficult to issue new government debt to finance their deficits as financial markets are seeking ever higher yields to lend to these countries.
The 10-year Greek government bond yield increased to around 12 per cent amid the sovereign crisis while the yields of the better performing eurozone economies (Germany and France, in particular) saw their yields reach multi-year lows in the light of the ‘flight to quality’ among investors.
Ms Ward expects interest rates to remain low for some time longer until there is clear evidence that the global economic situation is on a road to recovery. HSBC’s senior economist also made reference to the recent currency movements and she anticipates a further strengthening of the euro in the short-term as a result of some parts of Europe performing relatively well and also since the euro is in ‘limited supply’ as the ECB is not going to flood the system with euro.
So how did Malta fare amid this recent turbulence? Ms Ward stated that Malta did not suffer any housing crisis, banking crisis or sovereign debt crisis.
One of the charts she used depicting government deficit ratios revealed that Malta is among those with the least problems in this respect. This was recently confirmed by the international credit rating agency Standard and Poor’s when it maintained Malta’s ‘A/A-1’ sovereign ratings with a stable outlook. On the other hand, some eurozone nations have been suffering credit rating downgrades in recent months.
Standard and Poor’s also confirmed that “Malta’s economy has weathered the global economic crisis relatively well and the Maltese government is addressing the deterioration in its fiscal position”. While yields on government debt of the troubled economies spiked upwards, those of the stronger eurozone nations, including Malta, edged downwards. Locally, the 10-year MGS yield declined to 3.74 per cent from 4.60 per cent at the start of the year.
This positive assessment of the Maltese economy has so far failed to be reflected in the local financial market as the MSE Share Index (which is very heavily weighted by the banks) has trailed the performance of the international equity markets especially in the summer.
With HSBC’s senior economist claiming that interest rates will remain low, equity markets generally should not only remain well supported but should increase investors’ appetite for companies which are delivering growth and offering attractive dividends. Locally, some equities offer dividend returns which are higher than the yield on the 10-year Malta Government Stock and prospects of dividend increases as a result of improved profitability levels cannot be ruled out. This phenomenon is also present across international equity markets with dividend yields relative to bonds and cash at their highest levels since the 1950s.
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Mr Rizzo is director of Rizzo, Farrugia & Co. (Stockbrokers) Ltd.