Keeping public finances on the straight and narrow

The Government may not reach its deficit target. Central Bank of Malta Governor JOSEF BONNICI tells Kurt Sansone why the Bank issued such a warning.

In its latest quarterly review the Central Bank warned the Government may not reach its deficit target. Given the temporary nature of quarterly figures what is worrying you?

There has to be further progress on improving flexibility in the labour market

The comments were motivated by developments in the first quarter statistics, which showed that the general Government deficit increased to €85.5 million (3.3 per cent of GDP) from €44.5 million (2.7 per cent) when compared to the same quarter of 2011. This happened because expenditure outpaced revenue: while revenue in the first quarter increased by 5.1 per cent, expenditure increased by 10.9 per cent.

A closer look at the numbers also revealed that although part of the increase in spending reflected exceptional capital transfers to Air Malta, some aspects of current expenditure, such as intermediate consumption – purchases by the Government of goods and services, such as medicines and supplies for the hospital – also increased rapidly.

Since the end-of-year deficit target is 2.2 per cent, it is clear that more effort will be required to meet it. Quarterly data are subject to some volatility and there is a tendency for higher deficits in the early quarters of the year. However, given this widening and the further unplanned assistance to Enemalta due to higher oil prices, it becomes important to limit expenditure elsewhere and increase revenue, perhaps through greater efficiency in collection, so as to keep within the established target.

The Government has had to implement budget cuts of €40 million at the beginning of the year and is now shifting expenditure to meet various commitments. What is the Bank’s outlook on the deficit for the end of the year?

In a few weeks’ time the general Government data for the second quarter will be published, and we are waiting for this to track developments over the second quarter. There is still time for the overall target to be reached if measures are taken to address the widening deficit. The Bank’s fiscal outlook will be reviewed in the light of the new data on GDP, any revisions to the broader economic outlook, as well as general Government data covering the second quarter of the year. At this stage, therefore, it is premature to provide a revised fiscal projection.

The public debt has also soared to 75 per cent of GDP in the first three months. The Government said it loaded debt towards the beginning of the year to take advantage of favourable interest rates. How comfortable are you with this strategy?

We have to keep in mind that part of the increase in the debt ratio went to finance Malta’s share of the European Financial Stability Facility, the bailout fund, and that part was unavoidable. One should also mention that at a time of economic slowdown or contraction, Government revenues have declined across many countries, putting upward pressure on debt.

I would also recognise that the debt to GDP numbers for a single quarter are usually quite volatile, in part because of changes in the Treasury’s timing strategy, such as the front-loading that would exploit the current low yields. Nevertheless, for target commitments to be met, over-borrowing in one quarter has to be reversed during the remainder of the year.

Even if, as we anticipate, the debt target is met, it would still be above the 60 per cent threshold. As it stands, there is hardly any room for fiscal manoeuvre. At the current ratio of 75 per cent, the leeway to engage in fiscal stimulus, should the need arise, is extremely limited. Ideally, governments should cut debt during good times, leaving room to reverse the process during recessions.

Debt and deficit performance of the Government is important not only because of EU commitments but also in view of the exercise that is continuously performed by rating agencies.

The economy went into recession in the first quarter and came out of it with modest growth. The Government has also lowered its growth projections and yet inflation has increased. How can this be explained?

The two main measurements of inflation are showing conflicting tendencies. Inflation based on the Harmonised Index of Consumer Prices (HICP) has accelerated in recent months, with the annual rate rising from 1.7 per cent in January to 4.4 per cent in June, before moderating slightly in July. The Retail Price Index (RPI) does not show the same accelerating path. The RPI inflation rate, which hovered at rates of around 2.2 per cent in the first half of this year recently decelerated to 2.1 per cent in July. This is the price index that is of direct relevance to consumers, and is also more relevant than the HICP in terms of the risk of secondary price increases.

More than half of the annual increase in the overall HICP index in July reflects developments in the services sector, and particularly a sharp increase in hotel accommodation rates. These rates have a minimal impact on the RPI.

There have been a number of changes in the method used to gather hotel rates, and there are some unresolved issues concerning the methodology that would accurately measure changes in accommodation prices as paid by tourists. We have consulted the Malta Statistics Authority and the National Statistics Office on the issue, and they have agreed to look further into it. At this stage there is the possibility that the impact of accommodation prices on the HICP inflation rate is being overstated.

Does this worry you?

The HICP index is the instrument used to compare inflation internationally. As a result the view from abroad is that Malta has the second or third highest inflation in the eurozone. This is the first comment I get during meetings of the European Central Bank. We have offered the NSO to fund a survey to have a proper snapshot of hotel accommodation prices.

Apart from weak economies in Malta’s export markets, what else can the Government do to stimulate growth or mitigate the downward trend?

In view of the limited leeway for fiscal stimulus, the focus should be on structural reforms. Improving Malta’s international competitiveness is the priority and this involves reforms in various areas such as education, the labour market and pensions. There has to be further progress on reducing the school-leaving rate, raising the labour participation rate, particularly among women, and improving flexibility in the labour market. Another concern has to do with Malta’s dependence on imported fuel and energy.

It is also extremely important to boost efforts to promote Malta as an investment location, both in the manufacturing sector, especially firms with a higher value added, and in the financial and other service sectors which have been doing quite well. Efforts in tourism are also particularly important, especially in the marketing and upgrading of the product. The lower euro exchange rate should also boost competiveness, although it does impact negatively the cost of energy and other dollar denominated imports.

This is a challenge given the drive towards fiscal consolidation.

Many countries face the challenge of promoting growth and simultaneously lowering the debt to ratio. The need to stimulate the economy comes at a time when fiscal consolidation is not just commendable but also mandatory. However, although these two aims seem conflicting in the short term, fiscal consolidation is conducive over time to faster and durable economic growth.

The eurozone crisis has dragged on for two years now. One summit after another has simply produced stopgap solutions until the next round of problems crops up. Can a lasting solution be found?

The prospects for stability of financial markets have improved now that the ECB has pledged unlimited, though conditional and sterilised, bond-buying. Bond holders have been demanding a higher yield in some member states to cover what they see as the possibility of exits from the euro area and the resulting risk of being repaid in national currencies. The elimination of this premium is an objective of the new outright monetary transactions programme.

The problem so far has been that despite the range of standard as well as non-standard measures, the link between lower interest rates and the provision of ample liquidity that should lead to credit growth and economic expansion has remained impaired. The new outright monetary transactions seek to repair this.

At the institutional level, there have also been various far-reaching developments. The fiscal compact has been an important step towards budgetary consolidation. Moreover the appropriate design of the prospective banking union will address the interconnectedness between financial institutions and markets across the euro area.

There has to be a continued effort to restore competitiveness by addressing much needed structural reforms in the labour and product markets.

All these ingredients will help to restore market confidence and place the euro area back on the road to recovery and prosperity.

Are eurobonds a solution?

I think it is a premature solution. It will not solve Greece’s problems by transferring the country’s debt onto other EU countries. It will spread the burden without necessarily providing a solution.

Should Greece be cut loose from the euro?

There is a clear preference for the euro area to remain intact. What is important is that the Greek Government made a number of commitments, and ultimately it is up to the Greek Government to deliver on those commitments.