When launching the pre-budget document, Edward Scicluna, the Minister of Finance, “expressed concern about the low inflation rate that could create pressure for wage cuts, which he insisted were not acceptable”.
That, in my view, is an honest reference to one of the risks associated with the low inflation rates registered by the National Statistics Office since March 2013 but there are other risks which were not mentioned and which could impact our economy in the medium term, especially if the period of low inflation or disinflation is a prolonged one.
According to the minister, economic growth target is on track. One cannot argue against Malta’s growth potential but whether it always translates into real economic growth remains to be seen – especially given our reliance on the eurozone economies, where growth recovery remains slow. Though we have seen positive signals, the collective GDP in major eurozone economies has virtually stagnated. The effect of harsher sanctions on Russia will act as another drag on the eurozone economies.
On top of this, the eurozone is experiencing extraordinary low inflation rates with bond yields falling below one per cent in some cases. This, of course, is an indication of falling prices unlike (it must be said) Britain where the economy is showing encouraging signs of recovery after very bold political decisions on structural reforms.
The same cannot be said of most eurozone economies where commitment to structural reform has been sidelined by an EU lacking the leadership and appetite for farreaching changes.
The eurozone’s tight monetary policy hasn’t helped either.
Whereas it has been argued that loosening the reins of fiscal policy would stimulate economic growth, I’m not sure that will come about automatically if eurozone leaders are swayed by public opinion and are not committed to structural reform.
There needs to be a stronger commitment to structural reform to enhance our economy’s competitiveness
This brings me to the risks of disinflationary expectations where households across the eurozone are seemingly delaying purchases with retail sales dropping 2.5 per cent in July when compared to the same month last year – although it must be pointed out that the latest figures on consumption show an increase in volume terms..
Disinflationary expectations could also cause local companies to delay investment if they believe cheaper finance would be available in the future. Though the Maltese economy doesn’t have the same slack as say Italy or Spain, the risks of disinflation cannot ignored.
Of course, consumers would welcome lower prices but, as stated by the Minister of Finance, the risks of falling income are a matter of concern since falling incomes would raise debt burdens on households thereby reducing spending on goods and services at a time when economic growth is to a significant extent dependent on consumption.
Deflation risks are, of course, greater in major eurozone economies, especially in the weaker economies. To mitigate the risks of low rates of inflation or disinflation, new policies and initiatives are needed locally to further encourage investment. There needs to be a stronger commitment to structural reform to enhance our economy’s competitiveness. The forthcoming Budget should set some light on initiatives aimed at reaching this objective.