When Finance Minister Tonio Fenech presents his government’s budget for 2009, he will be doing so in the context of a world economic situation that is different to that prevailing at the time the government published its pre-budget document in summer. Indeed, the evolving situation following the financial crisis has robbed the document some of its value.

Fears of the worst effects of galloping fuel and food prices have been replaced by even bigger fears of the consequences of the financial crisis and of a recession that seems to have started in some of the countries directly hit by the credit crunch. The risks of inflation may now be eclipsed by the greater risk of price deflation in many markets.

These new circumstances present a formidable challenge to the government to come up with measures that promote economic growth but at the same time preserve fiscal rectitude.

We have already seen the tensions that are created by trying to balance the prevailing conflicting priorities of the economy.

The proposed changes in the water and electricity tariffs, combined with the probable increase in gas prices following the privatisation of the government’s gas bottling entity, are, no doubt, motivated by the sensible policy of charging market prices for the consumption of energy products. Similarly, the elimination of the last surviving subsidies on food products is based on the same economically-sound principle. This should continue to be the long-term goal of the government if the management of public finances is to be sustainable.

However, the social partners’ concern that the sudden increases in the price of food and fuel-related products and services have the potential of causing even more serious economic problems has some validity and needs to be addressed. The International Monetary Fund argues in a report that "In some countries where fuel and food prices have been kept artificially low, the existing substantial gaps with world prices may be difficult to eliminate because of social considerations. In such cases, it may be necessary to phase out subsidies gradually while putting in place social safety nets to help mitigate the impact of price adjustment on the most vulnerable segments of the population".

The report goes on to recommend, among other measures, the "creation of fiscal space", which it defines as "increasing revenue, reducing non-productive spending, raising borrowing in a non-inflationary and sustainable way, and securing higher external grants or concessionary loans provided by donors". This may be a tall order and not as easy to implement as it looks.

However, the risk of slowing economic activity is more dangerous than creating fiscal space which, in any case, should be a temporary measure until the economy starts to pick up and fiscal policy can once again be tightened. The Minister of Finance may no longer use monetary policy to stimulate growth but he can adopt a pragmatic approach with fiscal policy, without endangering the achievements the government has obtained over the last few years in the management of public finances.

If such a compromise between conflicting budgetary priorities can be achieved, the country can perhaps avoid the risk of spiralling wage inflation that could become unavoidable if the shock of higher fuel and food prices is not mitigated. The last thing the economy needs is a blow to competitiveness through unreasonable wage hikes.