Deloitte - Malta recently issued the results of a survey it conducted among the business community on the island to gauge the impact of the international recession on our economy.

The survey shows that all sectors of the economy are being affected by what is happening beyond our shores and that there is a general belief that this is not a short-term occurrence but may take up to 18 months to sort itself out. Those that operate predominantly in the local market speak of declining demand locally; however, even this declining demand is essentially the result of lower incomes earned from exporting activities such as manufacturing, tourism and financial services.

The results of this survey may not come as such a large surprise. Other research carried out shows that the Maltese population in general is very pessimistic about the state of the economy and do not expect it to get any better in the coming 12 months. Moreover, the Maltese overwhelmingly feel that the international economic situation is affecting negatively our economy.

However, both businesses and individuals tend to make an important distinction between what they perceive to be the state of the Maltese economy and their own situation. In both cases perceptions on the economy are worse than what they consider to be their own respective situation. This important distinction is most likely to be the result of sentiment.

The opinions of businesses and individuals about the Maltese economy depend on what they feel, what they read and what they hear and not of direct knowledge. Obviously the way they describe their own situation is the result of direct knowledge about themselves.

This does not mean that the state of the Maltese economy is not as bad as people are making it out to be. It just means that the situation is so volatile (the price of fuel is a proof of this volatility) that beliefs about the economy may not be based on solid grounding and could shift quickly.

Up to a certain extent we seem to have entered the world of relativity in the way we are describing the international and local situation. In other words we use words such as "bad" or "negative"; but how negative is negative or how bad is bad?

Governments, whose economy is expected to shrink by more than four per cent this year, are describing their own situations as not being that bad. Our economy is likely to register growth this year and we are describing it as very bad. This is what negative business sentiment does to people and businesses.

Everyone generally gets more cautious, restructures one's spending with a view to possibly reducing it or buying more for the same amount spent, and rethinks any important investment or expenditure.

It has thrown out of the window the so-called theory of rational expectations developed in the 1970s and 1980s, which basically assumes that individuals and businesses can correctly anticipate in a rational manner what is likely to happen in future.

This implies that the fundamentals of the economy need to be addressed as one cannot live in a fool's paradise, but one needs to address the issue of sentiment.

Going back to the Deloitte survey, the report does indicate the expectations of the business sector that the government should intervene to mitigate the impact of the international economic situation on our own economy. The opinions expressed by the survey respondents as to what the government should do are varied and, even, they may be the result of sentiment.

So far the government has tended to tackle situations on a sector by sector or company by company basis, with the objective of safeguarding jobs. I believe that is the correct approach as it tends to be more cost effective than large-scale initiatives.

There may be two other policy options that could be worth considering. Both relate to the use of fiscal policy. Should the government consider buying shares in Maltese quoted companies to generate a positive business sentiment? This should not be seen as government intervention in the economy but rather as a tool to generate liquidity in the equity market and strengthen investor confidence.

The second policy option would need to be resorted to once we get out of the recession. It relates to bubbles that get created in our economy mainly because of its small size. Property was our most recent one. Should the government consider using fiscal policy, that is mainly taxation, to try and burst any bubble before it starts to become dangerous?

These are not easy questions to answer. However, if we should have learnt a lesson from this recession, it must be the need for strong governance in the economy, without government having to crowd out the private sector. Contrary to the popular belief that has reigned for the last 25 years worldwide, strong economic governance helps business sentiment to grow.