The fragility of it all

During the past few days the Malta Labour Party has published its latest report on The Maltese Economy: Present State and Prospects, based on the economy's performance throughout the past year as well as during the first four months of 2002.

As a party we have also had the opportunity to express our views about the state of the economy during meetings with officials from two of the leading international credit rating agencies.

One of the best benchmarks against which Malta's economic performance can be gauged the expectations laid down in the reports which these credit rating agencies had carried out last year.

They had predicted that the removal of trade barriers should precipitate the decline in low value added manufacturing industries while increasing the dominance of the service sector. Latest figures show that the services sector under-performed throughout the last financial year.

Ratings last year were constrained by unsustainably high fiscal deficits and the concomitant increase in the government's debt burden. The situation has only worsened since then.

It was then forecast that a substantial downturn in international markets could undermine balance of payments stability, dampen growth prospects and place pressure on the pegged exchange rate. This has proved to be the case in recent months.

The credit rating agencies had argued that little budgetary flexibility would remain if growth proves slower than expected. It is for this reason that Government feels as if it is wearing a strait-jacket, particularly since it has turned a blind eye to the warning signal that structural reductions in government expenditure remain critical to maintaining Malta's creditworthiness at its present level.

Although liberalisation of remaining capital controls and privatisation were expected to continue to support FDI (foreign direct investment) inflows, these have been modest to say the least.

If Malta's credit standing has been eroded by political uncertainty and unsustainable economic policies, this is Government's own fault, since due to its single-minded pursuit of full EU membership it has failed to find the time, inclination or political will to address the chronic problems that have stifled economic growth in the past two years.

Meanwhile, as already commented on by these credit agencies, fiscal flexibility remains constrained by excessive government deficits.

The increase in the ratio of general government debt to GDP remains alarmingly high, particularly in view of the modest decline in the debt ratios of neighbouring Mediterranean destinations.

Malta has continued to rely on external trade to bolster domestic growth but its trade performance so far has been dismal, with drops in imports - including capital goods - outpacing those in exports, and thus leading to a narrowing of the visible trade gap.

The only reason why Malta's trade with the EU has increased in percentage terms is that, due to the downfall in the semi-conductor business, exports to Asia and the US have declined with our over-dependence on EU markets increasing in the process.

While in the past buoyant domestic demand had been driven by strong growth in real investment and continued expansion in private consumption, this has not been the case in recent years.

The long promised EU-motivated 'structural' reforms have failed to strengthen the underlying competitiveness of the economy as well as to improve our long-term growth prospects.

In the tourist sector, in spite of much talk to this effect, Government has failed to deliver on its publicly pledged medium-term strategy for the industry to focus on improving the tourist structure, upgrade the tourist product and diversify markets.

As predicted by the credit rating agencies, over the short to medium term, restructuring is resulting in further redundancies, exacerbating the skills mismatch.

Another area where Government has failed to deliver on the credit agencies' pious hopes is in containing the deficit by focusing on introducing expenditure restraint while simultaneously strengthening revenue collection. It has focused on the latter while ignoring the former priority.

In spite of efforts to play down the costs associated with EU negotiations, the fiscal impact of compliance has proved to be a real burden.

PPPs (Public-private partnerships) have failed to take off the ground, denying Government of another 'tool' that could effectively help lower the potential cost to the government budget.

While international credit rating agencies were led to believe that inflation was likely to remain close to 2.5 per cent over the medium term, published figures show that it has long surpassed the three per cent mark in past months.

S&P argued last year that even if the Government's privatisation programme is resumed in earnest, the general government debt burden is forecast to remain at similar levels in the near term. The fact that Government has adopted a sluggish approach to privatisation further goes to prove why the debt burden has actually increased.

The sharp increase in short-term debt has in its own way reflected the lower than expected receipts from privatisation.

Last year S&P argued that the prospect that gross problematic assets in the financial system could reach 28 per cent of GDP was a worst case scenario. The passage of time shows that it was not really so off the mark.

As for the MLP's first review of the Maltese economy, published last year, this bears closer scrutiny, particularly since most of the economic paths predicted have actually materialised.

Mr Brincat is the chief Opposition spokesman on the economy and finance.