Earlier this year, economists were relatively sure that inflation was a ‘transitory’ matter and that by the end of 2022, the situation would ‘normalise’. 

Now, most fear that ‘high’ inflation would go beyond 2023 and/or until the ‘war’ in Ukraine ends. This is not just a macroeconomic problem, given Malta’s lack of natural resources and dependence on importation, but it will also negatively affect local business. 

From a macro perspective, persistent ‘high’ inflation will put pressure (eventually) on the Central Bank of Malta to raise interest rates and this will not only negatively impact borrowers (ranging from home loans to business loans) but increase the likelihood of an economic slowdown. Clearly, after two-and-a-half years of pandemic hardship, this is the last thing we needed.

What do I mean by ‘high’ inflation? It is difficult to predict but it could be as high as eight to 10 per cent come the end of this year. In fact, some imported items are already experiencing double-digit inflation rates but this is not yet reflected in official statistics and we don’t know if this is a temporary situation or otherwise. Some businesses have thus far absorbed a lot of the increases in imported prices. The government too has stepped in to stabilise energy prices.

The problem with inflation, however, is that it literally causes havoc with production costs or the price of imported goods/services; fuels salary/wage inflation; disrupts investment planning; and, worse of all, it injects fear in the economy. 

In the UK, the Bank of England has already gone on record to say that the British economy faces a “sharp economic slowdown”. In Malta, the governor of the Central Bank of Malta has recently fired some subtle warnings of sorts and I am sure he will increase the dose of such warnings, as the year unfolds. I think he needs to find a delicate balance between measured warnings which open our eyes and encourage the right sort of action and, on the other hand, stop unnecessary alarmism. 

Right now, the only priority is to defend our fragile economic recovery

In my opinion, the government needs to have in place a national ‘Inflation Strategy’ which guides and directs business actors in the economy. I think growth will be curtailed this year but, if we play our cards right, we can avoid an economic slowdown. Unfortunately, the pandemic financial cost due to excessively restrictive public health policies has been far too high which, in turn, reduces our room for manoeuvre. This having been said, we can navigate these dangerous waters with the right strategy in place. 

What should such a strategy contain? I think the government needs to recognise that the current causes of inflation are unique, mainly driven by external supply shocks and disruption plus the war in Ukraine. Therefore, raising interest rates right now is not necessarily the appropriate macroeconomic tool; you would be hurting borrowers unnecessarily.

I think the government must first exhaust options to help industries source key raw materials from abroad and help stabilise prices in 2022. It must also use the vast resources of the state to help companies diversify their sources of supply, even leveraging EU networks and treaties.

The government has already intervened in the energy market, committing a sum close to the tune of €200 million. Furthermore, for the time being, the government must tolerate a higher-than-normal level of inflation and manage expectations; I am here referring to the perceived ‘natural inflation rate’ which central bankers obsess about. The free market will ensure that, this year, a mixture of factors absorb the rise in prices, from companies temporarily sacrificing their profit margins so as not to lose market share; workers/employees/pensioners ceding purchasing power; and investment decisions may be reconsidered and/or right-sized according to the perceived risk. 

By the end of the year, we should have a clear idea of how ‘transitory’ the situation is and how high inflation will be and, ultimately, how serious the problem is to our economy.

But if the Central Bank or government panic and intervene too soon and too aggressively, we could unintentionally enter a high inflation, high interest rate and low growth vicious circle which will be hard to get out of. 

Therefore, we all need to hold our nerve. We need to ride out the high inflation rates until the international picture becomes clearer.  What the government can do is ease off or even suspend any climate change reforms which comes at a huge cost to business. It can also convey the message that right now, the only priority is to defend our fragile economic recovery. 

The government should also declare the tourism industry as the island’s no. 1 priority in 2022/23, since this is the surest way of generating/protecting economic growth and attracting foreign cash inflows. 

We need to buy ourselves time, so as to learn how the world situation is going to unfold. We also need to hold our nerve and not rush into any monetarist economic policies which increase interest rates. The recovery is here but it is fragile and, therefore, we need to tread carefully and strategically.