Wednesday, 21 March 2012

Malta: The storm is coming? Lessons from Cyprus

Malta is right to congratulate itself and pat itself in the back. It has managed to maintain one of the best preforming economies in a particularly sluggish euro zone area, promoting triumphalist articles such as this "Malta grows faster in the Eurozone". The prime minsiter has been in power since 2004 and he can claim to have brought about the changes that are leading the economy forward: a great investment in IT and IT skills has led to Malta been a leader in technology relating to internet services,and a good relationship of the government with surrounding areas can be in part attributed to the success of Malta absorbing EU and other regional funds. Of course I much rather believe this is the work of institutions such as the university of Malta and the enterprising Maltese business community rather than government, but one must give credit to the strategic plans of the government for offshore business services and for tourism, whereby strategic investors in key services have allowed a move away from the traditional British market.

The success is noted outside Malta too. Very recently the General manager of the Employers' and Industrialists' Federation (OEB) of Cyprus, lambasted the bureaucratic and rigid procedures of Cyprus, pointing at the Maltese government's very successful transition to an on-line and easy to use platform for making business.

Yet I think it is good for Malta to also look the other way to Cyprus and see the trouble it is now in. the following is a list of things Malta can learn from the Cypriot "Fall from grace":
1) business services are not forever: In a competitive world, someone will find the next best place to relocate business services. Hence one must not assume the revenue stream from this section of the economy will remain high and it could very quickly decelerate.
2) contagion in very real in the Eurozone: If Cyprus can teach Malta anything is that trouble in Italy will hurt Malta, even through exposure is less pronounced that Cypriot exposures to Greece.
3) Lack of urgent action makes downgrades of its credit ability certain: Indeed the first slide of the almost inevitable downward pressure for credit markets has begun. Let us not forget Cyprus started at ratings slightly below Malta and ended up in the Junk category. Urgent action is needed to show to markets that the situation that led to the downgrade is being tackled.
4) Small countries find themselves biased due to their sovereign debt pool being small and hence illiquid: Small governments such as Cyprus and Malta are not a liquid market for government debt. Unlike Italy which its debt is so large you can find buyers and sellers, the lack of liquidity means that markets will discount option, quickly raising borrowing rates to prohibitive levels.
5) Domestic savings are not forever. Cyprus has been now locked out of international markets for 18 months, and despite early success in raising capital domestically, such capital is now scare. In fact substantial savings are slowly trickling out of the country as the continual downgrades have led to concern in both the government ability to raise funds and the Cypriot bank's survivability.
6) The above was preventable in Cyprus so long as the government acts fast:
This is perhaps the most important lesson can Malta learn from Cyprus. Now is the time for Malta to act hard to stop debt from becoming a problem. If Cyprus took measures to tackle its fiscal deficit two years ago it could have avoided the worse by having wriggle room to respond to crisis. It did not do so, and hence as a small country the risk on borrowing internationally on such illiquid sovereign bonds, very quickly locked Cyprus out of the international money market.

It is much more difficult to reduce government expenditure when incomes are falling. If the government of Malta undertakes a wage freeze, balances its budget and starts saving a small sovereign fund to have ready for any potential problems down the line, Malta can avoid or even reverse the process that led Cyprus into the gates of EU assistance. Tough decisions today meant that no one needs to take even toughter decisions in the future.

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