The Malta Independent 16 December 2019, Monday

Should Malta follow the US in lowering its fiscal drag?

Tuesday, 22 October 2019, 10:44 Last update: about 3 months ago

Anna Guth

On 31 July the US Federal Reserve System reduced interest rates for the first time in more than a decade due to concern over global growth and uncertainty in the trade. The last time this happened was in 2008 during the financial crisis. The corporate tax rate has been reduced from 35 per cent (Malta's current rate) to 21 per cent and deductions in personal tax rates were also announced.

While the dollar has strengthened as a result of this rate cut, the Euro is under immense pressure. The day after the cut in the US dollar interest rate, the European common currency fell to its lowest level in 26 months.

After the dramatic fall of the Euro, investors waited with bated breath for the European Central Bank - under Mario Draghi - to further loosen monetary policy in the Eurozone, especially if this helps revive the economic downturn. At that time, further reductions were expected before the end of Draghi's term on the 31st of this month.²

However, in anticipation of the departing ECB chief, who is proving to be a source of resistance - especially with regard to bond purchases and the introduction of graduated interest rates. Although there was agreement on continued quantitative easing of monetary policy, the majority supported the reduction in deposit rates. Many saw the purchase of debt as an emergency tool only.

It would seem that at the end of his term of office, which was marked by low interest rates, Draghi wants to dig deep into the ECB's toolkit.

Experts see the weak economy in the Eurozone and the low inflation rate as a reason to improve the monetary cornucopia. This money flow is supposed to support the financial markets: an impetus is the usual cure, but what about the state of the main economic motor in Europe?

We notice that Germany's Federal Minister for Economic Affairs Peter Altmaier stated that, after years of strong growth in Germany, there is currently a weak economy, although the country is not in recession. Reduced economic growth is contemplated for the entire year of 2019: according to media reports, the German government is only expecting growth of about 0.5 per cent.

The main reason for this is lower exports. Dwindling exports and the slowdown in economic growth are mainly caused by trade disputes between the US and China, as was the case last week when Donald Trump imposed new tariffs on China and Europe.

Politicians in Germany are uncertain regarding the best way to resolve the current economic downturn. For example, the call for help from BASF, a chemical giant based in Ludwigshafen (Rhineland-Palatinate) for a new boost generated a great response from government. The Social Democrats are resolute in their quest for more business-friendly and ecological reforms, stating that, currently, labour law measures and tax relief would not be enough.

The Green Party, which is particularly committed to environmental protection, see as a goal above everything else the continuation of the structured transition to clean energy. After all, the increase in the cost of CO² emissions is an important incentive for innovation, especially in order to further promote hydrogen as an energy carrier.

One of the leading parties in Germany, the Christian Democratic Union, sees as a solution the reform of the austerity measures put in place in 2008 to combat the financial and economic crisis. This included short-time working supported with on-the-job training. Certainly, in view of the digital revolution, the training of employees has to be strengthened.

Another remedy is to encourage more companies to invest in Germany. These measures should ideally be tax neutral. In this context, Union fraction chief Brinkhaus wants to promote the start-up sector to speed up its development.

Without any doubt, Germany's economy is on the decline; the federal government could help it by targeted measures, but it does not really do so. Accordingly, one is critical of the forecast for the coming year.

Back to Malta, which will record the largest economic growth of the 28 EU Member States in 2019 and probably in 2020, as projected by the European Commission. Real Economic Growth is expected to be 5.3 per cent in 2019 and the nominal economic growth is expected to be 6.6 per cent.

The EU Commission has reported that economic growth is based on a change of economic direction based on international services. As a country without resources, the services sector plays an important role for Malta when it comes to GDP growth. Economic development is principally driven by service exports such as I-gaming, and finance, tourism, banking and insurance business. And we should not forget the growth in aviation services and the nascent Blockchain sector.

The manufacturing industry has, by comparison, fallen to the second most important sector, especially regarding electrical and pharmaceutical products, refined petroleum and circuits. While net exports were the main growth driver in 2016-2017, domestic demand was set to become the most important growth contributor in 2018 and this continues this year.

One notes that private consumption in particular has grown considerably on the back of high employment growth and higher disposable income. While there is no harm in the explosion of domestic demand, the need to expand exports cannot be ignored.

The advent of EU membership and changing the currency from the Maltese Lira to the Euro in 2008 enabled Malta to attract a large amount of direct foreign investment in the IT, telecommunications and financial services sectors. Foreign investors, on the other hand, benefit from the favourable fiscal legislation on foreign investment, interest subsidies and grants for new recruitment.

 Likewise, investors receive generous support from Malta Enterprise. Online gaming and fund and real estate administration especially are growing in favour by foreign investors partly due to Brexit. Malta thus benefits sustainably from the European internal market and its related regulations. The Malta Budget for 2020 stated that exports are expected to rise by a modest 1.6 per cent (barely compensating for inflation) while imports are forecast to grow by two per cent.

In conclusion, the general economic weakness of the European economy has had a delayed effect on Malta's performance. The 2020 budget statement augurs that Malta's economic performance seems set for a stable, albeit reduced, growth. This is thanks to the strong multiplier effect of a burgeoning domestic market but we cannot rest on our laurels. Competition is tough (Malta fell two notches in the global scale) and the way ahead ought to be a likely reduction in fiscal drag.

 

Anna Guth is an Economic Analyst at PKF


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