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By George M. Mangion
Last month the European Union issued a report confirming the euro region's inflation rate was 2.1 percent in June, above the 2 percent ceiling set by policy makers. It is a fact that the euro is down 11 percent since the start of the year as the interest-rate gap between Europe and the U.S. widened.
Economists hopeful that a rate cut will strongly benefit the ailing EU economies have had their hopes dashed. Quoting Michael Klawitter, a currency strategist at West L B AG in Dusseldorf in his opinion the ongoing speculation about a rate cut is disappearing. On the other hand, the annual inflation rate in the UK nudged up to a seven-year high last month hitting the Bank of England's two per cent target as expected. But economists say that won't stand in the way of an August rate cut.
On the domestic front, NSO reported a 0.1 per cent drop in GDP in the first semester while exports have gone down by 17 per cent. Commentators blame this on the relative high cost of borrowing in Malta. Can we blame a drop of competitiveness due to this single factor? In truth the answer depends on a number of factors but monetarists strongly argue that a restrictive interest rate goes a long way to induce stagflation in the economy.
It goes without saying that a high cost of capital will impair the chances of exporters beating competition.
The Governor of the Central Bank of Malta, following the July meeting with the Monetary Policy Advisory Council, decided to leave the Bank's Central Intervention Rate (CIR) unchanged at 3.25 per cent.
Head over heels of the galloping inflation, which is close to reaching three per cent and everything remaining equal we note for a fact that when inflation creeps up the real cost of borrowing will conveniently ease down provided the interest rates do not rise.
This presents us with a paradox. A negative interest rate should in theory accompany a boost in new capital formation. This has not been manifest given that the quest for economic revival particularly on the manufacturing front and the tourist sectors are not so apparent. Ironically banks are having a bonanza because they are leveraging cheap saving deposits and riding on the crest of a thriving “plastic credit” demand and the burgeoning lending to the homes sector.
It comes as no surprise that HSBC posted a resounding Lm18.5m profit for first six months. Last year it proudly announced a Lm30m pre-tax surplus.
HSBC proudly announced the good news to its shareholders that operating profit before net loan impairment releases reached Lm17.5 million. This is all very hunky dory but just mull over the fact that the economy shrunk by 0.1 per cent last year and exports dropped by 17 per cent in the first six months. This phenomenal growth is expected of other local banks who many project to announce bumper profits this year. Can anyone explain why the pillars of the economy are creaking under the weight of a slowdown while the financial sector is booming? Why is there no visible correlation? Perhaps, the answer lies on the efficiency factors and the hard sell by banks of secondary financial products. Banks also arbitrage the lower rate paid on savings with the higher rate earned on diversified foreign currency portfolios.
Certainly there is open competition among local banks and their services are closely scrutinised by MFSA.
So one may ask which are the sub sectors that are contributing to the increased fee income generated by banks? The answer cannot be the hard hit tourist industry. Here we note that return on capital on quality hotels such as Jerma, Mgarr, Forum, Mistra Village and others seem to have wilted and enterprising developers have secured title to their freeholds. The popular theme is to pull hotels down and convert them into residential homes. It is opportune to quote an interesting study by Joseph Falzon, Wendy Zammit and Denis H. Camilleri who published an econometric exercise on property and mortgages in Malta. In their study they remarked about the consistent and sustainable growth in property values during the past 40 years. It comes as no surprise that Bank lending to developers comes to the forefront as a motor that sustained the property boom of the past years.
In their empirical study it was revealed that until 1988 the maximum bank loan was four times the husband's salary plus Lm5,000. Later on in 1999, it increased to 3.5 times joint income whereas the repayment period was increased twice, in 1995 from 25 to 30 years, and in 2003 to 40 years. Banks offered house loans on the double and recently are deemed to be even more accommodating. Mortgages swelled the loan books from less than Lm20 million in 1980 to more than Lm500 million in 2004 at which point total property lending reached Lm900 million. It comes as no surprise that property lending comprised more than 40 per cent of total bank lending, up from less than 25 per cent in 1981.
The study shows how the purchasing power of buyers show a generally downward trend while purchasing power fluctuated around in the 1980s, dipped steadily between 1988 and 1998 then jumping up until 2001.
Paradoxically the phenomenon of sky-rocketing property prices in Malta is not due to a scarcity of houses. On the contrary, there is a surplus. A conservative estimate shows that 25 per cent of properties in Malta are vacant. Pragmatists question whether MEPA should apply brakes to sanctioning permits for demolishing of hotels. But what about more private lending to first time buyers who can be persuaded to restore and rehabilitate vacant premises in core villages. There is a strong case for lowering mortgage rates on social housing when comparing our rate of 3.25 per cent to the lower ECB rate currently at two per cent.
Economists may disagree with cheap credit as this may further fuel more inflation but the other side of the coin is a high interest rate associated with high costs of borrowing. In an liberalised market there is nothing to compel a commercial Banks to subsidise (out of their windfall profits) the housing sector. Now that Malta has joined the ERM II, mortgage rates over the immediate future should converge to the EU average mortgage rate currently at 3.5 per cent, as competition from foreign lenders is theoretically possible. It is indeed a mystery why the Central Bank, two weeks prior to Malta joining ERM II, raised the basic bank rate by 25 points to 3.25 per cent. Higher interest rates result in higher inflationary pressures. Politicians know too well that inflation is a vote killer as it helps reduce the quality of life of the workers. Unchecked it fuels the risk of sending a greater proportion of households to living below the poverty line. Commentators on the local economic scene would like to see a drop in the CIR given that ours is 125 points above that of the ECB. Judging on the basis of the Governor’s comments at the last MPA council meeting it appears the pressure is on to cut rates but many feel that this option now seems to be closed. In my opinion the logic behind a moderate rate cut is pervasive.
gmm@pkfmalta.com
The author is a partner in PKFMALTA an audit and business advisory firm
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