From the Great Depression to the Great Lockdown

China, COVID19, and the future

WHAT CAN WE EXPECT FROM THE MALTESE ECONOMY?

The dramatic changes that we experienced in the past couple of months shook our foundations, our expectations and even our definition of normality. A rare disaster, possibly not even a one-in-a-life-time event, has resulted in tens of thousands of lives lost, and the resulting social distancing, quarantines and lockdowns have quickly translated themselves into an economic collapse whose size and speed is unlike anything we had ever seen.

The only logical comparisons that economists and historians could attempt is the Great Depression of the 1920s, and without even investigating the nature of what happened back then, the name is enough to hint what is in store.

The worst thing about carrying out an analysis right now is the unknown. Not only we do not know how long the current situation will linger, but epidemiologists and health authorities around the globe refuse to exclude a second wave later in Autumn or perhaps early in 2021. Earlier this month, the International Monetary Fund headlined an estimate that world GDP will lose 3% in 2020. Yet, it only took some gloomier health projections in Europe and the US a few days later for its managing director to admit that this outlook “could be too positive”.

However, there is one important consideration that seemed to have gone out of all economic analysis. The pandemic, surely, brought the world to its knees. However, international markets, particularly the eurozone, were already looking at a bleak year before all this has started. Gone were the days of significant growth and while the

European Central Bank was expecting a meagre 1.1% improvement, a number of economists were forecasting average growth that would not even reach the single figure, which would have constituted the eurozone’s slowest rate for at least seven years. The reasons for this sluggish growth varied from the uncertainty related to a potential hard Brexit and its consequences, the impact of escalating trade wars involving the US and potential geo-political flare-ups in the Middle East. China’s growth was also subsiding, leaving a deep impact on the rest of the word.

THE MALTESE SITUATION

This was reflected to a certain extent in the outlook for the Maltese economy. In its pre-Covid assessment earlier this year, the International Monetary Fund (IMF) had noted that high valueadded services, namely tourism, financial services and remote gaming had allowed Malta to register significant growth rates which boosted employment. Growth rates far exceeded EU averages while unemployment and inflation remained low, the public debt ratio stood on a declining path, and the current account surplus remained sizeable.

However, the Fund noted a significance dependence on foreign labour for economic growth as well as from the proceeds of the citizenship-by-investment (IIP) programme for financial stability. After surging to 7.3 percent in 2018, real GDP slowed to 4.4 percent in 2019, with the IMF projecting a further decrease in 2020, before the arrival of the deadly pandemic. Exports, an important contributor to production of wealth in Malta, were also expected to shrink due to weaker demand from Malta’s international partners. Moreover, the large influx of foreign employees was putting significant pressure on Malta’s infrastructure besides creating a number of social issues which requires addressing.

In its report, the Fund noted a number of needs which were required to support the economy, among them filling infrastructure gaps, improving public investment efficiency as well as addressing labour shortages and housing affordability will help mitigate bottlenecks associated with high growth and promote social inclusion. It also called on greater attention to governance issues, particularly on money-laundering issues, an area in which Malta continues to score low marks. The Fund concluded that growth was gradually converge to its potential rate of slightly above 3 percent as the most dynamic sectors reach steady-state and total factor productivity and population growth.

While this analysis hint at the direction the Maltese economy preCovid, a later assessment taking into account the current crisis, the Fund projected the Maltese economy to shrink by 2.8% this year, while bouncing back with a very strong 7% in 2021. While the IMF expects a number of jobs to be lost, it indicated that in consideration of the job support measures implemented so far, it was not expecting unemployment to exceed 5%.

This assessment sounded quite optimistic in view of the current situation where so many business are staring at a complete standstill – 40% of them small businesses have told the SME Chamber in a recent survey that there activity came to a complete halt. This suspicion tended to receive support when an assessment carried out by credit rating agency Fitch, painted a significantly gloomier forecast, with a 5.9% contraction expected this year, with next year’s

rebound not exceeding a moderate 3.6%. In its analysis, Fitch did also highlight that its forecast was generally optimistic, based on the assumption that the economy will get back to a normal level of activity the second half of the year as the impact of the virus subsides.

Fellow credit rating agency Moody’s prediction lies somewhere in between the two, expecting a contraction of 3.8% this year and a growth of 3.2% in 2021. Fitch also insists in highlighting an important disclaimer, that the extent and duration of the restrictions on activity could be greater and longer-than-expected, especially if Malta or its trading partners extend their lockdown periods. In that scenario, Fitch expects a larger decline in output in 2020 and a weaker-thanexpected recovery in 2021, which could have negative repercussions for growth prospects and public finances over the medium-term. On the positive side, all assessments welcome the health authorities’ response to health risks and the mobilisation of our healthcare system, while the announced economy measures should “soften” the impact of the shock on the domestic economy. In terms of Malta’s financial position, while all assessments note that the country’s position starts from a relatively healthy starting point, the expenditure required to support businesses and jobs will inevitably throw our numbers back in the red.

Fitch estimates the general government balance to deteriorate to a deficit of 8.2% of GDP in 2020, from a surplus of 0.8% in 2019, based on the operation of automatic stabilisers and the direct budget impact of close to EUR600 million (4.5% of GDP) from the government measures. Lower spending and a rebound in economic activity would partly shrink the deficit in 2021 to 5% of GDP.

It also forecasted general government debt to increase to 55.7% of GDP in 2020, from an estimated 43.4% in 2019. Government has publicly indicated the need for up to EUR2 billion (15.1% of 2019 GDP) in borrowing 2020, which is largely in line with Fitch’s expectations. The extent of the increase in public borrowing this year, and the pace at which it will happen remains uncertain, and crucially depends on the time it will take for economic activity to return to pre-pandemic levels. Fitch notes that Malta will inevitably emerge from this crisis

with a higher level of public debt, but positively notes that its generally healthy position, including consecutive fiscal surpluses between 2016 and 2019, means it is better prepared than quite a number of European partners in consolidating public finances over the medium-term.

The take home from these mixed messages is that doom and gloom scenarios have been ruled out, particularly if activity resumes to a degree of normality in the latter half of this year. Still, troubles abound, and they are not necessarily home-grown. Speaking to a local newspaper earlier this month, John Naudi an experienced entrepreneur in the field of oil and gas, noted that the biggest threat to European economies including ours, lays in the situation of large countries such as France, Spain and Italy, who have been hardlyhit by the crisis and have little room for manoeuvre in terms of spending. They are large economies – two of them members of the G7 – with huge interdependencies with their wider neighbourhood. They provide a big chunk of tourists visiting Malta every year. In this context, John Naudi calls for a stronger European financial effort to support these two economies, warning that “These are not Greece. Europe must realise that if they go down, many others will go down too.” The different assessments analysed above also come with a number of recommendations that should be heeded by the local authorities as Malta prepares itself for a rebound that eventually is due to happen. These include structural reforms which sustain a growthbased performance which is not short-term as the dependency on foreign workers, particularly through investment in long-term education, upskilling of workers, the stimulation of innovation and the promotion of social inclusion. Such moves will strengthen Malta’s position at the start of a new race which will undoubtedly re-commence as soon as this terrible phase sets over. Malta needs to ready itself with the right tools to achieve first-mover advantage as soon as engines start moving again, to ensure that the impact of the current crisis is as short-lived as realistically possible.