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Malta

Author(s):
International Monetary Fund
Published Date:
August 2008
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I. Introduction and Background

1. Malta successfully adopted the euro on January 1, 2008: a crucial milestone in the authorities’ growth-oriented reform agenda. This agenda appropriately aims at leveraging Malta’s strengths and income-generating potential through closer integration in the European and global economies. As the cost-competitiveness of traditional low value-added exports wanes, market liberalization and EU membership are intended to facilitate upward shifts in the value-added and quality export ladders. This is a promising but demanding strategy. It will require enhancing market-based flexibility and reducing the inefficiencies created by an overextended public sector. Robust fiscal savings are needed to provide a stable macroeconomic setting, reduce debt, and maintain the tax burden low—as the authorities intend—while investing in education and infrastructure.

2. Progress has already been made in this direction (Appendix I). Following sustained fiscal consolidation since 2003, the budget deficit was further reduced in 2007 to 1.8 percent of GDP, prompting the abrogation of the Maastricht Treaty's excessive deficit procedure in June 2007. Public debt fell to 62½ percent of GDP (from 72½ percent in 2004) helped by divestments. Also, direct public sector involvement in economic activities has been scaled down in the key areas of telecommunications, postal services, and airport and port services—though the public enterprise sector remains large, with subsidies and state aid among the highest in the EU.

Malta: Fiscal Indicators 2003-07

(Percent of GDP)

3. Largely as a consequence of liberalizing reforms, Malta has experienced a three-year-long expansion underpinned by foreign direct investment (FDI) and export diversification. In the context of buoyant EU activity, growth accelerated to 3.8 percent in 2007 while the current account deficit declined to 5½ percent of GDP. Growth has been driven both by rising productivity and labor supply mobilization. Increased female participation helped raise the employment rate, while unemployment reached record lows. This reflected booming new manufacturing and services export activities, and a revival of tourism. Strong FDI (29 and 13 percent of GDP in 2006 and 2007, respectively) provided welcome know-how and global market access. Employment and income gains supported domestic demand.

GDP Growth

(Percent)

Source: Eurostat.

GDP per Capita

(PPP, percent of EU-27 average, 2007)

4. However, while economic liberalization has started to pay off, it is far from complete and a less favorable external environment will test the economy’ resilience. Despite recent positive economic performance, productivity is still low and the large public enterprise sector is a source of market distortions and budgetary strains—particularly since administered prices have lagged import price increases. The growth contribution of net exports became negative in the two quarters to 2008:Q1 as several export companies (textile and tobacco) closed down, and semiconductor sales (about half of goods exports) remained weak. During this latter period, activity was supported by domestic demand, notably government spending. Going forward, traditional manufacturing exports may experience further declines against the backdrop of softer external demand and an increasingly competitive global environment, despite subdued unit labor cost growth. Thus, Malta's competitiveness and economic prosperity will hinge on a stable macroeconomic framework and continued reforms to facilitate the reorientation toward high-growth export activities—buttressing FDI and investor confidence.

5. The March 2008 general elections returned to office the ruling Nationalist Party with a narrow parliamentary majority. During the preelectoral period, the authorities continued with important liberalizing initiatives and fiscal consolidation, but some controversial reforms were delayed—including restructuring of the loss-making public shipyards.

II. Report on the Discussions

6. The authorities emphasized their determination to proceed with reforms. They agreed that the initial period of the new legislature offered the opportunity to press ahead with crucial medium-term oriented reforms, thus anchoring investors’ expectations. In this connection, they reiterated the 2008 budget deficit target of 1.2 percent of GDP (although premised on a more favorable macroeconomic scenario than staff's), the MTO of structural budget balance by 2010 based on expenditure retrenchment, and the intention to meet remaining EU accession commitments. Regarding the latter, the authorities are unbundling and opening to private participation the fuel and LPG operations of the public energy company (Enemalta), and have recently announced their intention to restructure and privatize the shipyards shortly.

7. Policy discussions focused on the following areas, essential for success within EMU and economic stability.

  • Cementing fiscal consolidation. Despite substantial fiscal retrenchment, the public finances remain fragile. Reinforcing the fiscal position is a core policy priority to ensure the domestic stability of Malta, highly vulnerable to external shocks and with volatile growth. In this vein, staff supported the authorities’ target of structural budget balance by 2010 and argued for a surplus thereafter as a desirable policy buffer.
  • Strengthening the banking sector. The impact of international financial turbulence on the domestic banking sector is assessed to be small. However, lending concentration, real estate exposures, and thin provisioning pose risks. Malta is actively participating in EU-wide efforts to strengthen mechanisms for crisis prevention and resolution.
  • Improving economic efficiency. Reducing the role of the public sector is key. The authorities intend to reinvigorate, early in the legislature, their privatization and liberalization agenda, and reduce subsidies. The agenda could usefully be extended to competition policy and wage indexation, which however is not currently contemplated.

Standard Deviation of Real GDP Growth,1970–2006

(Percentage points)

Source: World Development Indicators; and IMF staff calculations.

A. Outlook: Competitiveness and External Stability

8. Improvements in cost fundamentals affecting competitiveness continued in 2007 (Figure 1, Box 1). After large competitiveness losses through 2004, ULC increases have generally been below trading partners’ reflecting productivity gains and wage moderation. These trends continued in 2007, resulting in a ULC-based real depreciation of 1 percent relative to the rest of the euro area. On a multilateral trade-weighted basis, however, the ULC-based REER appreciated by 1.2 percent, highlighting Malta's vulnerability to euro appreciation—non-EMU countries account for 65 percent of goods exports. Labor cost growth has remained low (Figure 2) as the end of the agreed wage moderation period in the public sector appears not to have affected the private sector so far. Going forward, ongoing investment is likely to sustain productivity gains, while labor cost growth is expected to remain contained by slowing activity. All said, staff sees only a moderate competitiveness gap, based on CGER-type analyses, in the range 3–7½ percent.

Figure 1.Malta: Cost Competitiveness

Sources: European Commission; ECB; Eurostat; INS; and IMF staff calculations.

Figure 2.Malta: Labor Market Developments

Sources: Eurostat; and Ameco.

Figure 3.Malta: External Current Account Developments

Sources: National Statistics Office; European Commission; Eurostat; Semiconductor Industry Association; IMF Direction of Trade Statistics; IMF Balance of Payments Statistics; and IMF staff calculations.

Figure 4.Malta: External Competitiveness, 1995–2007

Sources: NSO; IMF Balance of Payments Statistics; and IMF Direction of Trade Statistics.

1/ Size of spheres depicts the size of exports as a percentage of GDP in last available year.

ULC Growth

(Percent)

Labor Productivity

(Growth in percent)

9. Noncost competitiveness trends—central to the authorities’ strategy—have been particularly positive. Terms-of-trade (TOT) gains and FDI-driven export diversification, especially into new services sectors, epitomize these trends.1 The export structure is rapidly

Box 1.Competitiveness

Early this decade, Malta's narrow economic base (tourism, electronics) was shaken by the decline in tourism following the 9/11 events and the bursting of the dot-com bubble, while traditional manufacturing (e.g., textiles) came under pressure from low-cost competitors. Moreover, wage-inflation pressures led to large REER appreciation. EU entry in 2004 marked the start of a reversal (Figure 1). Updated national statistics show ULC growth below competitors (and euro area) during most of the 2004–07 period, stemming from sizable productivity gains and relatively subdued labor costs.

In recent years, FDI has driven the redeployment of resources toward new export activities (Figures 3,4). Within manufacturing, airplane maintenance, and a tripling of generic pharmaceutics output helped cushion the decline of goods exports (Box Figure A below). Also, new services exports have emerged (Box Figure B), such as online gaming (9 percent of GDP), IT, call centers, and other business services (10 percent of GDP) and financial services (3 percent of GDP). Tourism rebounded recently owing to the airport opening to low-cost airlines, and harbor improvements enhanced cruise tourism. This reorientation has led to substantial terms-of-trade (TOT) gains (despite weak semiconductor prices), reflecting upward shifts in export quality and value-added. TOT gains are especially visible in services (Box Figure C), which exhibit high price elasticity relative to trading partners’ income.

However, competitive pressures on traditional manufacturing remain, with output and employment losses of 60 percent in textiles through 2004–07 amid factory closures. Given the high import content of lower value-added manufactures, downsizing has caused a long-term downward trend in goods exports and imports (Box Figure D). Some manufactures (e.g., semiconductors) are counteracting competitive pressures by moving to higher skill and technology products. In the short run, the main risk lies in a faster-than-expected winding down in traditional manufacturing—adversely affected by euro appreciation, given the predominant weight of non-EMU export destinations (65 percent in goods).

The positive trends in Malta's competitiveness are partly captured by CGER-type estimates, which staff updated and extended in light of 2007 outcomes; new forecasts; and revised historical trade, current account, and international investment position (IIP) statistics.2,3

  • The macroeconomic balance approach indicates a competitiveness gap of around 3 percent, versus 10–15 percent last year—reflecting better-than-expected current account outturn and data revisions. Closing this gap would bring the underlying current account (estimated at -2.4 percent of GDP) to an estimated long-run equilibrium level of -0.8 percent of GDP.
  • The external sustainability approach indicates that stabilizing the net international investment position at current levels would require a competitiveness improvement of 7½ percent.

Box Figure A:Goods Exports World Trade Share

(2000=100)

Box Figure B:Malta: Services Exports

(Percent of GDP)

Box Figure C:Malta: Terms of Trade

(1995=100)

Box Figure D:Malta: Goods Trade

(Percent of GDP)

Sources: Ameco; NSO; Central Bank of Malta; IMF Direction of Trade Statistics; and IMF staff estimates.

changing due to strong expansion of niche exports and tourism (Figure 5). As a consequence, the trade deficit in goods and services narrowed to 1.9 percent of GDP in 2007 (from 5.3 percent in 2005). Thus, the authorities felt that traditional aggregate cost-based competitiveness analyses should be complemented with micro-based angles—particularly in small economies. Staff's research also shows that quality upgrading and trade-specialization shifts have supported export performance in several neighboring euro area economies.4 Indeed, there was broad consensus among the mission's interlocutors that changes in export structure were an equilibrium response to a higher REER—a hypothesis supported by sustained improvements in the goods and services trade balance despite a broadly stable ULC-based REER (after a large appreciation early in the decade).

Figure 5.Malta: Tourism Services Exports

Sources: NSO; Eurostat; World Economic Forum Travel; and Tourism Competitiveness Reports.

1/ Rank out of 130 countries.

Trade and Cost Competitiveness

(Percent of GDP)

Sources: National Statistics Office; and European Commission.

10. Staff's central scenario envisages growth decelerating temporarily to 2¼–2½ percent in 2008–09 reflecting unfavorable external conditions (Table 1); the authorities see a shallower slowdown. Staff does not project a growth contribution of the external sector in the short term on account of weak foreign demand and further traditional manufacturing export contraction. This, coupled with high import prices will temporarily widen the current account deficit to close to 7 percent of GDP—partly reflecting high dependence on oil and food imports. Domestic demand, in turn, will be dampened by relatively high inflation during 2008 (annual average of about 4 percent, Figure 6), sluggish employment and real income growth, and tighter credit conditions. Inflation is expected to ease in 2009 as food and oil prices stabilize, the pricing power of the tourism sector weakens with the global environment, and base effects from the recent electricity price hike fade. Output is estimated to have reached its trend level in 2007, although the envisaged slowdown will reopen a modest gap in 2009, contributing to moderate inflation. The authorities envisage a more supportive external environment and thus project better export performance. There is broad consensus that investment will support activity, reflecting planned FDI projects. 5 There was also agreement that, over the medium term, activity will recover swiftly toward trend, sustained by FDI, emerging export activities, and terms-of-trade gains.

Table 1.Malta: Selected Economic Indicators, 2004–13
Proj.
2004200520062007200820092010201120122013
Real Economy(Change in percent)
Real GDP0.63.23.43.82.52.32.73.03.23.4
Domestic demand2.25.52.32.92.32.22.42.83.03.1
Consumption2.01.41.81.22.32.02.22.62.93.0
Private consumption2.41.90.71.62.32.22.62.83.13.2
Public consumption0.6-0.56.0-0.12.61.10.82.02.12.3
Fixed investment-3.28.23.83.82.63.53.73.73.73.7
Inventory accumulation 1/1.13.10.21.30.00.00.00.00.00.0
Foreign balance 1/-1.7-2.60.90.70.0-0.10.10.10.10.2
Exports of goods and services2.2-0.810.0-0.6-0.31.11.72.12.32.5
Imports of goods and services3.81.88.4-1.3-0.21.11.51.92.12.2
Output gap (percent)-3.1-1.7-0.60.40.1-0.5-0.6-0.5-0.20.1
CPI (harmonized)2.72.52.60.74.12.72.42.42.42.4
Unemployment rate EU stand (percent)7.47.37.36.46.57.06.76.46.26.1
Gross national savings (percent of GDP)10.711.712.416.115.315.917.318.018.619.2
Gross capital formation (percent of GDP)16.720.420.721.622.022.122.021.921.721.6
Public finance(Percent of GDP)
General government balance-4.6-3.0-2.5-1.8-1.7-1.0-0.3-0.10.20.4
Revenue41.042.041.340.640.840.740.740.640.540.4
Expenditure45.645.043.842.442.541.741.140.740.340.0
General government debt72.470.364.162.460.959.056.052.649.145.5
Money and credit(Change in percent)
International Investment Position (millions of euros)1,814.91,778.91,496.7
Broad money (M3) growth2.44.25.211.1
Domestic credit5.51.39.210.7
o/w private sector-1.39.015.310.2
Balance of payments(Percent of GDP)
Current account balance-5.9-8.8-8.2-5.4-6.7-6.2-4.8-3.8-3.1-2.4
Trade balance (goods and services)-3.8-5.3-3.9-1.9-3.9-3.5-2.0-1.0-0.10.7
Exports of goods and services79.277.687.487.486.986.385.484.583.682.8
Imports of goods and services83.182.991.489.390.889.887.485.483.882.1
Goods balance-15.6-18.7-18.9-17.4-20.2-21.1-20.8-20.7-20.2-19.8
Services balance11.813.315.015.516.317.618.819.720.120.5
Exchange rates
Exchange rate regimeJoined EMU on January 1, 2008
Nominal effective rate (2000=100)110.9109.8110.2114.7
Real effective rate, CPI-based (2000=100)112.9112.7113.8117.3
Real effective rate, ULC-based (2000=100)122.7120.2119.8120.8
Memorandum item:
Nominal GDP (millions of euros)4,488.94,770.45,075.15,398.55,651.45,941.36,311.36,724.47,172.37,664.4
Sources: Central Bank of Malta; National Statistics Office; Eurostat; and IMF staff calculations.

Contribution to growth.

Sources: Central Bank of Malta; National Statistics Office; Eurostat; and IMF staff calculations.

Contribution to growth.

Figure 6.Malta: Price Developments

Sources: Haver; Central Bank of Malta; Bank of Spain; and Eurostat.

Dependence on Food and Fuel Imports
Net imports (Percent of GDP)2/
Oil equivalent

consumption/

GDP 1/
FuelFoodFuel and Food
Malta147.26.84.511.3
euro area100.02.40.02.4
EU-27113.5n.a.n.a.n.a.
Europe 3/n.a.2.20.12.4
Sources: Eurostat; IMF.

In kg/€’000 (euro area=100) for 2005.

Average of 2006 and 2007.

Excludes Norway and Russia

Sources: Eurostat; IMF.

In kg/€’000 (euro area=100) for 2005.

Average of 2006 and 2007.

Excludes Norway and Russia

11. In staff's view, the decline of traditional export sectors poses short-term risks, underscoring the need to maintain cost competitiveness and reform momentum. The authorities see this decline as having largely run its course; any tail effects would likely be offset by the ongoing rapid growth of new exports. Staff, on the other hand, saw the risks to its scenario somewhat tilted to the downside. In the short term, given the small size of the economy, even modest additional export losses in some individual companies subject to intense international competition could significantly disrupt output and employment. Staff emphasized the need to prevent wage growth from running ahead of productivity, while accelerating reforms that foster the ongoing economic transformation. Competitiveness pressures within EMU might otherwise lead to a period of lackluster growth as has occurred in some euro area countries.

Main Economic Projections, 2008–09(Percent)
GDPInflationCA balanceFiscal deficit
20082009200820092008200920082009
IMF staff (June 08)2.52.34.12.7-6.7-6.21.71.0
Stability Program (Nov. 07)3.13.22.52.3-2.6-1.91.20.1
Central Bank of Malta (June 08)2.52.64.02.7-6.2-6.31.60.7
European Commission (Apr. 08)2.62.53.42.2-5.9-5.61.61.0

12. Long-term external sustainability risks are tempered by envisaged large FDI inflows and a strong net international investment credit position (Tables 2 and 3). The authorities pointed out that the current account deficit had been amply overfinanced by FDI, supported by Malta's history of stable institutions and internationally harmonized business environment—enhanced by EU and EMU membership. Staff's external sustainability analysis also points to a robust external balance sheet (Table 4). However, staff emphasized the need for fiscal and financial policy buffers given the volatility associated with the economy's small size and its reliance on continued positive investor sentiment.

Table 2.Malta: International Investment Position, 2002–06
20022003200420052006
(Millions of euros)
International Investment Position1,501.91,783.71,814.91,778.91,496.7
Direct investment-1,989.4-1,880.8-2,158.6-2,805.2-4,061.8
Assets252.6736.8823.1840.5868.8
Liabilities-2,242.0-2,617.6-2,981.7-3,645.7-4,930.6
Portfolio investment3,700.35,271.46,789.89,640.910,963.8
Assets4,043.35,600.67,144.410,053.911,371.6
Liabilities-343.0-329.2-354.6-413.0-407.8
Financial derivatives0.0-21.1-27.4-1.9-14.9
Other investment-2,261.1-3,786.1-4,817.8-7,243.8-7,631.0
Assets5,623.85,803.46,745.29,595.712,328.2
Liabilities-7,884.9-9,589.5-11,563.0-16,839.5-19,959.2
Reserves2,051.82,200.32,029.02,188.92,240.7
(Percent of GDP)
International Investment Position35.140.640.437.329.5
Direct investment-46.5-42.9-48.1-58.8-80.0
Assets5.916.818.317.617.1
Liabilities-52.4-59.6-66.4-76.4-97.2
Portfolio investment86.5120.1151.3202.1216.0
Assets94.6127.6159.2210.8224.1
Liabilities-8.0-7.5-7.9-8.7-8.0
Financial derivatives0.0-0.5-0.60.0-0.3
Other investment-52.9-86.3-107.3-151.8-150.4
Assets131.5132.2150.3201.2242.9
Liabilities-184.4-218.5-257.6-353.0-393.3
Reserves48.050.145.245.944.1
Memorandum items:
Gross external debt (millions of euros)8,179.09,881.111,799.517,070.820,180.6
Gross external debt (percent of GDP)191.3225.2262.9357.8397.6
Sources: Eurostat; and Maltese authorities.
Sources: Eurostat; and Maltese authorities.
Table 3.Malta: Summary Balance of Payments, 2004–13
Proj.
2004200520062007200820092010201120122013
(Millions of euros)
Current account balance-263.7-418.2-418.6-292.3-379.2-369.2-299.9-257.6-222.3-182.8
Trade balance (goods and services)-171.5-254.6-200.3-100.7-221.0-207.6-126.9-65.3-8.554.8
Goods balance-700.4-891.1-960.6-937.1-1,141.6-1,253.6-1,312.7-1,391.9-1,448.8-1,517.5
Exports2,188.22,083.12,333.72,347.82,379.22,430.02,530.82,656.12,804.42,966.1
Imports-2,888.6-2,974.3-3,294.3-3,284.9-3,520.8-3,683.6-3,843.6-4,048.1-4,253.2-4,483.6
Services balance528.9636.6760.3836.5920.61,046.01,185.81,326.71,440.31,572.3
Exports1,369.01,617.22,104.02,370.12,530.62,697.72,856.13,023.23,195.03,383.7
Imports-840.0-980.6-1,343.7-1,533.6-1,610.0-1,651.7-1,670.3-1,696.5-1,754.7-1,811.4
Current income, net-43.5-199.6-212.7-129.5-152.6-154.5-164.1-181.6-200.8-222.3
Current transfers, net-48.735.9-5.6-62.1-5.7-7.1-8.8-10.8-12.9-15.3
Private-60.414.2-48.313.2-6.6-8.1-9.9-11.9-14.1-16.6
Public11.721.742.8-75.31.01.01.11.11.21.3
Capital account, net66.6155.6149.449.368.989.1116.2127.0136.1157.6
Financial account, net140.3300.2326.1107.7310.3280.1183.7130.586.225.3
Direct investment312.0560.41,481.8684.4401.7528.2544.9556.7579.7577.8
Portfolio investment-1,681.1-2,137.3-1,980.8365.9-503.0-1,027.8-1,268.6-1,499.5-1,728.5-1,931.4
Other investment1,348.32,064.9908.2-616.2411.6779.8907.41,073.41,235.01,378.9
Reserves (- inflow; + outflow)161.1-187.8-83.1-326.50.00.00.00.00.00.0
Errors and omissions56.8-37.5-56.9135.30.00.00.00.00.00.0
(Percent of GDP)
Current account balance-5.9-8.8-8.2-5.4-6.7-6.2-4.8-3.8-3.1-2.4
Trade balance (goods and services)-3.8-5.3-3.9-1.9-3.9-3.5-2.0-1.0-0.10.7
Goods balance-15.6-18.7-18.9-17.4-20.2-21.1-20.8-20.7-20.2-19.8
Exports48.743.746.043.542.140.940.139.539.138.7
Imports-64.4-62.3-64.9-60.8-62.3-62.0-60.9-60.2-59.3-58.5
Services balance11.813.315.015.516.317.618.819.720.120.5
Exports30.533.941.543.944.845.445.345.044.544.1
Imports-18.7-20.6-26.5-28.4-28.5-27.8-26.5-25.2-24.5-23.6
Current income, net-1.0-4.2-4.2-2.4-2.7-2.6-2.6-2.7-2.8-2.9
Current transfers, net-1.10.8-0.1-1.2-0.1-0.1-0.1-0.2-0.2-0.2
Private-1.30.3-1.00.2-0.1-0.1-0.2-0.2-0.2-0.2
Public0.30.50.8-1.40.00.00.00.00.00.0
Capital account, net1.53.32.90.91.21.51.81.91.92.1
Financial account, net3.16.36.42.05.54.72.91.91.20.3
Direct investment7.011.729.212.77.18.98.68.38.17.5
Portfolio investment-37.4-44.8-39.06.8-8.9-17.3-20.1-22.3-24.1-25.2
Other investment30.043.317.9-11.47.313.114.416.017.218.0
Reserves (- inflow; + outflow)3.6-3.9-1.6-6.00.00.00.00.00.00.0
Errors and omissions1.3-0.8-1.12.50.00.00.00.00.00.0
Memorandum items:
Official reserves, end of period
(Millions of euros)2,193.22,081.52,360.22,753.1
(Millions of U.S. dollars)2,733.92,578.72,980.93,798.4
(Months of imports of goods and services)7.16.36.16.8
Sources: Eurostat; Central Bank of Malta; and IMF International Financial Statistics.
Sources: Eurostat; Central Bank of Malta; and IMF International Financial Statistics.
Table 4.Malta: External Debt Sustainability Framework, 2003–13(Percent of GDP, unless otherwise indicated)
ActualProjections
20032004200520062007200820092010201120122013
Debt-stabilizing
non-interest
I. Baseline projectionscurrent account6/
1External debt1/-26.3-36.722.6-53.5-55.5-54.1-55.1-56.9-58.9-61.3-63.7-14.3
2Change in external debt2.0-10.459.3-76.1-2.11.4-0.9-1.8-2.1-2.4-2.4
3Identified external debt-creating flows (4+8+9)-4.00.30.3-20.9-2.52.60.60.1-0.2-0.5-0.3
4Current account balance, excluding interest payments3.19.713.313.811.914.014.313.713.613.613.7
5Deficit in balance of goods and services3.23.85.33.91.93.93.52.01.00.1-0.7
6Exports79.979.277.687.487.486.986.385.484.583.682.8
7Imports83.283.182.991.489.390.889.887.485.483.882.1
8Net nondebt creating capital inflows (negative)-7.9-6.2-10.7-27.8-11.1-6.6-8.3-7.9-7.5-7.2-6.7
9Automatic debt dynamics 2/0.8-3.3-2.4-6.9-3.3-4.8-5.5-5.7-6.2-6.9-7.4
10Contribution from nominal interest rate0.0-3.9-4.5-5.6-6.5-7.3-8.1-8.9-9.7-10.5-11.3
11Contribution from real GDP growth-0.10.11.1-0.71.91.31.21.41.61.81.9
12Contribution from price and exchange rate changes 3/0.80.41.1-0.61.31.21.51.81.91.92.0
13Residual, including change in gross foreign assets (2-3)6.1-10.659.0-55.20.4-1.2-1.5-1.8-1.9-1.9-2.1
External debt-to-exports ratio (percent)-32.9-46.329.1-61.2-63.6-62.3-63.8-66.6-69.8-73.3-76.9
Gross external financing need (billions of euros) 4/-0.5-0.91.2-1.8-2.1-2.2-2.4-2.7-3.1-3.5
Percent of GDP-10.3-19.022.8-33.210-Year10-Year-37.6-36.9-38.7-40.9-43.2-45.7
HistoricalStandardProjected
Key macroeconomic assumptionsaveragedeviationaverage
Nominal GDP (billions of euros)4.44.54.85.15.45.75.96.36.77.27.7
Real GDP growth (percent)-0.30.63.23.43.81.82.12.52.32.73.03.23.42.9
GDP deflator (change in domestic currency)3.01.73.02.92.53.42.62.22.83.53.43.33.43.3
Nominal external interest rate (percent)-0.115.013.1-26.213.01.211.813.815.817.218.219.119.818.0
Growth of exports (euro terms, in percent)-6.21.44.019.96.37.311.44.14.45.15.45.65.85.3
Growth of imports (euro terms, in percent)-0.82.26.117.33.96.712.66.54.03.34.24.64.84.2
Current account balance, excluding interest payments-3.1-9.7-13.3-13.8-11.9-7.55.6-14.0-14.3-13.7-13.6-13.6-13.7-13.8
Net nondebt creating capital inflows7.96.210.727.811.110.210.06.68.37.97.57.26.77.5
Debt-stabilizing
noninterest
A.Alternative scenariosII. Stress tests for external debt ratiocurrent account6/
A1.Key variables are at their historical averages in 2008-2013 5/-54.1-56.3-58.7-61.1-63.4-65.9-7.7
B.Bound tests
B1.Nominal interest rate is at baseline plus one-half standard deviation-54.1-58.1-63.4-69.7-77.1-85.7-21.7
B2.Real GDP growth is at baseline minus one-half standard deviations-54.1-55.8-58.5-61.7-65.5-69.7-16.2
B3.Noninterest current account is at baseline minus one-half standard deviations-54.1-52.3-51.0-49.6-48.0-46.0-12.2
B4.Combination of B1-B3 using 1/4 standard deviation shocks-54.1-55.6-58.0-60.8-64.2-68.0-17.3
B5.One time 30 percent real depreciation in 2009-54.1-89.2-99.3-110.6-123.4-137.6-26.5

External debt in this table relates to net external debt.

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in U.S. dollar terms; g = real GDP growth rate; e = nominal appreciation (increase in dollar value of domestic currency); and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both noninterest current account and nondebt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and nondebt inflows in percent of GDP) remain at their levels of the last projection year.

External debt in this table relates to net external debt.

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in U.S. dollar terms; g = real GDP growth rate; e = nominal appreciation (increase in dollar value of domestic currency); and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both noninterest current account and nondebt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and nondebt inflows in percent of GDP) remain at their levels of the last projection year.

B. Cementing Fiscal Consolidation

13. Expenditure-based consolidation continued in 2007, though the public finances remain fragile (Figure 7). Tight spending control achieved the first recorded current surplus in recent years while allowing some tax cuts. The structural deficit (net of one-offs, mainly land sales) improved by almost ½ percentage point of GDP (Table 5). However, the public finances are under endemic stress from sizable subsidies (about twice the EU average) and state aid (four times the EU average); health care costs; the public wage bill (13 percent of GDP); and pensions and other social spending (over 13 percent of GDP). Also, public enterprise guarantees, and other contingent liabilities remain high.

Figure 7.Malta: Fiscal Developments

Sources: Eurostat; European Commission; EPC; and IMF staff calculations.

Table 5.Malta: Fiscal Developments and Projections 2004–13(Percent of GDP)
Proj.
2004200520062007200820092010201120122013
Revenue41.042.041.340.640.840.740.740.640.540.4
Current revenue39.238.738.239.639.539.539.439.339.239.1
Tax revenue (o/w)26.226.927.028.328.328.428.628.528.428.3
Indirect taxes14.514.614.914.714.714.714.714.614.514.4
Direct taxes11.512.011.813.313.313.413.613.613.613.6
Social security contributions8.08.17.77.47.47.27.17.17.17.1
Other current revenue5.03.73.54.03.83.83.73.73.73.7
Capital revenue1.83.33.01.01.31.21.31.31.31.3
Expenditure45.645.043.842.442.541.741.140.740.340.0
Current expenditure41.140.039.238.638.738.237.537.236.836.6
Wages and salaries14.714.013.413.012.912.612.212.011.711.5
Goods and services5.65.05.85.65.55.55.45.45.45.4
Social transfers13.313.513.112.913.113.213.413.513.713.8
Subsidies1.92.11.92.02.32.12.01.91.81.8
Interest payments3.73.73.53.43.23.13.02.82.72.5
Other current expenditure2.01.71.61.71.71.71.61.61.61.6
Capital expenditure4.54.94.63.73.93.53.53.53.53.5
Overall balance-4.6-3.0-2.5-1.8-1.7-1.0-0.3-0.10.20.4
Structural balance (net of one-offs)-4.3-4.0-3.0-2.6-1.9-1.0-0.20.00.20.4
Public debt72.470.364.162.460.959.056.052.649.145.5
Government guaranteed debt13.613.211.411.6
Memorandum items:
Primary balance-1.00.81.01.61.52.12.72.82.93.0
One-offs0.81.60.70.70.20.20.10.10.10.0
Privatization receipts0.01.24.40.50.20.00.00.00.00.0
Sources: NSO; Eurostat; and IMF staff estimates and projections.
Sources: NSO; Eurostat; and IMF staff estimates and projections.

14. The authorities are adopting additional measures to meet the 2008 budget target (1.2 percent of GDP). 2008 data show a significant increase in outlays. The authorities indicated that there had been frontloaded expenditures that they planned to claw back within the year. They anticipated, however, that given higher-than-projected oil prices and other costs, the budget would be substantially overrun if prevailing policy parameters were maintained through year end. Thus, the authorities were planning offsetting cuts in discretionary spending, including prioritization and sequencing of capital projects, additional hiring controls, and other savings in current spending. They also have raised electricity prices by about one-third since the mission (although staff estimates that they remain some 25 percent below cost recovery). This latter measure will limit electricity subsidies to 0.7 percent of GDP (0.25 percent in the original budget). In staff's view, the measures in train will limit overall 2008 underperformance to ½ percentage point of GDP relative to budget—partly due to the play of automatic stabilizers, given lower growth assumptions. The structural balance, however, is forecast to improve by ¾ of a percentage point of GDP—making a sizable contribution toward the MTO.

Medium-term Fiscal Targets in the Stability Program(Percent of GDP)
2007200820092010
Structural balance-1.9-1.2-0.60.1
Overall balance-1.6-1.2-0.10.9
Memorandum items:
Staff overall balance (current)-1.8-1.7-1.0-0.3
European Commission overall
balance (April 08)-1.8-1.6-1.0n.a.

15. The authorities anchor their medium-term strategy in further spending retrenchment, which will require expenditure reforms. The authorities intend to continue reducing subsidies and still-high public employment (about 30 percent of full-time employees). In particular, they have announced the elimination of shipyard and bread subsidies in 2009, and are identifying savings on other subsidies and health costs—although delivery-point health care charges have been ruled out. The mission encouraged early formulation of detailed and more explicit multiyear measures to reduce current spending.6 This would minimize uncertainty and the encroachment, forced by events, on growth-enhancing capital spending—especially, in view of upside risks to expenditure plans, including unbudgeted potential costs of public enterprise restructuring. Staff suggested complementing attrition with proactive personnel redeployment and selection based on training and performance; and consideration of market-based measures to rationalize public services demand and increase supply efficiency, including in health care, if administrative cost control measures prove ineffective. There was agreement that 2009–10 revenue projections were appropriately conservative—given authorities’ indications that tax cuts would be implemented prudently, as cost savings materialized.

16. The authorities are reinforcing the fiscal framework with a medium-term orientation. They are pursuing more structured multiyear fiscal planning and the introduction of performance budgeting methods. Evaluation procedures for investment projects (crucial for optimizing reduced EU funds) and hospital performance are being improved. Staff recommended extending spending reviews to all major areas (particularly education, given its competitiveness-enhancing role), and parliamentary agreement on aggregate expenditure limits before starting budget appropriation discussions. On longer-term issues, the EU pensions working group projects age-related spending to be relatively benign, though revised estimates of the 2006 pension reform impact still need to be finalized.

C. Strengthening the Growing Financial System

17. The financial sector appears to be resilient to international developments, though it has experienced some adverse effects (Box 2). The authorities and private sector analysts considered the banks well-placed to weather the global turmoil. Banks have strong liquidity positions (Table 7) and no exposure to subprime-related assets. They are also profitable, although some banks’ financial results were affected by markdowns in security portfolios, and equity valuations saw substantial declines in 2008—possibly accentuated by local stock market thinness (Figure 8). The internationally oriented financial sector (now fully under uniform regulation) is expanding rapidly.

Table 6.Malta: Public Sector Debt Sustainability Framework, 2005–13(Percent of GDP, unless otherwise indicated)
Projections
200520062007200820092010201120122013Debt-stabilizing primary balance8/
1Baseline: public sector debt1/70.364.162.460.959.056.052.649.145.5-0.6
Of which: foreign-currency denominated1.41.21.00.80.60.40.20.10.1
Change in public sector debt-2.1-6.2-1.7-1.5-1.9-3.0-3.4-3.5-3.6
3Identified debt-creating flows (4+7+12)-2.5-6.1-2.7-1.3-2.0-3.1-3.4-3.5-3.6
4Primary deficit-0.8-1.0-1.6-1.5-2.1-2.7-2.8-2.9-3.0
5Revenue and grants42.041.340.640.840.740.740.640.540.4
6Primary (noninterest) expenditure41.240.339.039.338.638.137.937.637.5
7Automatic debt dynamics 2/-0.5-0.7-0.50.40.1-0.5-0.6-0.6-0.6
8Contribution from interest rate/growth differential 3/-0.5-0.7-0.40.40.1-0.5-0.6-0.6-0.6
9Of which: contribution from real interest rate1.71.61.81.91.41.01.01.00.9
10Of which: contribution from real GDP growth-2.2-2.2-2.3-1.5-1.3-1.5-1.6-1.6-1.6
11Contribution from exchange rate depreciation 4/0.00.0-0.1
12Other identified debt-creating flows-1.2-4.4-0.5-0.20.00.00.00.00.0
13Privatization receipts (negative)-1.2-4.4-0.5-0.20.00.00.00.00.0
14Recognition of implicit or contingent liabilities0.00.00.00.00.00.00.00.00.0
15Other (specify, e.g., bank recapitalization)0.00.00.00.00.00.00.00.00.0
16Residual, including asset changes (2-3) 5/0.5-0.11.0-0.20.10.10.00.00.0
Public sector debt-to-revenue ratio 1/167.4155.3153.7149.1145.0137.4129.4121.1112.5
Scenario with key variables at their historical averages6/60.963.666.368.971.674.20.5
Scenario with no policy change (constant primary balance) in 2008-201360.959.357.555.353.251.0-0.6
Key macroeconomic and fiscal assumptions underlying baseline
Real GDP growth (percent)3.23.43.82.52.32.73.03.23.4
Average nominal interest rate on public debt (percent)7/5.55.35.65.45.45.45.45.45.5
Average real interest rate (nominal rate minus change in GDP deflator, percent)2.52.43.23.22.61.92.02.12.2
Nominal appreciation (increase in U.S. dollar value of local currency, percent)-0.41.09.1
Inflation rate (GDP deflator, percent)3.02.92.52.22.83.53.43.33.4
Growth of real primary spending (deflated by GDP deflator, percent)1.41.00.43.40.31.32.52.63.0
Primary deficit-0.8-1.0-1.6-1.5-2.1-2.7-2.8-2.9-3.0

General government and gross debt.

Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - Π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r).

For projections, this line includes exchange rate changes.

Last six years. The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

General government and gross debt.

Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - Π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r).

For projections, this line includes exchange rate changes.

Last six years. The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Table 7.Malta: Financial Soundness Indicators, 2004–07(Percent)
2004200520062007
Banking sector (unless noted, includes internationally-oriented banks)
Regulatory capital to risk-weighted assets21.320.422.023.2
Domestically oriented banks 1/15.116.1
Domestically controlled banks2/15.417.315.514.8
Regulatory Tier 1 capital to risk-weighted assets18.219.020.821.7
Domestically oriented banks1/13.613.9
Domestically controlled banks2/12.714.113.213.0
Nonperforming loans net of provisions to capital30.020.112.510.3
Domestically oriented banks 1/28.824.5
Domestically controlled banks 1/77.749.442.038.7
Nonperforming loans to total gross loans6.53.92.81.8
Domestically oriented banks 1/10.17.76.05.1
Domestically controlled banks 2/17.512.09.27.6
Return on assets1.41.41.31.0
Domestically oriented banks 1/1.81.5
Domestically controlled banks2/1.21.41.51.4
Return on equity13.214.311.710.7
Domestically oriented banks1/15.313.6
Domestically controlled banks 2/15.920.820.718.9
Interest margin to gross income45.348.656.358.5
Domestically oriented banks1/63.476.5
Domestically controlled banks 2/68.968.165.866.1
Noninterest expenses to gross income47.841.344.451.9
Domestically oriented banks1/45.045.0
Domestically controlled banks2/49.845.950.350.1
Liquid assets to total assets24.321.719.521.8
Domestically oriented banks 1/21.924.2
Domestically controlled banks2/24.426.824.930.5
Liquid assets to short-term liabilities49.955.752.252.5
Domestically oriented banks1/50.749.1
Domestically controlled banks 2/54.150.750.854.9
Net open position in foreign exchange to capital-1.60.2
Domestically oriented banks1/2.014.3
Domestically controlled banks 2/4.42.30.8
Capital to assets7.96.88.6
Domestically oriented banks1/9.18.7
Domestically controlled banks2/7.38.07.47.6
Gross asset position in financial derivatives to capital37.283.121.3
Domestically oriented banks 1/2.83.4
Domestically controlled banks 2/1.21.10.90.9
Gross liability position in financial derivatives to capital39.482.521.9
Domestically oriented banks 1/3.22.2
Domestically controlled banks 2/3.43.71.31.7
Trading income to total income3.519.9
Domestically oriented banks1/0.2-4.9
Domestically controlled banks 2/0.10.0-12.9
Personnel expenses to noninterest expenses38.840.837.6
Domestically oriented banks1/53.555.6
Domestically controlled banks 2/59.858.855.955.8
Spread between reference lending and deposit rates (in basis points)340.7345.2
Customer deposits to total (noninterbank) loans92.1100.170.3
Domestically oriented banks 1/129.2140.0
Domestically controlled banks 2/167.0164.3154.6156.0
Net open position in equities to capital38.534.625.0
Domestically oriented banks1/5.66.7
Domestically controlled banks 2/9.517.09.512.0
Real estate markets
Residential real estate prices (annual percentage increase)20.39.93.51.1
Residential real estate loans to total loans12.914.212.9
Domestically oriented banks 1/26.930.3
Domestically controlled banks 2/26.229.029.831.7
Commercial real estate loans to total loans6.99.5
Domestically oriented banks 1/32.332.6
Domestically controlled banks2/3/7.510.233.033.1
Source: Central Bank of Malta.

Domestically oriented banks are those that predominantly work with Malta’s residents.

Banks that on a group consolidated basis are regulated by Malta’s Financial Services Authority.

A sharp break in the time series in 2006 is due to a change in methodology.

Source: Central Bank of Malta.

Domestically oriented banks are those that predominantly work with Malta’s residents.

Banks that on a group consolidated basis are regulated by Malta’s Financial Services Authority.

A sharp break in the time series in 2006 is due to a change in methodology.

Figure 8.Malta: Financial Sector Developments

Sources: Bank of Malta; Datastream; and IMF staff estimates.

1/ For domestically oriented banks (DBs).

2/ Bond yields are measured in percent and spreads are in basis points.

Box 2.Spillovers from International Financial Turmoil

Malta's domestic banks, as elsewhere, have seen some fallout from the turmoil, including mark-downs in the security portfolios, trading losses, and increased funding costs. Lending surveys indicate tightening credit conditions, and securities valuation losses could increase in case of prolonged international market turbulence. But overall, the following factors indicate low risk of direct contagion.

  • Strong domestic franchises. The systemically important banks have robust brand recognition and a solid presence and expertise in key domestic sectors.
  • Good funding profile. Domestic banks rely mainly on resident deposits and little on wholesale market funding—being generally net lenders in cross-border interbank money markets. Hence, higher funding costs affect profits only moderately.
  • High liquidity. Liquidity ratios are well above the 30 percent prudential requirement. This buffer should permit the banks to recover valuation losses by holding securities (generally highly rated and with maturity under five years) to maturity.
  • Negligible subprime exposures. Main agencies have confirmed bank ratings with stable outlooks and reported very limited exposure to structured and similar instruments—a point confirmed by Central Bank of Malta's surveys.

18. The housing market remains overall broadly stable, although some market segments have recently experienced real price declines as credit conditions tightened (Box 3). Banks’ exposure through mortgages and corporate lending, at 57 percent of resident loans, is large and has been growing quickly (Figure 9). Recently, banks have become more cautious in extending high loan-to-value mortgages and are reducing exposures to construction, while using opportunities for asset diversification created by EMU entry. The housing market has remained generally stable since 2005, and staff concurred with the authorities that there is probably little, if any, overvaluation relative to fundamentals. Nonetheless, some market segments could experience additional real price declines if credit tightens further.

Figure 9.Malta: Credit Developments

Sources: Central Bank of Malta; ECB; and Eurostat.

Banks’ Loan Portfolio, end-2007

(Percent of GDP)

Source: Central Bank of Malta.

Box 3.Housing Market

Real house prices increased by 54 percent during 2002–05 but have since been broadly stable (Figure 6). Staff's regression analysis, based on the spring 2008 WEO methodology, indicates that most of these price dynamics reflect changing fundamentals in the run up to EU accession (Box Figure A). In particular, lower interest rates on predominantly variable-rate mortgages and financial development during 2001–07 are identified as the main drivers (Box Figure B).

In recent months, interest rate and credit tightening also explain the observed decline in real prices, which could continue for some time if credit conditions remain restrictive—despite the estimated absence of significant overvaluation relative to fundamentals. The authorities and private analysts pointed out that the market was highly fragmented, with pent-up supply concentrated in certain segments, where the real price falls had occurred (e.g., apartments).

Empirical Results
Reg.1Reg.2Reg.3
Explanatory Variables 1/Dependent Variable

Real House Price (Growth)
Affordability ratio (lagged)-0.464-0.335-0.513
(0.000)(0.001)(0.001)
Short-term interest rate-0.059-0.085-0.064
(0.000)(0.000)(0.001)
Household credit growth (lagged)0.9280.728
(0.008)(0.088)
Working age population (growth)74.12445.29786.290
(0.003)(0.054)(0.015)
Constant-1.826-0.979-2.018
(0.000)(0.024)(0.007)
Memorandum items:
Adjusted R squared0.7480.6480.753
Number of observations272825
Implied current over (+) / under(-
) valuation (percent)-0.030.58-0.05
MethodOLSOLS2SLS
Source: IMF staff estimates.Notes: P-values in parentheses. Reg. 1 applies the spring 2008 WEO methodology to Malta. The other two regressions aim to avoid reverse causality between credit growth and house prices by (i) excluding credit growth (Reg. 2) and (ii) instrumenting it with its own lags in a two stage least squares regression (Reg. 3). Over-/undervaluation calculated over the period from 2001Q4 to 2007Q4 (Regressions 1 and 3) and 2001Q4 to 2008Q1 (Regression 2).

In all specifications, the variance of the explanatory variable is overwhelmingly explained by interest rates.

Source: IMF staff estimates.Notes: P-values in parentheses. Reg. 1 applies the spring 2008 WEO methodology to Malta. The other two regressions aim to avoid reverse causality between credit growth and house prices by (i) excluding credit growth (Reg. 2) and (ii) instrumenting it with its own lags in a two stage least squares regression (Reg. 3). Over-/undervaluation calculated over the period from 2001Q4 to 2007Q4 (Regressions 1 and 3) and 2001Q4 to 2008Q1 (Regression 2).

In all specifications, the variance of the explanatory variable is overwhelmingly explained by interest rates.

Box Figure A.Malta: Real House Price

(Interannual percent change)

Sources: Central Bank of Malta; and IMF staff estimates.

Box Figure B

19. Domestic asset quality remains weak due to relatively high—and thinly provisioned—NPLs. Despite substantial reduction in recent years, the NPLs in domestically controlled banks are high (7.6 percent of loans at end-2007)—and edging up in construction. The authorities partly shared staff concerns over the low and declining provision-coverage ratio (below 30 percent before collateral at end-2007). Staff recommended that the supervisor discuss with banks means to increase provisioning, while enhancing incentives by introducing tax deductibility of specific provisions. The authorities noted, however, that unprovisioned loans are fully backed by high-quality collateral.

20. Malta is making good progress in introducing Basel II and other EU prudential standards. The authorities saw merit in staff's recommendations to introduce more frequent (quarterly) public reporting by the main banks and improve consistency in NPL reporting. Regarding the former, however, they observed that more frequent reporting may also cause a higher noise-to-information ratio.

21. Malta is actively strengthening its national and cross-border crisis management framework in the light of lessons from the financial turmoil. The Domestic Standing Group was established last year and Memoranda of Understanding have been signed among key agencies and with relevant foreign jurisdictions—increasingly important due to rising internationally oriented bank presence. The authorities are also participating in various EU and ECB cross-border reviews, as well as conducting simulations and stress tests. In staff's view, Malta's preparedness to engage in bank resolution is satisfactory but could be improved in some respects. In this regard, the authorities were receptive to staff recommendations to review the legal means and procedures to act expeditiously—including systemic solvency support provision—should it ever be necessary. They were also introducing initiatives to buttress deposit insurance coverage based on recent international experience.

D. Improving Economic Efficiency

22. The authorities have made remarkable gains in strengthening the business environment and improving education outcomes, but rigidities in product and labor markets hinder growth. Policies seek additional improvements in educational attainment and labor market participation, particularly among females. Staff suggested reconsideration of the existing across-the-board mandatory inflation adjustment of wages (COLA), which, although partial, may hinder productivity-based wage increases and help entrench inflation.7 The authorities, however, thought that COLA's impact was limited and facilitated consensus in wage negotiations. Staff also recommended granting institutional independence to the competition authority (currently part of the Ministry of Finance). The authorities thought this premature, while agreeing that a proactive stance was crucial in fostering price flexibility and efficient markets, hampered by the economy's small size. They also viewed implementation of the EU services directive as an opportunity in this regard.

23. Renewed momentum in public enterprise reform would also improve economic efficiency, while freeing public resources. Privatization and outsourcing has continued in several areas (harbor services, post, energy), soon to include the shipyards—but the public sector remains large (Table 9). Although not opposed in principle, the authorities have no immediate plans to privatize Bank of Valletta8 partly because they consider current market conditions unfavorable. Staff agreed with the latter point but argued for a more active search of a suitable strategic investor as the sale would crowd in FDI and have positive spillovers within the financial system.

Table 8.Malta: Indicators of External and Banking Sector Vulnerability, 2004–08(Percent of GDP, unless otherwise indicated)
Latest
observation
20042005200620072008date
Financial indicators
Government debt72.470.364.162.4
Broad money (percent change, 12-month basis)2.44.25.211.1
Credit to nonbank private sector (percent change, 12-month basis) 1/-1.39.015.310.2
Three month T-bill yield (percent)3.03.23.94.44.9Jul
Nonperforming loans (all banks)6.53.92.81.8
External indicators
Exports of G&NFS (percent change, average in U.S. dollars)11.23.321.816.416.3Q1
Imports of G&NFS (percent change, average in U.S. dollars)12.15.319.013.921.4Q1
Current account surplus-5.9-8.8-8.2-5.4
Capital and financial account balance4.69.69.42.9
Of which
Capital account1.53.32.90.9
Inward portfolio investment (debt securities, etc.)-37.4-44.8-39.06.8
Other investment (loans, trade credits, etc.)30.043.317.9-11.4
Inward foreign direct investment7.011.729.212.7
Gross official reserves (millions of US dollars; e.o.p.)2,7342,5792,9813,798
Official reserves in months of imports GNFS7.16.36.16.8
Ratio of foreign reserves to base money (percent)133.7143.3141.3143.4
Ratio of foreign reserves to broad money (percent)29.830.930.131.0
Exchange rate (per U.S. dollar, period average)2.92.92.93.23.6Jun
REER appreciation, CPI-based (period average)4.1-0.21.03.1
Change in stock market index (percent, year-to-date)44.462.3-2.21.3-13.4Jun
Sources: Central Bank of Malta; Central Office of Statistics; European Commission; and IMF staff estimates and projections.

Excludes credit to public nonfinancial enterprises.

Sources: Central Bank of Malta; Central Office of Statistics; European Commission; and IMF staff estimates and projections.

Excludes credit to public nonfinancial enterprises.

Table 9.Malta: Privatizations and Remaining Public Enterprises
Privatizations:
Maltacom (telecom)Successful privatization of 40 percent through floatations until 1998. Sale of remaining 60 percent to TECOM investments in 2006 (which will also develop the SmartCity).
Malta International AirportSuccessful privatization through sales of 40 percent to private operator in 2002 and a further 40 percent through floatations in 2002 and 2005. The government retains a 20 percent stake.
Tug Malta (harbor towage)In July 2007, the authorities sold their 73 percent stake to the Italian Rimorchiatori Riuniti SpA.
Malta Freeport (main cargo harbor)Concession to operate and develop extended in 2008 to 65 years to French shipping company CMA-CGM, in return for future expansion/modernization worth 130 million euros and 500 jobs over the next five years.
Maltapost (postal service)Successful privatization through sales of 60 percent to Lombard Bank plc (2003 and 2005) and 40 percent through a highly oversubscribed floatation in February 2008.
Remaining public enterprises:
Malta shipyardsPrivatization is now envisaged. Subsidies are scheduled to end in 2008 (an EU accession commitment) and recent government statements point to interest by several bidders. The process can be expected to require a considerable downsizing of the current 1700-strong workforce. Until now there had been persistent losses, despite a 7-year restructuring plan including 700 million euro debt write-offs and 148 million euros in operating aid.
AirMalta (airline)No privatization plans for 98 percent government stake. AirMalta’s losses were reduced from 30 million (2004) to 5 million euros (2007) in a restructuring program. Funding for the restructuring emanated from sales of AirMalta’s hotel properties, so that no subsidies were paid. Recently AirMalta has expanded into intra-Italian routes.
Enemalta (energy)Consists of three divisions. For the two smaller ones - Petroleum (profit of 20 million euros in 2005) and LPG Gas bottling and distribution (0.4 million euros profit in 2005) -privatization/long-term leasing is currently underway. The larger electricity division recorded a loss of 20 million euros in 2005, mainly attributable to its pricing not keeping pace with costs. Since then the introduction of a surcharge to cover rising fuel costs had alleviated the problem somewhat, until the strong rise of oil prices at end-2007. The government guarantees 70 percent of Enemalta’s debt.
Water Services Corporation (water)Privatization is not envisaged, but some efficiency-enhancing reforms have been undertaken. The tariffs WSC charges are set by the government. High subsidies ensue (25 million euros in 2006) as water prices to end users are kept artificially low.
Bank of Valletta (largest bank)The authorities sold 15 percent to the Italian bank Unicredit and 60 percent in floatations up to 1995. However, the state retains a 25 percent stake. The bank is run on a commercial basis with no government interference in day-to-day decisions.
There are another 36 (fully or partially) public enterprises in the sectors of waste management, ferry services, air traffic control, culture and broadcasting, amongst others.

24. The authorities are increasing the pass-through of fuel prices to avoid derailing budget plans and prevent distortions while exploring means to shield vulnerable groups. The authorities already increased the price of electricity in July 2008, although a significant gap relative to costs remains. They also intend to introduce a water and electricity tariff reform by the fall aiming to protect low-income households and progress toward cost recovery. In this connection, staff advocated the introduction of rule-based mechanisms to regularly update administered prices—according to market conditions and aiming to reach cost recovery over a reasonable period. This would avoid the need for discretionary government decisions, which have often been protracted and unnecessarily controversial.

25. Provision of economic statistics has improved substantially but remains below international best practices (Appendix II). Progress has been made toward SDDS subscription (expected shortly). The authorities indicated their intention to reinforce the National Statistics Office, including by filling essential management-level vacancies and improving further national accounts and business statistics.

III. Staff Appraisal

26. Malta's EMU membership in January 2008 is an important step forward in seizing the opportunities of a global marketplace. The authorities’ strategy of boosting competitiveness through liberalization, export diversification, and value-added upgrading is beginning to pay off. Growth averaged 3½ percent in 2005–07, underpinned by fiscal adjustment and economic liberalization, and driven by FDI and new niche exports. Export reorientation, rising productivity, and terms-of-trade gains supported cost and noncost competitiveness, trimming the current account and trade deficits. However, competitiveness gaps remain, and Malta is particularly vulnerable to euro strength given its trade orientation. These factors are intensifying the decline of traditional exports despite subdued ULC growth.

27. Growth is expected to decelerate to 2¼–2½ percent in 2008–09 due to unfavorable external developments before reverting back to trend of some 3 percent. Import-price-driven inflation will curb domestic demand this year, while a weaker external environment eliminates the growth contribution of net exports. Risks are on the downside: traditional export sector declines could outpace the emergence of new activities, especially if complacency over reforms were to dent investor sentiment and FDI.

28. Seizing the potential of new growth niches will require improvements in economic efficiency and market-based flexibility. Further fiscal consolidation and public sector streamlining will be key. The start of the new legislature is an opportunity to reinvigorate the necessary fiscal, financial, and structural reforms.

29. The authorities’ MTO of structural fiscal balance by 2010 based on expenditure retrenchment will require tackling the high cost of subsidies, payroll, and entitlements. The authorities are appropriately identifying and implementing immediate spending cuts to address expenditure overruns—partly caused by higher-than-budgeted fuel prices. This should ensure a continuation of good progress toward the medium-term objective. Reinforcing the fiscal framework with a medium-term orientation would help preserve the benefits of fiscal consolidation and prioritize spending. Vulnerabilities inherent to Malta's small economy argue for targeting a surplus beyond 2010.

30. The banking system is well placed to weather the current global turmoil but is weakly provisioned and exposed to Malta's narrow economic base. The supervisory framework is rapidly improving in the wake of EU membership and further steps would enhance resilience and market discipline. Banks have healthy liquidity and a good funding profile. But exposure to the slowing housing market, and low and uneven provisioning call for close vigilance. Recent international experience offers an opportunity to review mechanisms for crisis prevention and resolution, including the needed authority and flexibility to act expeditiously.

31. Further public sector streamlining and market-oriented reforms are key to realizing Malta's growth potential. Reform of the public enterprise sector and administered price-setting mechanisms will be essential to mitigate market distortions and redirect public spending toward growth-enhancing investment. Enhancing the competition framework and wage-bargaining flexibility would help to fight inflation and increase competitiveness.

32. It is proposed that the next Article IV consultation be held on the 12-month cycle.

Appendix I. Malta: Fund Policy Recommendations and Implementation
Policy AreaFund RecommendationsImplementation
Fiscal policyPursue expenditure-based consolidation, further reducing subsidies and public consumption. Improve medium-term budget planning. Adopt financial incentives in healthcare.Fiscal adjustment continued in 2007 and 2008. After delays, substantial progress in curbing subsidies is being made since mid-2008. Effort to improve budget planning is ongoing; new procedures for capital projects are being implemented. Performance budgeting in hospitals is being introduced, but co-payments have been ruled out.
Financial sectorMonitor non-performing loans (NPLs) and concentration risks, notably exposure of financial sector to the real estate sector. Bolster provisioning by introducing tax deductibility of specific provisions.NPLs have continued to decline but provisioning has remained thin, with no tax deductibility. While exposure to the real estate sector remains high, good progress has been made in introducing Basel II standards and upgrading the crisis management and resolution framework.
Structural reformsBolster competitiveness by improving the flexibility of the economy and rationalizing the public sector. Enhance productivity by raising the efficiency of energy and maritime transportation networks and streamlining of loss-making public enterprises; thereby reduce ensuing subsidies.The authorities have continued streamlining the public sector with renewed momentum. Long-term lease of port operations and post privatization have been completed. Privatization process was initiated for shipyards to stop subsidies by end-2008. Unbundling and privatization of LPG and gasoline distribution operations is underway. Retail electricity prices were increased and the subsidy reduced, although prices remain below cost recovery. Reforms of the electricity pricing system and domestic transportation have been announced.

The independence and profile of the competition authority remains low. Partial indexation of wages hampers the alignment of wage and productivity increases and could sustain inflationary pressures.
1TOT gains averaged 0.9 percent annually in 2005–07, partly reflecting export quality and value-added upgrading. TOT-adjusted GDP grew 5.2 percent in 2007. TOT-adjusted GDP is computed by deflating exports by the import deflator and measures the volume of goods and services an economy can command.
2Malta significantly revised its statistics in 2007–08 with assistance from Eurostat and the IMF to increase consistency with ESA95 and SDDS, resulting in a more benign external competitiveness assessment than in the last Article IV consultation.
3The methodology follows Exchange Rate Assessments: CGER Methodologies(by Lee, et al, IMF Occasional Paper 261, 2008).
4See France, Greece, Italy, Portugal, and Spain -Competitiveness in the Southern Euro Area (IMF Country Report No. 08/145), Chapters I, II, VI, and IX.
5Projects include the construction of an IT park by TECOM—strategic investor from Dubai in GO (former Maltacom)—starting at end-2008 and ongoing harbor investments by the private operator (a large French maritime transport company).
6A point also made by the EC in its assessment of Malta's Stability Program (ECFIN/REP50669/08). Staff's medium-term scenario (Table 5) assumes an underlying expenditure-based effort (public employment, subsidies and other spending reductions) similar to 2004–06. The pace of spending reduction would be however slower reflecting the expiration of the public wage moderation agreement and increasing demographic pressures on social spending.
7See ECB Monthly Bulletin, 5/2008, Box 5 “Wage Indexation Mechanisms in Euro Area Countries” and ECB Occasional Paper No. 90, 7/2008, “Wage Growth Dispersion Across the Euro Area Countries: Some Stylised Facts” (Andersson, et al).
8One of the two dominant banks in the domestic market (by deposits). The government is the main shareholder with a 25 percent stake.

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