Public Information Notices
Malta and the IMF
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On August, 18, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Malta.1
Malta enjoyed rapid economic growth during most of the 1990s fueled by a vibrant tourist sector (which accounts for roughly 30 percent of GDP) and the semi-conductor industry (which accounts for about 75 percent of manufactured exports). Malta's per capita income almost doubled in the past ten years, and its income as a share of the European Union (EU) average rose to 56 percent-well above most accession candidates, although lower than the least affluent EU members.
Adverse shocks to tourism and the semi conductor sectors, however, weighed on economic developments in the past two years. The September 11 attacks further dented the tourism sector that was already affected by a weak European market. At the same time, the bursting of the high-tech bubble dampened exports and private investment, the latter being further weakened by the uncertainty about the EU referendum. Despite these adverse developments, relatively flexible labor markets kept unemployment fairly steady at 5-5¼ percent. A modest recovery began in 2002-with some improvement in tourist arrivals in the second half of the year-but employment growth remained weak.
The fiscal situation remains difficult despite some progress in consolidating public finances. The deficit was brought down to 6½ percent of GDP in 2002, still a high level, mainly through increases in tax rates, and improved collection through the creation of the Tax Compliance Unit. Current expenditures-particularly the public sector wage bill and subsidies to public enterprises-were reduced in the late 1990s, but have crawled back up with subsidies reaching 5 percent of GDP in 2002; public sector employment remains high. Fiscal deficit outturns have exceeded the budget by an average ¾ percent of GDP since 2000. Substantial privatization proceeds since 1999 (about 7½ percent of GDP) limited increases in public debt, which stood at 64 percent of GDP in 2002.
Malta maintains a long-standing exchange rate peg to a basket of currencies-currently composed of the euro, pound sterling, and dollar. The peg has delivered low inflation and served Malta well, including during the recent period of liberalization. Initially, capital account restrictions allowed the Central Bank of Malta (CBM) some room for active monetary policy, but the gradual liberalization of the capital account has diminished the ability to conduct monetary policy independently of world rates. Thus, the CBM's central intervention rate and world rates have become increasingly aligned in the past two years-resulting in considerable easing since late 2001. Nonetheless, a favorable interest rate differential remains that combined with the investment repatriation scheme have led to growing international reserves. A narrowing of the external current account deficit further contributed to diminish worries about the balance of payments and competitiveness.
Domestic credit growth remains on a downward trend, with banking credit to the private sector particularly weak. Combined with the strong growth in deposits in the past couple of years, this has led to a rapid buildup of liquidity in the banking system and pressures to reduce interest rates that are now fully liberalized. With the liberalization of the financial sector, steps have been taken to strengthen supervision: supervisory responsibilities were consolidated in the Malta Financial Service Authority (MFSA) during 2002. The previous responsibility of the CBM for oversight of the banking sector has thus been transferred to the MFSA, which also supervises the less developed securities and insurance sectors.
Executive Board Assessment
Executive Directors noted that Malta has advanced towards accession to the EU and that its progress in opening markets to international competition and reducing the fiscal deficit has contributed to rapid economic growth and enhanced the economy's resilience to economic shocks. They stressed, however, that achieving sustained, robust growth hinges on fiscal consolidation and continued efforts to reform the economy.
Directors observed that Malta's economic growth in the near term will be restrained by the difficult international environment, but that as the European economy improves, growth is expected to pick up gradually over the course of 2004. They saw this improved economic outlook supported by stronger domestic investment following the positive outcome of the EU referendum in early 2003 and continued robust consumption buoyed by a decline in income taxes.
Directors attached great importance to strengthening the public finances, which deteriorated in 2002 owing to election-related expenditure overruns and weak tax revenue reflecting the economic slowdown. They expressed concern at the large projected 2003 budget deficit, which would miss the budget target by a substantial margin.
Directors strongly urged the authorities to strengthen the medium-term fiscal consolidation objectives beyond those envisaged in the 2003 budget, which would also be consistent with meeting the Maastricht criteria. This would help guard against economic shocks, decisively reverse the increase in public debt, prepare for ERM II and the economic requirements associated with euro adoption, and allow room for interest rate cuts.
Directors stressed that the fiscal adjustment should avoid social dislocations and should be anchored by cuts in current expenditure, especially the public sector wage bill, subsidies to public enterprises, and welfare payments to those abusing the system. They observed that a heavy existing tax burden makes it difficult to increase taxes.
Directors welcomed the rolling three-year financial plan as an important step in establishing a medium-term fiscal framework. They saw merit in introducing strict expenditure ceilings-allowing flexibility for routine budgetary management across expenditure categories-to instill fiscal discipline and foster lasting consolidation.
Directors saw reforms to the pension and welfare systems as supporting fiscal consolidation. They supported the authorities' commitment to deal with the challenges posed by an ageing population by increasing social awareness of the need for reforms and encouraged the authorities to move forward without further delays with a sufficiently ambitious pension reform that would ensure the financial viability of the system.
Directors considered that the current exchange rate regime was an appropriate framework to prepare for ERM II, and that the exchange rate peg has served Malta well-including during the recent period of capital account liberalization-and has contributed to low inflation rates. They concurred with the authorities' decision to increase the weight of the euro in the currency basket. They stressed, however, that the timing of ERM II entry should be linked to Malta's ability to deliver lasting fiscal consolidation.
Directors commended recent amendments to the central bank law, which strengthen the bank's independence and define price stability as the primary goal of monetary policy. They indicated a need to improve transparency in central bank operations in government securities.
Directors noted that the financial system appears to be sound and well supervised, though they expressed concern about the concentration of bank lending, a high level of nonperforming loans, and recent inflows into the banking system. In this connection, they welcomed the steps taken to improve prudential oversight, including the consolidation of regulatory and supervisory responsibilities of the financial system in the MFSA. They encouraged the authorities to remain vigilant in preserving the soundness of the financial system as competition and transformation in the financial sector intensifies with EU accession. They welcomed the authorities' efforts in the area of anti money laundering and the combating of the financing of terrorism, and urged the authorities to specifically criminalize the financing of terrorism.
Directors highlighted the importance of further structural reforms in order to improve the economy's competitiveness and diversification. They welcomed efforts to reduce public sector involvement in the economy and encouraged the authorities to press ahead with privatization and related reforms. In view of the labor market constraints on growth and a need to reduce income inequality with EU countries, they supported the authorities' policies to reduce excessive employment in the parastatal sector and their encouragement of increased female participation in the work force.
Directors welcomed Malta's progress in improving the quality of data and the intention to subscribe to the Special Data Dissemination System this year.
1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.
IMF EXTERNAL RELATIONS DEPARTMENT