IMF Executive Board Concludes Article IV Consultation with MaltaPublic Information Notice (PIN) No. 09/116
September 14, 2009
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2009 Article IV Consultation with Malta is also available.
On September 4, 2009, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Malta.1
After a period of sustained expansion following successful EU entry, Malta started feeling the effects of the global downturn in the fall of 2008, with declining trade flows and investment. More recently, private consumption also weakened, as the labor market prospects deteriorated, and growth slowed substantially in the early-2009. Although inflation has begun moderating recently, it has remained the highest in the euro area since October 2008, and reached 3.4 percent in the second quarter of 2009, mostly as a result of a lagged impact of energy price increases and imperfect pass-through in food prices.
Fiscal consolidation came to a halt in 2008, with the deficit widening to over 4½ percent of GDP, both as the result of restructuring measures in the state-owned shipyards and of spending slippages, most notably in energy subsidies and the health care sector. With the economy deteriorating, the authorities are letting the automatic stabilizers play and are implementing a stimulus package, focused on infrastructure projects and support to the manufacturing and tourism sector. The authorities have managed to finance the fiscal deficit without difficulties, although at a higher cost, but the debt ratio has started to inch up again.
Banks have so far withstood the global financial turmoil relatively well, as they were protected by their limited exposure to structured products, a traditional retail funding model, and conservative lending policies. Credit has proved resilient, and no government intervention to shore up capital or liquidity has been necessary. Nonetheless, some institutions suffered large valuation losses on their security portfolio, and credit concentration in the construction and real estate sectors remains a concern, especially as property prices have fallen noticeably recently.
The external current account deficit narrowed to 5½ percent of GDP in 2008, reflecting continuous efforts at export diversification and value-added upgrading. Competitiveness has therefore remained broadly stable, notwithstanding moderate appreciation of the real effective exchange rate driven by accelerating wage costs, weakening labor productivity gains, and the strengthening of the euro. Nonetheless, labor market participation remains low, particularly for women, and education attainment trails peers. Furthermore, wage flexibility is limited by an automatic indexation to inflation.
Executive Board Assessment
The Executive Directors noted that past efforts at fiscal consolidation and export diversification toward high-value-added services activities in the run-up to euro adoption had increased the resilience of the Maltese economy. Nevertheless, the global crisis had started to affect the manufacturing and tourism sectors, weakening growth prospects and jeopardizing the hard-won gains. The main challenges facing policymakers in the current environment are to remain supportive in the short run without compromising the fragile fiscal position, and to preserve competitiveness as a foundation for medium-term growth.
Directors considered that the fiscal stance for 2009 is appropriately accommodative. The full play of automatic stabilizers, combined with a limited stimulus package focusing on infrastructure investment, should provide an adequate counter-cyclical response to the slowdown. Directors encouraged the authorities to improve the composition of the fiscal stimulus by winding down measures to support enterprises as the implementation of planned investment projects gathers pace. While recognizing the need to avoid premature withdrawal of fiscal support, Directors considered it important that consolidation efforts start as soon as feasible, with a number suggesting frontloaded measures in order to reach the Maastricht deficit target by 2010. Directors called for a well-articulated medium-term consolidated strategy, supported by a strengthened institutional framework and budget execution discipline. This would require targeted action on the expenditure side, particularly with regard to the wage bill, social transfers, and pension and health care spending. Directors welcomed recent steps to privatize the shipyards industry and eliminate utility subsidies.
Directors observed that the banking sector has weathered the global crisis relatively well and capital ratios remain adequate. However, rising nonperforming loans and credit concentration in the context of the downward correction in property prices and the economic slowdown have increased vulnerabilities. Directors recommended that banks build additional capital buffers and set provisioning more proactively. Directors looked forward to the early finalization of legislation on a bank resolution regime and deposit insurance coverage.
Directors saw merit in reassessing the costs and benefits of Malta’s banking business model, in view of the risks brought to light by the global financial crisis. Noting the rapid expansion of internationally oriented banks and their increasing linkages with the domestic economy, Directors welcomed ongoing efforts to conduct stress tests and risk assessments, and to gradually incorporate these institutions into the exercise. Containing these risks would require supervisors to further enhance capacities and to better incorporate systemic considerations into prudential standards.
Directors noted that euro area membership provides a clear opportunity for Malta in terms of trade and financial integration. At the same time, it highlights the urgency of improving internal flexibility to remain competitive, especially given persistent inflation in Malta. A concerted effort would be necessary to complete the difficult reform agenda focusing on cost adjustments and productivity improvements, in particular a move toward productivity-linked wage increases and a restructuring of public enterprises. Directors welcomed progress in utility tariff reform, and recommended that the new price-setting formula be applied fully and transparently.