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Malta- 2013 Article IV Consultation Concluding Statement
May 15, 2013
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Macroeconomic outlook and challenges
1. Malta has shown remarkable resilience in the face of a major crisis in Europe, and its main challenge is to preserve this macroeconomic stability. Average growth of the Maltese economy (relative to historical average) has been the best in the euro area since the beginning of the crisis, and the unemployment rate remains one of the lowest. This resilience was underpinned by robust export growth and a sound banking system. The current account balance has improved gradually in recent years, turning into surplus in 2012. However, economic growth slowed to about ¾ percent in 2012 and remains below potential, reflecting a weak external environment and subdued domestic demand. In addition, the fiscal position has deteriorated and the level of public debt is uncomfortably high, constraining the fiscal space for maneuver in the event of further shocks.
2. Going forward, domestic demand is expected to become a larger contributor to economic growth. The mission projects a moderate acceleration in real GDP growth in 2013-15, which means that Malta would continue to outperform the euro area average. The pick-up in activity is predicated on the recovery of private consumption and improved confidence, as policy uncertainty decreases. While this would lead to some increase in imports, the current account balance is projected to remain slightly positive.
3. Short-term risks to this scenario are largely related to the external environment. A protracted period of slower growth in Europe, or re-emergence of euro area financial stress if policy momentum is not sustained, would negatively affect the economy through the trade channel. In addition, close financial integration with the euro area entails a spillover risk via banking and financial markets channels. However, relatively strong fundamentals in Malta, including a comfortable external position, very small reliance on external financing by the government, a resilient financial system, and relatively healthy balance sheets of households and nonfinancial corporates limit the vulnerability against these risks.
4. In the longer term, regulatory and tax reform at the European or global level could erode Malta’s competitiveness. The Maltese economy, including the financial sector and other niche services, has greatly benefitted from a business-friendly tax regime. Greater fiscal integration of EU member states and potential harmonization of tax rates could erode some of these benefits, with consequences on employment, output, and fiscal revenues.
5. Against this background, policies should aim at maintaining macroeconomic and financial stability, safeguarding fiscal sustainability, and enhancing the growth potential. The mission’s key recommendations to the authorities are the following:
Financial sector
6. Recent events in Europe have heightened perceptions about risks of hosting a large banking sector in a small country. In the case of Malta, these risks are contained because the large international banking segment has limited balance sheet exposures to the Maltese economy and negligible contingent claims on the deposit compensation scheme. The authorities should, nonetheless, continue monitoring closely developments in all banks, including links between foreign parent banks and their Maltese entities. The authorities should also stand ready to take action if spillovers from abroad become imminent or the internationally-oriented banks increase their exposure to the domestic economy. In this context, the mission supports the recent introduction of more frequent monitoring of banks’ liquidity.
7. Near-term risks related to the core domestic banks appear to be contained. Despite turbulence in the euro area, the performance of Maltese banks has been satisfactory. Banks report adequate capitalization, liquidity, and profitability and are well positioned to transition to the Basel III regime. In contrast to many European countries, banks’ deposits and credit to the private sector continued to increase in 2012, albeit at a slower pace than in 2010-11. However, these banks are heavily exposed to the local property market and non-performing loans are on the rise, reflecting subdued conditions in the construction and real estate sectors. A significant decline in house prices, although not likely in the short term, could have a sizeable impact on the domestic banking sector.
8. Further efforts in several specific areas are still needed to shore up the resilience of Maltese banks and ensure financial stability.
Public finances
9. The government’s objective to balance the budget over the medium term remains essential, but it requires credible and sustainable consolidation efforts. After notable progress in 2011, the fiscal deficit widened to 3.3 percent of GDP in 2012 amid the election cycle, triggering a reassessment of Malta’s public finances under the EU Excessive Deficit Procedure. Discretionary measures in the 2013 budget are expansionary and tax revenues appear optimistic in light of the moderate growth outlook and developments so far. Therefore, the mission urges the Maltese authorities to adopt additional measures to ensure that the deficit falls below 3 percent of GDP in 2013 and public debt is put back on a sustainable path. These measures should be designed to contain the fast growth in current spending, while preserving capital spending. The focus should be on tightening controls on the growth of health spending, greater use of means-testing for government benefits, and containing the wage bill through prudent collective wage agreements and compression of public sector employment through attrition.
10. Restoring the profitability and viability of large public corporations is crucial to alleviate fiscal pressures. The high level of government-guaranteed debt and delicate financial position of Enemalta and Airmalta heighten concerns about fiscal sustainability. Progress on the restructuring of Airmalta appears on track and the restructuring plan of Enemalta was approved in December 2012. In this context, budget assistance to Enemalta needs to be phased out, as it crowds out priority public spending. The mission supports the government’s objective to reduce energy costs—one of the highest in the EU—and diversify energy sources to reduce Malta’s dependence on oil. However, any reduction in electricity tariffs should be contingent on the success of the government’s strategy to reduce costs and restore Enemalta’s financial health.
11. Further progress is needed to strengthen the fiscal governance framework. The authorities need to undertake the necessary reforms to ensure that the fiscal framework meets the EU requirements under the six-pack and fiscal compact by end of 2013. A clear rule-based multi-year fiscal policy framework would reinforce the linkage between annual budget laws and the medium-term target. Fiscal discipline and governance should also be strengthened by establishing an independent fiscal council to guide and assess the government’s consolidation efforts.
Structural reforms
12. Steady implementation of structural reforms is critical to boost potential growth and ensure sustainability of public finances. The mission welcomes the government’s recent adoption of the National Reform Program that includes specific measures in different areas. Pension reform remains a priority to ease long-term fiscal pressures. In particular, the retirement age should be aligned with life expectancy, and second and third pension pillars should be introduced. The latter, which would require an appropriate legal framework, would support the development of the local capital market and allow households to diversify their sources of savings. Continued efforts are also needed to strengthen female labor participation and educational attainment. Ongoing efforts to incentivize and support job search are welcome. Education reforms should focus on promoting greater social inclusion and linking vocational training more closely with labor market needs.
13. With Malta’s growth model increasingly dependent on financial and niche services, measures to broaden competitiveness would help diversify the economy. The authorities should ensure better alignment of wages and productivity at the enterprise level, promote foreign investment, improve the judicial system, and promptly implement structural reforms. This is particularly important at a time when many of Malta’s trading partners are undergoing internal devaluation, fiscal consolidation, and structural reforms to restore their competitiveness. More generally, these reforms would make the economy less vulnerable to sectoral setbacks and more resilient to a potential harmonization of tax rates at the EU level.
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The mission is grateful to the authorities and other interlocutors for the excellent cooperation, open discussions, and warm hospitality.
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