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Malta

Author(s):
International Monetary Fund
Published Date:
January 2011
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I. The Economic Agenda

1. Further policy effort is needed to fully exploit the benefits offered by EU and euro membership. As a small and very open economy, Malta has benefited from tighter integration into the European economy and participation in the euro area. Pragmatic and flexible polices played a crucial role but more action is needed. Catching up further with incomes of richer European countries requires raising productivity, skills and employment rates simultaneously, which is a formidable challenge many other countries in Europe are facing as well. Continued diversification into high-value exports offers the most promising source of sustained recovery for Malta. Further upgrading the various economic clusters and promoting synergies between them would also reduce the risks stemming from potentially unfavorable changes in the European or international regulatory and taxation framework.

2. Strong and sustainable growth requires a strategic policy approach and prudent risk management. The increase to relatively high levels of public debt, guarantees, and implicit liabilities—also related to state-owned enterprises—necessitates ambitious fiscal consolidation. Consolidation should be expenditure based but growth-friendly and not impede further progress in attracting high value added export activities. Recent international experience underlines that prudent financial regulation and supervision, well coordinated with the new European institutions, is indispensable. Rising vulnerabilities associated with high domestic credit risk and the growing linkages of Malta’s financial sector with the rest of the world in the context of volatile international financial markets make this all the more urgent. The authorities considered the staff’s overall assessment fair and realistic.

II. The Outlook for Malta’s Economy

3. Malta weathered the global recession relatively well. Output fell less than the euro area average, unemployment rose modestly and the fiscal deficit remained contained at around 4 percent of GDP. Service activities held up especially well during the crisis reflecting ongoing diversification and expansion into higher value added export niches. The government provided some targeted assistance to the manufacturing sector which helped to stabilize output and employment, and some additional social benefits.

A. Recent Developments and Near-term Outlook

4. Malta is experiencing a cyclical upswing driven by strong external demand, but momentum is expected to fade. Manufacturing and tourism activity, hit hard by the global recession, have recovered with the latter near pre-crisis record levels. However, the recovery is not yet broad based and some sectors, including construction and retail, are lagging. On the back of softer real estate prices, elevated unemployment, and higher uncertainty about job prospects, consumption growth slowed but has been supported by very low interest rates. Investment, especially in construction, decelerated sharply and remains sluggish. Inflation has picked up as the ongoing rebound allows firms to rebuild profit margins and pass on higher energy prices, but underlying inflation is expected to remain contained.

Contribution to Real GDP Growth

(Percent, seasonally and working day adjusted)

Exports and Imports

(Percent, seasonally and working day adjusted)
Sources: Eurostat; Haver; and IMF staff calculations.

B. Shape and Strength of the Recovery

5. Imbalances, primarily accumulated in the run-up to joining the EU and the euro area, are expected to weigh on the recovery. Over the past two decades, Malta experienced a real-estate boom which intensified around EU accession (Box 1). As in other countries, this boom temporarily boosted tax revenues and consumer and investment demand reflected in elevated current account deficits. Excess supply in segments of the real estate market, combined with high corporate leverage in this sector, is expected to weigh on domestic demand for some time.

6. Competitiveness needs to be reinforced to support the export-led recovery. The persistence of current account deficits suggests some erosion of competitiveness in Malta’s traditional exports, especially in the early 2000s, but the gradual loss of market share in merchandise trade has more recently been largely offset by gains in services. Also, large net income deficits increasingly contribute to Malta’s relatively weak current account performance reflecting the presence of many foreign-owned corporates, including banks. They also have a sizable effect on Malta’s international investment position which, however, remains in positive territory (Figure 1). Traditional price competitive measures, including estimates in line with the CGER methodology, suggest that Malta’s real effective exchange rate (CPI, GDP and ULC-based) is broadly in line with fundamentals following some euro depreciation over the past year.

Figure 1.Malta: Economic Indicators, 1995–2011

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

Malta: Real GDP Growth Projections, 2010–12(Percent)
SourceDate201020112012
IMF10-Dec3.12.02.0
Central Bank10-Nov3.22.32.8
Ministry of Finance10-Nov3.43.0
European Commission10-Nov3.12.02.2
Euro area - WEO projection10-Oct1.71.51.8
Sources: IMF, WEO; and authorities data.
Sources: IMF, WEO; and authorities data.

7. Long-term sustainable growth requires policies to focus on raising productivity, skills and employment rates. Under current policies and in view of the above mentioned imbalances, Malta is expected to grow only slightly faster than the euro area average over the medium term. But further structural reform and a strategic policy approach could lift potential growth further (Box 2).

Box 1.Real Estate Market Developments in Malta

Malta experienced a real-estate boom which intensified around EU accession but has tapered off following the global financial crisis. Increased foreign demand associated with EU entry and a tax amnesty for residents on investments abroad boosted property prices. In 2007-08 the cycle turned, but the price correction of less than 10 percent1 has been more moderate than in other countries with comparably sharp house price appreciation. The prices of apartments and maisonettes, which constitute the bulk of Maltese properties, have declined the most, while high-end real estate held up considerably better. More recently, house prices appear to have stabilized, supported by stronger labor markets, low interest rates and continued provision of mortgage credit by banks.

House Prices

(2000=100)

Sources: BIS; and CBM.

Excess supply remains in segments of the housing market and commercial real-estate. Anecdotal evidence suggests that arrears are building in the commercial real estate sector and there is a significant overhang of unsold properties. The very high number of vacant dwellings is partly related to a legal framework that features significant rental restrictions. A recent rental law reform, however, is expected to gradually remove some of these distortions. Moreover, the authorities have argued that the relative scarcity of land, high home ownership and continued strong demand from foreigners will continue to support the Maltese real-estate market.

With elevated house prices and higher mortgage debt, housing affordability has decreased. The income-to-house price ratio has been eroded during the boom years. The price-rental ratio has also increased considerably, although this partly reflects rigidities in rental prices due to strong tenant protection. Low interest rates, increased competition in the mortgage markets and longer maturities continue to stimulate the demand for mortgages. Household mortgage debt has risen to about 44 percent of GDP, close to the euro area average, and 85 percent of mortgage debt is financed with adjustable rates. While some housing loans with higher loan-to-value (LTV) ratios (80 percent to 100 percent) have been granted in recent years, typical LTV ratios for first-time house buyers have been around 63 percent in 20072.

Affordability Indicators

(2000=100)

Source: IMF staff calculations based on CBM data.

1 According to the residential property index compiled by the CBM on the basis of advertised property prices, the fall was on average 7 percent. Based on a separate index computed by the NSO using information from contracts of sale registered with the Inland Revenue Department, the decline amounted to about 5 percent.2 ECB (2009): Housing Finance in the Euro Area, Occasional Paper Series, No 101, March.

Box 2.Drivers for Balanced and Sustainable Growth

In the context of joining the EU in 2004 and the euro area in 2008, Malta undertook a wide range of reforms which spurred economic growth. In terms of GDP per capita and TFP growth - at 3.4 and 0.9 percent respectively between 2004 and 2008—Malta appears to have escaped the stagnation faced by some Southern European countries, but lags behind the fast converging economies in Eastern Europe1.

The global crisis has had a moderate effect on potential output in Malta, although staff estimates suggest potential growth slightly below pre-crisis levels going forward. Different estimation methods suggest that output was above potential by almost 3 percent in 2008. The collapse in output since then has taken it below potential, with output gap estimates of about negative 1 percent in 2009. The total impact of the global crisis in terms of potential output contraction was relatively mild in international comparison.

Contributions of TFP to Growth, 2004–08

(Percent)

Source: European Commission.

Output Gap

(Percent of potential output)

Real GDP

(Millions of euros, 2000 prices)
Sources: Eurostat; and IMF staff estimates.

Increasing potential output requires a comprehensive strategy to enhance both the extensive and intensive sources of growth. Boosting labor utilization and labor productivity is key to reducing the income gap with richer European countries—which in 2008 stood at 28 percent in terms of per capita GDP. Employment rates, in particular for women, remain low and more flexible arrangements for part-time work and flexible working practices could help. Support for higher education should continue, but efficiency needs to increase and direct support accompanied by rigorous means testing. Increasing human capital through better targeted support, aimed at retaining the highly qualified, as well as improving primary and secondary education, should help satisfy the demand for higher skills. Linking wage increases to productivity gains would foster external competitiveness. Further measures aimed at improving the business environment, including simplifying administrative procedures and addressing infrastructure bottlenecks (as soon financial conditions permit) would increase efficiency and improve further Malta’s attractiveness to international investors.

Differential in GDP per Capita, 2008

(Gap vs. EA16, percent)

Differential in Labor Utilization, 2008

(Gap vs. EA16, percent)
Source: European Commission.

1 Based on the European Commission’s DG ECFIN (2008) “The LIME assessment framework (LAF): A methodological tool to compare, in the context of Europe 2020, the performance of EU Member States in terms of GDP and in terms of twenty policy areas affecting growth”. European Economy, Occasional Papers No 41. October 2008. Brussels.

C. Contagion and Other Risks

8. Uncertainty remains high and the risks tilted to the downside. Malta is facing high risk of contagion if the fragile economic and financial situation in parts of the euro area worsens. Some banks, involved mainly in international business, are exposed to euro area debt securities that have recently faced significant price pressure. Malta’s sovereign spreads have remained relatively contained but international market sentiment has proven volatile over the past year. Real estate market weakness could turn out deeper and more protracted than expected as excess supply in segments of the real estate market and some debt overhang need to be worked off. In this case negative feedback loops between the real economy and the financial sector could materialize. Moreover, Malta’s attractiveness as a business location and some of its new high-growth export activities (e.g. some business and financial services, pharmaceuticals, etc.) could be adversely affected should EU or member state regulations or taxation change. On the upside, low interest rates and stronger demand for Malta’s exports could sustain growth momentum longer than anticipated.

Financial Stock Indices

(1/1/07 = 100)

Spread with 10-year Government Bond

(Basis points)
Sources: Bloomberg; and IMF staff calculations.

Authorities’ views

The authorities, especially the Ministry of Finance, were more upbeat on the near-term outlook and medium-term prospects. The authorities agreed that there likely is excess supply in segments of the housing market and commercial real estate but referred to sustained demand for upscale housing, including from abroad, and the relative scarcity of land in Malta.

III. Fiscal Policy: Background, Outlook and Consolidation Agenda

A. Background

9. Fiscal performance weakened in 2008–09, but deficits and debt remained relatively contained (Figure 2). After several years of fiscal consolidation, the fiscal deficit climbed to 4.7 percent of GDP in 2008 from 2.3 in 2007, reflecting substantial one-offs as well as slippages in current expenditure. The reclassification of Malta Shipyards Ltd within the general government sector, larger energy subsidies in the context of rising international oil prices, and slippages in healthcare outlays and in the public sector wage bill resulted in a deterioration of about 2 percent of GDP. Despite the recession and helped by the proceeds from a tax amnesty and relatively strong income tax performance by international companies registered in Malta, the overall deficit narrowed to 3.7 percent of GDP in 2009. Additional spending to stimulate the economy accounted for about 0.7 percent of GDP, while energy subsidies dropped sharply as tariffs were raised significantly. Nevertheless, in July 2009 the European Commission concluded that Malta had an excessive deficit and recommended to bring it below 3 percent of GDP by 2011.

Figure 2.Malta: Fiscal Sector, 2003–15

Sources: Eurostat; European Commission; Maltese Authorities; Bloomberg; and IMF staff estimates.

B. Fiscal Outlook and Consolidation Agenda

10. The 2010 deficit is expected to have remained at about the previous year’s level. Revenue performance was boosted by another tax amnesty and relatively strong corporate profits, which contributed to higher income taxes, also reflecting the economic recovery. Only few and targeted stimulus measures were executed, including some measures to support investment and the tourism sector, some support to households compensating for the sharp rise in utility tariffs, and some increase in childcare benefits. Mostly financed with EU funds, public investment growth is estimated to have accelerated strongly.

Malta: IMF Staff Medium-Term Fiscal Projections, 2010–13(Percent of GDP, unless otherwise indicated)
Est.Proj.
2010201120122013
Overall balance-3.9-3.0-3.0-2.6
Overall balance excl. one-offs-4.0-3.1-3.1-2.6
Change in the balance excl. one-offs-0.21.00.00.5
Real primary expenditure growth (percent)4.0-0.62.20.8
Real public investment growth (percent)8.23.24.16.2
Public debt67.868.068.167.9
Authorities’ target (2011 Budget)-3.9-2.8-2.2-1.4
Sources: Malta’s authorities; and IMF staff estimates.
Sources: Malta’s authorities; and IMF staff estimates.

11. The government’s goal of reducing the fiscal deficit to 1.4 percent by 2013 is appropriate. Malta’s high vulnerability as a small and very open economy calls for prudent debt management which should also anticipate the tightening of EU-wide rules on high levels of public debt. Continued progress in attracting high value added export activities requires Malta’s tax regime to remain competitive and consolidation should be expenditure based and conducive to sustainable and strong growth.

12. Under current plans, however, the staff expects future deficits to exceed the government targets, especially in outer years. There are significant risks that adjustment may fall short of targets, due to possibly lower growth and financial activity than currently expected by the government. In the staff scenario, future tax revenue, including VAT, would turn out lower than the government’s latest targets. On the expenditure side, the government’s intention to contain wages and spending on goods and services over the next years is welcome but slippages are likely. Plans to raise the efficiency of government departments and entities and to slow recruitment in some areas are well founded but they should be complemented by rigorous means testing of social benefits. The current restructuring of Air Malta is also likely to involve additional fiscal costs and represents an upward risk for the 2011 budget deficit. A more strategic approach for the next budget that protects spending priorities, identifies areas to cut and is fully backed up with concrete measures should raise the credibility of adjustment plans. Moreover, the government should stand ready to introduce additional cost-saving measures to meet its deficit targets, preferably on the expenditure side including through personnel retrenchment, if the staff’s more conservative growth outlook or other risks materialize. In the long term, age-related public spending higher than the EU average may pose increasing budgetary pressure (Box 3).

13. Sovereign financing needs appear manageable in 2011, but are quite substantial in the following years. The average maturity of Maltese government debt is relatively high—at 7 years—and the rollover need is therefore limited. In 2010, most primary issuance was oversubscribed and spreads remained relatively contained. The annual financing needs in 2011 are projected at about the 2010 level but the rollover needs increase substantially in the following years (Figure 2).

14. The reformed framework for electricity tariff adjustments should help in limiting fiscal risk. Significant tariff increases occurred since late 2008 and helped in reducing subsidies to Enemalta. The company’s high debt has been singled out by rating agencies as a possible reason for a sovereign debt downgrade. The authorities may want to consider limiting further downside budgetary risk by encouraging the public utility Enemalta to hedge against the possibility of sharp oil price increases at least through the next election year.

15. A strengthening of fiscal institutions would safeguard the government’s consolidation plans. Ongoing initiatives to enhance accountability and transparency of the financial and budgetary framework are welcome. The government has introduced stricter rules for the approval of expenditure increases for governmental entities and monthly budgetary reviews to ensure fiscal discipline. Additional action should be supported by the recent EU directive on requirements for budgetary frameworks of Member States. The implementation of a legally anchored, strong fiscal rule to better control public expenditure growth should be considered. Further tax amnesties may result in moral hazard and harm tax collection over the medium term.

Box 3.Age-Related Public Spending in Malta

The fiscal impact of ageing is projected to be substantial in Malta on account of a sharp rise in the old-age dependency ratio. Malta’s age-related public spending is expected to increase by 9.2 percentage points of GDP between 2010 and 2060, significantly more than the EU average. Despite some pension reform in 2006, most of the increase still reflects higher subsidies for the pay-as-you-go (PAYG) pension system as dependency ratios are set to rise significantly (Table 1).

Dependency Ratios in Malta

(Percent)

Source: European Comission, The 2009 Ageing Report.

1/ Population aged 65+ as a percentage of the population aged 15-64.

2/ Inactive population aged 65+ as a percentage of employed population aged 15-64.

The Government’s gradual overhaul of the pension system started in 2006. The first phase of the reform consisted of a staggered increase in the retirement age from 61 to 65 years and in the regular contribution period to the state pension from 30 to 40 years. The reform also included the introduction of private occupational pension schemes and voluntary personal contributions. Although the overall legislative framework for the establishment of funded schemes has been set up, the specific regulations are yet to be elaborated. Under the current law, the government is legally bound to carry out a periodic strategic review every five years to reflect evolving circumstances in changes to the system. The law stipulates that the first review must be carried out and presented to Parliament by the end of this year.

Malta. Age Related Government Expenditure, Change 2007—60
PensionHealth careLong-term careUnemployment benefitsEducationTotal
(Percent of GDP)
Malta6.23.31.60.0-1.010.2
EA2.81.41.4-0.2-0.25.2
Source: European Commission, The 2009 Ageing report.
Source: European Commission, The 2009 Ageing report.

Pension reform in several EU countries has established defined-contribution second pillar systems, substantially improving long-term fiscal sustainability1. A few of these countries also moved from defined benefits to notionally defined contribution systems in the first pillar (Sweden, Italy, Latvia and Poland). For most countries which have successfully reformed their pension systems, the projected increase in age-related public spending is significantly lower than in Malta.

Further pension reform is critical to contain future fiscal costs of the system. Additional changes to the current PAYG system could include indexing the retirement age to life expectancy, or further lengthening the contribution period for full entitlement. A timely but gradual introduction of an additional mandatory and privately funded pillar would allow the government to reduce further the benefits of the pay-as-you-go system over time. Another option would be to gradually transition from a pay-as-you go to a notionally defined contribution system under the condition it delivered the needed cost saving. However, this option appears somewhat more difficult to implement and administer and shifts the demographic risk to pensioners requiring a rigorous informational campaign.

Age-Related Government Expenditure, Change, 2007-60

(Percent of GDP)

Government Expenditure, Change, 2007-60

(Percent of GDP)
Source: European Comission, The 2009 Ageing Report.

Authorities’ views

16. The authorities appeared open to the staff’s suggestion for a legally anchored, strong fiscal rule to better control public expenditure growth. They acknowledged the need to contain the costs of the public pension system and pointed to the ongoing review and past reforms. They were confident that the 2010 deficit target would be met.

IV. Financial Sector: Developments, Vulnerabilities and Policy Challenges

17. The Maltese banking sector has weathered the global financial crisis relatively well, but vulnerabilities are rising. Relatively conservative funding models and little exposure to U.S. toxic assets have kept spillovers from the global financial crisis to banks in Malta at bay. However, a long real estate boom contributed to a significant increase in private sector debt and as a result domestic credit risk. Real estate prices and collateral values experienced some correction and appear to have stabilized more recently, but excess supply remains in segments of the market (Box 1). Household debt has grown rapidly but, at 55 percent of GDP, still remains somewhat below the euro area average. Non-financial corporate sector debt exceeds 130 percent of GDP, with a significant share of debt incurred by the construction and real estate sectors. Banks have tightened lending policies and bank credit growth has decelerated but remains strong compared to the euro area average. At the same time, larger non-financial corporates have substituted bank loans with capital market debt by issuing bonds with construction companies and hotels playing an important role.

18. Profitability in the banking sector is coming increasingly under pressure. The sharp price recovery of equity and debt securities boosted profitability in 2009. Low funding rates and higher capital markets activity in Malta also supported banks’ profitability. Moreover, some improvement in interest income, possibly also reflecting increased risk appetite by some banks, has occurred more recently. However, provisions and non-performing loans are on an upward trend, with mortgages, construction and other real estate loans being key drivers weighing on profitability. Through the third quarter of 2010, banks’ return on equity (ROE) declined to 5.5 percent from 12.2 percent at the end of 2009, and the dispersion across banks remains significant.

19. The upward trend in NPLs calls for close monitoring and adequate provisioning. Total NPLs of domestically-oriented banks1 reached 6.3 percent of their total loans in September 2010 mainly reflecting problem loans in the real estate, wholesale and retail sectors. The NPL ratio for all banks registered in Malta, however, improved slightly to 2.3 percent of total loans. Households NPLs have increased to 3.1 percent in 2010 from 2.5 percent in 2008. Coverage ratios are relatively low in Malta, at about 22 percent, compared to over 50 percent for the euro area average. Together with some degree of uncertainty associated with real estate collateral valuation, this requires a conservative supervisory approach to ensure appropriate provisioning.

20. More protracted weakness in the real-estate market could lead to some financial sector pressures. The banking sector remains exposed to real-estate collateral where valuation uncertainty raises vulnerabilities. Household mortgages and loans to construction and real-estate companies account for close to 60 percent of total loans and NPLs in these sectors are rising. While household mortgage NPLs are still relatively low, the figures are much higher in the construction and real-estate sectors, at 15.7 and 8.7 percent respectively. As banks are curtailing credit for commercial real-estate, some developers have issued unrated bonds to the domestic base of retail investors seeking higher yields, which calls for heightened transparency and auditing standards.

21. Also, the risks associated with the growing exposure to debt securities in parts of the banking sector require heightened vigilance and determined supervisory action. A few banks are highly invested in foreign debt securities, including to euro-area peripherals currently under stress, making full use of ECB enhanced credit support and low refinancing rates. Stringent bank stress testing is essential including for banks that are applying the simple standardized approach under Basle II, often heavily relying on ratings that at times may lag actual developments, especially for debt securities classified as held-to-maturity. The authorities should discourage bank business models that are overly reliant on ECB facilities for financing large investment portfolios and employ all available tools to aggressively reduce leverage in these cases.

Figure 3.Malta: Financial Sector Developments, 2004–10

(Percent)

Sources: IMF, Global Financial Stability Report; Central Bank of Malta; and IMF staff calculations.

1/ Refers to domestically oriented banks.

2/ As of end-September, 2010 (for Malta).

3/ January-September 2010 (for Malta).

Box 4:Malta’s Rapidly Expanding Banking Sector

Malta’s banking sector expanded significantly during 2004-10. Bank assets surged from about €20 billion in 2004 to currently about €50 billion, over eight times of GDP. At the same time, the number of licensed banks increased from 16 to 25 of which many are subsidiaries of foreign banks.

Total Banking Assets, 2009

(Percent of GDP)

Composition of Banks’ Foreign Assets 1/

(Millions of euros)
Sources: Central Bank of Malta; and European Central Bank, EU Banking Structures, September 2010.1/ Data as of September 2010.

Foreign financial institutions benefit from low costs for certain activities, including back-office functions, and easy access to the regulatory and supervisory authorities, as well as a competitive tax regime, featuring low tax rates for dividend payments, backed by extensive double-taxation treaties. EU membership in 2004 and subsequent euro adoption have further raised Malta’s attractiveness as a financial hub. The entry of foreign banks crucially helped in improving competition for many banking services in Malta and boosted the GDP contribution of financial services and tax revenues. However, the rapid expansion of the banking sector also entails risks, including:

  • Exposure to a broad variety of international loans, trade financing and securities, which require a sophisticated internal risk assessment and close supervision.

  • Higher funding risk due to increased bond and other wholesale funding and increased reliance on ECB liquidity of some banks.

  • High concentration risk and large exposure to parent banks, which increased in the wake of the financial crisis.

Net Large Exposures-Limit at 800 Percent of Own Funds, September 2010 3/

(Percent of own funds)

Ratio of the Share in Eurosystem Refinancing vs. Share of MFI Sector in Euro Area MFI Assets

Source: Central Bank of Malta.1/ Including connected parties.2/The value of ‘zero’ for Malta for January 2008 is due to the fact that th ere was no local participation in refinancing operations as at end of January 2008.3/ Refers to domestically oriented banks.

In view of the systemic and fiscal risk these developments may pose, effective supervision and regulation of all banks registered in Malta is essential.

22. In view of high credit risk and stricter regulatory requirements under Basle III, a number of banks need to raise capital. Average capital adequacy ratios have declined somewhat relative to 2009, but capital predominantly consists of equity and retained earnings and Tier 1 capital to risk-weighted assets still stood at about 12 percent in September 2010. However, there is wide dispersion across banks, and concentration risk remains high.

23. The authorities need to step up efforts to protect financial stability and safeguard against systemic and fiscal risks. Growing linkages in financial markets require that the central bank’s Financial Stability Reports include all banks operating in Malta, and continue discussing them in an appropriately differentiated manner by, for example, grouping them by business model. The reports should also include thorough assessments of the real estate and capital markets. For the latter, transparency and auditing standards should be raised as credit rating for domestic corporate bond issuance is mostly absent, often involving retail investors or insurance companies while relying on the same auditing firm that has worked in the bond issuance process. As a result of a recent self assessment of Basle core principles, the MFSA decided to better separate licensing and supervisory functions. However, a strengthening of supervisory and regulatory arrangements especially to better link macro and micro prudential regulation is warranted, for both the banking sector and capital markets in line with developments at the European level. This should be supported by enhanced coordination between the relevant institutions and more frequent high-level meetings which would also facilitate crisis management.

Authorities’ views

24. The authorities agreed that a conservative supervisory approach is needed to ensure appropriate provisioning given the soft property market and the fact that a substantial proportion of loans is backed by real estate. The authorities also thought that a number of banks would require additional high-quality capital, preferably equity and retained earnings, to ensure sufficient buffers. Moreover, the authorities agreed with the mission’s call for a prompt strengthening of the supervisory and regulatory arrangements to better link macro and micro prudential regulation, and of the crisis management framework. They considered the staffs overall assessment of the financial sector realistic.

V. Staff Appraisal

25. Malta’s economy is expected to grow at a moderate pace over the medium term. Malta is experiencing a robust cyclical upswing driven by strong external demand but more modest growth is expected over the next years while some imbalances and debt overhang need to be worked off. In the long term, growth may exceed the euro area average if reform momentum and diversification into high value export activities is sustained.

26. The government’s goal of reducing the fiscal deficit to 1.4 percent by 2013 is appropriate. Malta’s high vulnerability as a small and very open economy calls for particularly prudent debt management which should also anticipate the tightening of EU-wide rules on high debt. The increase in public debt, guarantees, and implicit liabilities also related to state-owned enterprises, necessitates ambitious fiscal consolidation. Consolidation should be expenditure based and not impede further progress in attracting high value added export activities. Setting expenditure priorities and containing entitlements are crucial for lasting fiscal consolidation.

27. However, there are significant risks that adjustment may fall short of targets, especially in outer years. A more strategic approach for the next budget that protects spending priorities, identifies areas to cut and is fully backed up with concrete measures would raise the credibility of adjustment plans. This would limit the chance of last minute cuts, often at the expense of investment, or missing deficit targets. If the staffs more conservative growth outlook or other risks to the government’s deficit targets materialize, the government should be prepared to introduce additional cost-saving measures, preferably on the expenditure side including through personnel retrenchment. A strengthening of fiscal institutions would safeguard the government’s consolidation plans and the implementation of a legally anchored, strong fiscal rule to better control public expenditure growth should be considered.

28. A comprehensive pension reform is critical to contain its future fiscal costs. Under the current system, Malta’s age-related public spending is projected to increase significantly over the long term and by more than the EU average. A timely but gradual introduction of an additional mandatory and privately funded pillar would allow the government to reduce further the benefits of the pay-as-you-go system over time. Another option would be to gradually transition from a pay-as-you go to a notionally defined contribution system under the condition it delivered the needed cost saving.

29. The authorities need to step up efforts to protect financial stability and safeguard against systemic and fiscal risks. Growing linkages in financial markets require that the central bank’s financial stability assessment include all banks operating in Malta in addition to thorough assessments of the real estate and capital markets. For the latter, transparency should be raised as credit rating for domestic corporate bond issuance is absent and often involves retail investors. A strengthening of supervisory and regulatory arrangements to better link macro and micro prudential regulation is warranted, for both the banking sector and capital markets as is also being implemented at the European level. The crisis management framework should also be enhanced.

30. High credit risk and growing exposure to securities in parts of the Maltese banking sector call for heightened vigilance and determined supervisory action. Vulnerabilities are rising in Malta’s financial sector. The past real estate boom led to a large increase in private debt. More protracted weakness in the real-estate market could lead to financial sector pressures. Some banks need to strengthen their capital buffers, preferably through equity injections and retained earnings. The authorities should discourage bank business models that are overly reliant on ECB facilities for financing large investment portfolios.

31. Raising productivity, skills and employment rates simultaneously is a challenge but necessary for catching up with incomes of richer European countries. State divestment has boosted economic efficiency and should be continued. Wages should follow productivity developments. Employment rates, in particular for women, remain low and more flexible arrangements for part-time work and flexible working practices could help. Support for higher education should increase, but a high quality public primary and secondary education system is also critical to reduce skill mismatch and ensure good employment and income opportunities for all.

32. It is recommended that the next Article IV consultation with Malta be held on the standard 12-month cycle.

Table 1.Malta: Selected Economic Indicators, 2007–16
Est.Proj.
2007200820092010201120122013201420152016
Real economy(Percent change)
Real GDP3.92.7-1.93.12.02.02.02.02.02.0
Domestic demand0.52.7-4.11.21.71.81.92.01.91.9
Consumption0.86.2-0.50.81.31.41.71.81.91.9
Private consumption1.04.4-0.40.81.31.51.82.02.02.0
Public consumption0.012.8-1.01.01.11.31.41.41.51.5
Fixed investment5.0-26.3-16.21.54.94.73.53.22.52.5
Inventory accumulation 1-1.33.6-1.20.30.00.00.00.00.00.0
Foreign balance 13.4-0.22.41.90.30.20.20.00.10.1
Exports of goods and services4.9-5.1-8.218.42.93.43.43.23.23.2
Imports of goods and services1.2-4.8-10.415.82.63.23.23.23.13.1
Potential GDP growth2.32.32.12.12.02.02.02.02.02.0
Output gap (percent of potential GDP)2.83.2-0.90.00.00.00.00.00.00.0
HICP (period average)0.74.71.81.92.12.22.32.42.42.4
GDP deflator2.92.52.62.72.22.22.22.22.22.2
Unemployment rate EU stand. (percent)6.46.07.06.56.56.46.46.46.46.4
Employment growth (percent)3.12.51.10.51.31.51.61.61.51.5
Gross domestic savings (percent of GDP)15.213.39.011.512.012.613.013.413.713.9
Gross capital formation (percent of GDP)20.718.915.816.016.617.117.417.617.817.9
Public finance(Percent of GDP)
General government balance-2.3-4.7-3.7-3.9-3.0-3.0-2.6-2.4-2.4-2.4
Revenue39.939.739.639.339.339.339.339.039.039.0
Expenditure42.244.443.343.242.342.341.841.441.441.4
General government debt61.362.667.767.868.068.167.967.567.267.2
Balance of payments(Percent of GDP)
Current account balance-5.5-5.7-6.8-4.4-4.6-4.5-4.3-4.2-4.1-4.0
Trade balance (goods and services)-1.0-3.00.21.50.90.80.80.70.60.6
Exports of goods and services90.083.172.976.377.878.980.181.582.784.0
Imports of goods and services91.086.072.774.977.078.179.480.882.183.4
Goods balance-17.8-21.2-16.6-18.8-18.9-19.1-19.4-19.7-19.9-20.1
Services balance16.818.316.820.319.819.920.120.420.520.7
Income, net-3.5-3.5-6.4-5.9-5.5-5.3-5.1-4.9-4.7-4.5
Transfers, net-1.00.8-0.60.00.00.00.00.00.00.0
Capital account, net0.90.51.21.51.71.92.12.12.12.1
Financial account, net5.56.02.22.92.92.62.22.12.01.9
Direct investment13.27.49.67.07.58.08.07.88.18.1
Portfolio investment6.76.3-32.7-18.5-18.3-18.1-17.2-17.0-17.0-17.0
Other investment-8.4-9.625.414.413.712.711.411.310.910.8
Reserves (- inflow; + outflow)-5.91.90.00.00.00.00.00.00.00.0
Errors and omissions-1.0-0.83.40.00.00.00.00.00.00.0
Memorandum item:
Nominal GDP (millions of euros)5,5095,7975,8306,1746,4336,7126,9997,2987,6117,938
Sources: National Statistics Office; Central Bank of Malta; Eurostat; and IMF staff estimates.

Contribution to growth.

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

Contribution to growth.

Table 2.Malta: Fiscal Developments and Projections, 2007–13(Percent of GDP)
Est.Proj.
2007200820092010201120122013
Revenue39.939.739.639.339.339.339.3
Current revenue38.939.138.738.138.138.037.9
Tax revenue28.027.427.827.327.227.026.8
Indirect taxes14.614.313.913.813.713.713.8
Direct taxes13.212.813.613.213.213.012.8
Other taxes (capital taxes)0.30.30.20.20.30.20.2
Social security contributions7.27.57.57.37.37.47.3
Other current revenue3.74.33.53.53.53.73.7
Capital revenue1.00.50.91.21.21.31.4
Expenditure42.244.443.343.242.342.341.8
Current expenditure38.241.140.340.039.139.038.4
Wages and salaries12.814.314.313.813.513.613.5
Goods and services5.36.76.16.36.26.16.0
Social transfers13.013.113.913.713.713.813.8
Subsidies2.02.21.11.00.80.80.7
Interest payments3.33.23.13.13.13.13.0
Other current expenditure1.71.61.82.11.71.61.5
Capital expenditure4.03.33.03.23.23.33.4
Overall balance-2.3-4.7-3.7-3.9-3.0-3.0-2.6
Overall balance excl. one-offs-2.9-3.9-3.8-4.0-3.1-3.1-2.6
Memorandum items:
Cyclically adjusted overall balance-2.8-5.3-3.5-3.9-3.0-3.0-2.6
Cyclically adjusted overall balance, excl. one-offs-3.4-4.5-3.6-4.1-3.1-3.1-2.6
Cyclically adjusted primary balance, excl. one-offs-0.1-1.2-0.5-1.00.10.00.4
Primary balance1.0-1.5-0.6-0.80.20.20.4
One-offs0.6-0.80.10.20.10.10.0
Of which: Malta Shipyards reclassification/liquidation-1.1-0.6
Public debt61.362.667.767.868.068.167.9
Government guaranteed debt11.412.1
Sources: National Statistics Office, Eurostat, and IMF staff estimates.
Sources: National Statistics Office, Eurostat, and IMF staff estimates.
Table 3.Malta: Balance of Payments, 2007–16(Percent of GDP)
Est.Proj.
2007200820092010201120122013201420152016
Current account balance-5.5-5.7-6.8-4.4-4.6-4.5-4.3-4.2-4.1-4.0
Trade balance (goods and services)-1.0-3.00.21.50.90.80.80.70.60.6
Goods balance-17.8-21.2-16.6-18.8-18.9-19.1-19.4-19.7-19.9-20.1
Exports43.737.429.635.435.936.336.637.037.237.4
Imports-61.5-58.7-46.3-54.2-54.8-55.4-56.0-56.7-57.1-57.5
Services balance16.818.316.820.319.819.920.220.420.520.7
Exports46.345.643.240.941.942.643.544.545.546.6
Imports-29.5-27.4-26.4-20.7-22.2-22.7-23.4-24.1-25.0-25.9
Current income, net-3.5-3.5-6.4-5.9-5.5-5.3-5.1-4.9-4.7-4.5
Current transfers, net-1.00.8-0.60.00.00.00.00.00.00.0
Private0.3-0.3-0.10.00.00.00.00.00.00.0
Public-1.41.2-0.50.00.00.00.00.00.00.0
Capital account, net0.90.51.21.51.71.92.12.12.12.1
Financial account, net5.56.02.22.92.92.62.22.12.01.9
Direct investment13.27.49.67.07.58.08.07.88.18.1
Portfolio investment6.76.3-32.7-18.5-18.3-18.1-17.2-17.0-17.0-17.0
Other investment-8.4-9.625.414.413.712.711.411.310.910.8
Reserves (- inflow; + outflow)-5.91.90.00.00.00.00.00.00.00.0
Errors and omissions-1.0-0.83.40.00.00.00.00.00.00.0
Memorandum items:
Official reserves, end of period 1/
Gross external debt503.1551.7506.6577.8653.3723.8790.6854.5914.2970.3
Net external debt-88.7-75.9-81.4-80.8-82.1-84.0-86.2-88.3-90.7-93.1
Sources: National Statistics Office; and IMF staff estimates.

Projection for 2008.

Sources: National Statistics Office; and IMF staff estimates.

Projection for 2008.

Table 4.Malta: International Investment Position, 2003–09
2003200420052006200720082009
(Millions of Euros)
International investment position1,7841,8151,7791,41992151769
Direct investment-1,881-2,159-2,805-4,121-4,875-5,142-5,495
Assets7378238418748207691,041
Liabilities-2,618-2,982-3,645-4,994-5,695-5,911-6,536
Portfolio investment5,2716,7909,64110,96310,2899,63511,935
Assets5,6017,14410,05411,37110,69610,19112,437
Liabilities-329-355-413-408-407-556-502
Of which: debt instruments-292-237-231-222-228-393-358
Financial derivatives-21-27-2-1528-5-43
Other investment-3,786-4,818-7,244-7,649-7,082-4,705-6,001
Assets5,8036,7459,59612,35119,40425,70521,857
Liabilities-9,590-11,563-16,839-19,999-26,486-30,410-27,859
Reserves2,2002,0292,1892,2412,561268374
(Percent of GDP)
International investment position40.640.436.927.616.70.913.2
Direct investment-42.9-48-58.1-80-88.5-88.7-94.2
Assets16.818.317.41714.913.317.9
Liabilities-59.6-66.4-75.6-97-103.4-102-112.1
Portfolio investment120.1151.1199.8212.9186.8166.2204.7
Assets127.6159208.4220.8194.2175.8213.3
Liabilities-7.5-7.9-8.6-7.9-7.4-9.6-8.6
Of which: debt instruments
Financial derivatives-0.5-0.60-0.30.5-0.1-0.7
Other investment-86.3-107.2-150.1-148.5-128.6-81.2-102.9
Assets132.2150.1198.9239.8352.2443.4374.9
Liabilities-218.5-257.4-349-388.3-480.8-524.6-477.8
Reserves50.145.245.443.546.54.66.4
Memorandum items:
Gross external debt (millions of euros)10,15712,12017,58521,12427,71631,98229,534
Gross external debt (percent of GDP)231.5269.8364.5410.2503.1551.7506.6
Net external debt (percent of GDP)-81.9-87-86.4-89.1-88.7-75.9-81.4
Sources: Central Bank of Malta; and IMF staff estimates.
Sources: Central Bank of Malta; and IMF staff estimates.
Table 5.Malta: Financial Soundness Indicators, 2005–10(Percent)
200520062007200820092010
Banking sector (unless noted, includes internationally-oriented banks) 1/
Regulatory capital to risk-weighted assets20.422.020.317.724.255.2
Regulatory Tier 1 capital to risk-weighted assets19.020.819.015.721.452.7
Nonperforming loans net of provisions to capital20.112.510.610.812.65.6
Nonperforming loans to total gross loans3.92.81.81.72.62.3
Return on assets1.41.31.00.61.81.3 (*)
Return on equity13.012.711.94.612.25.5 (*)
Interest margin to gross income48.656.456.359.549.864.0 (**)
Noninterest expenses to gross income41.444.453.860.426.330.2 (**)
Liquid assets to total assets21.719.721.917.416.514.8
Liquid assets to short-term liabilities55.752.552.749.347.549.8
Net open position in foreign exchange to capital 2/1.02.28.8-0.40.2-0.2
Capital to assets12.914.213.712.615.230.9
Gross asset position in financial derivatives to capital1.41.21.85.90.50.5
Gross liability position in financial derivatives to capital1.91.41.15.11.61.2
Trading income to total income 3/22.718.020.01.333.317.5 (**)
Personnel expenses to noninterest expenses40.936.825.726.440.146.8 (**)
Customer deposits to total (noninterbank) loans100.175.466.058.774.480.5
Net open position in equities to capital34.524.920.711.717.57.1
Residential real estate loans to total loans13.212.810.49.512.211.5
Commercial real estate loans to total loans18.218.120.119.422.517.1
Spread between reference lending and deposit rates (basis points)347.8345.3348.1266.4259.2223.2
Domestically oriented banks
Regulatory capital to risk-weighted assets17.115.014.714.615.914.9
Regulatory Tier 1 capital to risk-weighted assets15.613.512.712.513.011.8
Nonperforming loans net of provisions to capital33.629.926.326.531.338.1
Nonperforming loans to total gross loans7.45.95.14.85.66.3
Return on assets1.61.81.5-0.32.11.3 (*)
Return on equity12.815.414.1-3.420.312.6 (*)
Interest margin to gross income66.064.667.5154.051.369.2 (**)
Noninterest expenses to gross income46.044.143.6106.137.747.1 (**)
Liquid assets to total assets23.121.824.320.320.923.2
Liquid assets to short-term liabilities53.050.349.045.143.746.9
Net open position in foreign exchange to capital 1/-2.91.40.4-0.80.00.3
Capital to assets12.010.910.59.510.610.7
Gross asset position in financial derivatives to capital2.43.03.515.01.11.7
Gross liability position in financial derivatives to capital3.03.32.48.33.97.6
Trading income to total income 2/11.18.25.9-108.527.210.2 (**)
Personnel expenses to noninterest expenses54.053.855.956.856.054.8 (**)
Customer deposits to total (noninterbank) loans132.5127.3136.2120.3118.1124.0
Net open position in equities to capital47.148.441.320.939.442.0
Residential real estate loans to total loans25.326.930.530.031.433.2
Commercial real estate loans to total loans32.332.732.831.831.530.1
Spread between reference lending and deposit rates (basis points)347.8345.5348.3301.1265.4312.3
Source: Central Bank of Malta.

The spike in CAR is due to the inclusion of an international bank in March 2010, which had substantial amount of capital.

Break in time series in 2007 due to change in the reporting schedule.

Prior to 2008 a different methodology was used. The results under the old methodology for 2007 were 10.5 and -5, and for 2008 the results were -5.7 and -122.4 for the total and domestically oriented banks, respectively.

End-September 2010, net priofit before tax is the flow for a year (Oct-09, Sep-10)

End-September 2010, covers the period Jan-Sep 2010.

Source: Central Bank of Malta.

The spike in CAR is due to the inclusion of an international bank in March 2010, which had substantial amount of capital.

Break in time series in 2007 due to change in the reporting schedule.

Prior to 2008 a different methodology was used. The results under the old methodology for 2007 were 10.5 and -5, and for 2008 the results were -5.7 and -122.4 for the total and domestically oriented banks, respectively.

End-September 2010, net priofit before tax is the flow for a year (Oct-09, Sep-10)

End-September 2010, covers the period Jan-Sep 2010.

In its Financial Stability Reports, the central bank classifies banks based on their business into internationally- and domestically-oriented banks which are defined by a combined minimum-threshold resident exposure of one percent for several asset categories (assets, deposit, securities). However, reclassification often takes place with significant lags if licensed banks decide to alter their business model.

Progress and key challenges in the delivery of adequate and sustainable pensions in Europe (European Economy, Occasional Papers. 71. November 2010).

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