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Malta: 2019 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Malta

Author(s):
International Monetary Fund. European Dept.
Published Date:
February 2019
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Context and Key Policy Issues

1. The rapid expansion of services exports continues to support Malta’s robust growth. Real GDP growth averaged 7.2 percent over 2013–17, against the backdrop of structural rebalancing towards fast growing export-oriented services industries, notably remote gaming. This structural shift has boosted the current account balance and facilitated rapid income convergence to the EU average. The share of foreign workers in total employment roughly tripled between 2010 to 2017, supporting buoyant job creation.

Key Economic Indicators

(2000Q1=100, seasonally adjusted)

Source: Haver Analytics.

Employment by Citizenship

(Thousands)

Source: Eurostat.

2. But the economy faces capacity constraints. The strong economic expansion is exacerbating bottlenecks. Physical infrastructure gaps, including in road quality and waste management, may weigh on future productivity and social welfare. Firms continue to face skills shortages as labor supply has become heavily dependent on migrant inflows. And while supply in the housing market gradually catches up with strong demand, property prices and rents in the nonprotected market are rising fast, intensifying affordability concerns. The authorities have devised plans to address these issues (Annex III), but the effects of the measures may take time to fully materialize.

Quality of Roads

(1-7, 7=best)

Source: World Economic Forum.

Monthly Rent of 2-bedroom Flats 1/

(2003–2017 percent change; deflated by CPI)

Sources: EC Estate Agency Rent Surveys and Haver Analytics.

1/ Data refer to selected cities.

Recent Developments

3. Rapid growth continued but the economy may be approaching its cyclical peak. After expanding by 6.6 percent in 2017, real GDP grew by 6.3 percent (y/y) in the first three quarters of 2018, reflecting strong private and public consumption growth. In contrast to 2016–17, the contribution of net exports to growth was small due to the deceleration of real exports and a slight pickup in imports. Several high-frequency indicators, including impressive employment creation, suggest continued growth momentum in the near term. The unemployment rate remained below 4 percent as of 2018:Q3.

Contributions to GDP Growth

(Percentage points; year-on-year)

Sources: Haver Analytics and IMF staff calculations.

4. Inflation has picked up somewhat. In 2018, headline and core inflation (which excludes energy and unprocessed food) gained some pace but remained below 2 percent. Services were the main contributor to inflation, especially tourism-related categories such as accommodation services. Hourly labor costs for the whole economy increased by 1.6 percent in 2018:Q3 compared with a year earlier, below the EU average. Strong inflows of foreign workers and rising labor force participation have helped contain generalized wage pressures, even if signs of acceleration are visible in certain sectors.

Inflation and Labor Cost

(Year-on-year percent change)

Source: Haver Analytics.

5. Public finances have continued to improve. The 2017 fiscal balance printed at a record surplus of 3.5 percent of GDP, outperforming last year’s projection of only 0.8 percent of GDP and a budget target of 0.5 percent of GDP. Even excluding the large proceeds from the Individual Investor Program (IIP), the surplus reached 1.3 percent of GDP (1.3 percent of GDP in structural terms), supported by large and partly cyclical tax revenues and contained public-sector compensation. This is well above the medium-term objective (MTO) of a structural balance and helped reduce the public debt to about 50 percent of GDP at the end of 2017.

6. The current account balance remained on a positive trend, driven by strong services exports. The external position is assessed to be moderately stronger than fundamentals and desirable policy settings. The current account surplus surged from 3 percent of GDP in 2016 to 10 percent of GDP in 2017 as imports of capital goods moderated following a one-off investment in the aviation sector. The trend continues to be driven by a sizable and increasing trade surplus in services, largely accounted for by remote gaming and tourism. Consecutive current account surpluses in recent years have also contributed to increase the net international investment position (NIIP), which rose to 66 percent of GDP in 2017, the highest in the EU. Following a decline between 2013 and 2015, the real effective exchange rate (REER) stabilized and only recently appreciated to above pre-crisis levels. Due to its status as a small financial center, Malta hosts a large number of special purpose entities (SPEs) and multinationals— complicating the measurement of the current account—and is undergoing rapid structural changes, all of which introduces high uncertainty to normative conclusions regarding the external position. Relying on IMF methodologies and judgment, staff assess that Malta’s external position was moderately stronger than fundamentals and desirable policy settings in 2018 (see Annex II, Annex IV, Figure 5).

Figure 1.Malta: Economic Indicators

Sources: Central Bank of Malta; Eurostat; IMF World Economic Outlook; and IMF staff calculations.

Figure 2.Malta: Short-Term Indicators

Sources: European Central Bank; Central Bank of Malta; European Commission; and IMF staff calculations.

Figure 3.Malta: Fiscal Developments

Sources: Eurostat, Haver Analytics, and IMF staff.

Figure 4.Malta: Financial Soundness Indicators 1/

1/ The financial soundness indicators cover only core domestic banks in Malta, except for credit growth, deposit growth, and housing market exposure where the total banking sector is included.

Sources: IMF, Financial Soundness Indicators, Central Bank of Malta, Malta Financial Services Authority, and IMF staff.

Figure 5.Malta: External Sector

Sources: Haver Analytics; Eurostat; UNCTAD; IMF World Economic Outlook; and IMF staff.

Current Account Components

(Percent of GDP)

Sources: IMF BOP Statistics and IMF staff calculations.

Unit Labor Cost

(Year-on-year percent change)

Sources: Haver Analytics and IMF staff calculations.

7. Bank lending has been lagging economic activity reflecting diverging trends in mortgage and nonfinancial corporate (NFC) loans. Household leverage1 remained above the euro area average as banks continued to focus on mortgage credit, increasing the sector’s exposure to the housing market. Although credit to NFCs has staged a gradual recovery in 2018 following a five-year contraction, it still grows more slowly than nominal GDP. NPLs in core banks have been reduced rapidly between 2014 and 2017 but progress has stalled since then.

Non-Performing Loans (Percent of total loans) and Coverage Ratio (Percent of NPLs)

Source: Central Bank of Malta and ECB.

1/ Core domestic banks.

2/ All domestic banks. The reporting framework is FINREP since 2014Q4.

Credit to Domestic Economy

(Year-on-year percent change)

Sources: Central Bank of Malta and IMF staff calculations.

Outlook and Risks

8. Growth is projected to gradually moderate as the output gap closes. Real GDP growth is expected to remain robust, easing to 6.4 percent in 2018 and 5.2 percent in 2019, with highly elastic foreign labor supply supporting potential output. Then, growth would gradually converge to its potential rate of slightly above 3 percent as capacity constraints hamper labor supply and total factor productivity growth – temporarily boosted by efficiency gains in the energy sector and inflows of highly educated foreign workers – slows down to its long-term average pace. The small positive output gap is projected to close over the medium term, consistent with the projected evolution of the unemployment gap, labor compensation and inflation which is set to remain around 2 percent over the near to medium term. Domestic demand is projected to become the main driver of growth as a strong labor market supports private consumption and planned private and public investment projects materialize. While both export and import growth are expected to moderate, the current account surplus should remain large over the forecasting horizon, reflecting enduring trade surpluses in services.

Real GDP (Year-on-year percent change) and Output Gap (Percent of potential GDP)

Sources: WEO and IMF staff calculations.

Malta: Contributions to Potential GDP Growth

(Percentage points)

Sources: Haver Analytics, AMECO, and IMF staff calculations.

9. Risks to the outlook are broadly balanced. On the downside, unsustainable macroeconomic policies in systemically important countries, rising global protectionism, a no-deal Brexit, or a sharp tightening of global financial conditions could significantly reduce exports (especially of services) and FDI flows to Malta. Moreover, possible changes in international corporate and personal taxation could adversely affect foreign investment inflows and reduce demand for the IIP, with negative effects on growth, tax revenues and the external position. A sharp correction in housing prices could trigger adverse macrofinancial effects, while slow progress in addressing structural deficiencies may limit potential growth, including by hurting competitiveness and deterring foreign workers. Given Malta’s exposure to money laundering risks, a failure to effectively implement the AML/CFT framework could undermine the business and financial environment and potentially imperil financial stability. On the upside, employment growth and private consumption could continue to surprise positively, the import intensity of domestic demand could continue to decline, and investment plans (including from businesses related to the blockchain) could be implemented faster than expected possibly implying higher potential growth (see Annex V: RAM).

Authorities’ Views

10. The authorities broadly agreed with staff’s assessment of the outlook and risks. Domestic demand would continue to be the main driver of growth, and persistent labor market tightness might eventually put some pressure on wages and prices. They consider global protectionism as a key external risk and emphasized ongoing actions to address domestic risks related to money laundering. While potential growth is expected to remain healthy, they highlighted their actions and plans to upgrade infrastructure and mitigate labor supply constraints, including by streamlining bureaucratic steps for hiring foreign workers. The government stressed the importance of investing in new technologies, such as blockchain or artificial intelligence, to diversify the economy and support future growth. Finally, the authorities consider that the large current account surplus is sustainable and mainly driven by structural factors, emphasizing that there are no significant macroeconomic imbalances.

Policy Discussions

A. Safeguard Financial Stability and Integrity

Malta’s financial system is large and complex. The share of foreign ownership and exposure is high, but thanks to a liquid, deposit-based domestic core banking system the domestic economy remains relatively insulated from international financial shocks. Following the global financial crisis, domestic core banks have become increasingly focused on mortgage lending as intercompany loans substituted for bank credit to NFCs. The FSAP has highlighted the resilience of the banking sector to real and housing shocks, but stressed shortcomings in banking supervision—which extend to the implementation of the AML/CFT framework—and in the legal regime for banks winding-up and insolvency proceedings.2

11. The banking system remains well capitalized, liquid and profitable, but faces challenges ahead. Core domestic banks’ capital stayed above 17 percent of risk-weighted assets in 2018H1, with a loan-to-deposit ratio hovering around 60 percent. Findings from a stress test covering 11 banks3 conducted as part of the FSAP for Malta confirmed that the overall banking system is well capitalized and liquid, with vulnerabilities limited to a few small banks. While banks’ profitability remains above peers in the euro area, it is at risk of erosion due to rising exposure to low-yield bonds, a shrunk corporate loan portfolio, increased regulatory compliance costs and the implementation of the minimum required eligible liabilities (MREL). Competition from rapidly growing corporate bonds market and non-bank financial institutions could pose a challenge in the long run. Partly reflecting recent regulatory reforms (including the phased in threshold on NPL ratio at 6 percent over 5 years) the overall NPL ratio of core domestic banks was reduced from 9 percent to slightly above 4 percent over 4 years. However, this positive development seems to have stalled in 2018 and legacy NPLs in construction and real estate sectors continue to weigh on banks’ balance sheets, reflecting enduring inefficiencies in the corporate insolvency process.

Maltese Domestic Banks: Profits and Losses

(Percent of assets)

Sources: European Central Bank and IMF staff.

1/ RoA is based on a four-quarter moving average.

12. The rapidly rising importance of intercompany lending and non-bank financial institutions warrants enhanced data collection and monitoring efforts. As bank lending conditions tightened post-crisis, corporates have been gradually diversifying their source of funds towards non-bank financial intermediaries. Intercompany loans have become the most important source of funds for Maltese firms, potentially increasing contagion risks as concentration and liquidity risks could be significant in the corporate sector. At the same time, direct issuance of corporate debt and credit from non-bank financial institutions have also increased fast, but from a low level. Strong inter-linkages between some insurance companies and large domestic financial groups may also further elevate contagion risks. Against this backdrop, recent efforts in collecting granular loan-level data and the establishment of a central credit registry will help close some of the data gaps. To improve the monitoring of contagion risks, they need to be complemented by data on sectoral and cross-border intercompany financing. The FSAP also stressed that enhancing the analytical tools to assess systemic risks in the non-bank financial sector would help further mitigate financial stability risk.

Corporate Loans

Sources: ECB and IMF staff calculations.

Corporate Sector Financing

(Percent of GDP)

Sources: Central Bank of Malta and IMF staff.

13. Capacity constraints and deficiencies in the regulatory framework undermine the effectiveness of financial supervision and crisis management. The increasing number of financial entities under supervision, the rapid development of new products and the evolving regulatory framework have put the Malta Financial Services Authority’s (MFSA) under considerable strain. The FSAP highlighted that large gaps in operational capacity for the supervision, winding-up and crisis management functions have become apparent and need to be addressed urgently (see Annex VII, FSAP’s main recommendations).

  • The authorities need to take rapid actions to ensure the long-term financial and operational independence of supervisory authorities. They are encouraged to rapidly develop a medium-term quantitative assessment of resource needs, including by mapping required skills, and to conduct regular reviews of the compensation package to guarantee the MFSA’s capacity and autonomy to recruit and retain qualified staff. The authorities should also develop a five-year plan to ensure sustained budgetary resources for the MFSA. This is all the more urgent that the effective implementation of the new regulations regarding the licensing and supervision of crypto-asset-related companies will demand significant resources and appropriate expertise.

  • The crisis management framework should be improved. Protracted and recurrent delays in liquidating banks demonstrate a lack of clarity in the legal insolvency regime, which should be administrative (led by the resolution arm of the MFSA), in line with international standards, rather than court-led. As a prerequisite for efficient insolvency proceedings, the creditor hierarchy in liquidation should be clarified.

14. The recent revocation of Pilatus bank’s license by the ECB has highlighted important deficiencies in the implementation of Malta’s AML/CFT framework. An investigation by the European Banking Authority (EBA) into the country’s supervisory and enforcement approach in relation to Pilatus bank pointed to general and systemic shortcomings in the Financial Intelligence Analysis Unit’s (FIAU) application of the national rules that transposed European anti-money laundering directives (3rd AMLD)4 and in the MFSA’s authorization and supervisory practices. These concerns were echoed by the FSAP which also emphasizes that AML/CFT supervisors need to focus on banks’ application of preventive measures regarding their higher risk services and clients, including the significant nonresident sector, politically exposed persons, new technologies (e.g., remote gaming, crypto-currencies) and the IIP.

15. The Maltese authorities need to take immediate actions to contain financial integrity risks. Given the size and importance of Malta’s financial sector, the exposure of certain banks to correspondent banking risk, the fast-growing remote gaming sector and the high demand for the IIP, the effective enforcement of the AML/CFT framework is critical. The measures taken to implement the recently-enacted 50-point action plan (based on the latest National Risk Assessment) are steps in the right direction, and the authorities should endeavor to implement the plan in full without delay. The FSAP recommends a multi-prong approach, with a focus on developing more effective AML/CFT enforcement and ensuring that banks apply preventive measures in relation to their high-risk activities and clients. First and foremost, supervisory resources at both FIAU and MFSA should be increased and steps should be taken to improve the understanding of risks and enhance their identification through intrusive, risk-based supervision. Second, the authorities need to ensure the effective application of AML/CFT preventive measures (customer due diligence, including with regard to beneficial owners). Third, implementation of fit and proper tests must be enhanced for financial institutions. Fourth, timely, dissuasive and proportionate sanctions must be imposed whenever breaches of AML/CFT requirements are identified. Finally, the authorities are also encouraged to pursue regional options for strengthening AML/CFT supervision, which would facilitate a consistent and comprehensive approach and minimize regulatory arbitrage.5

16. Malta’s new development areas related to the distributed ledger technology (DLT) present both opportunities and risks. The passage of three bills in June 2018 was an important milestone in establishing a new regulatory framework for DLT and virtual financial assets.6 This made Malta one of the first countries to provide a specialized regulatory framework to previously unregulated activities and is expected to lead to the migration of some of the largest crypto-asset exchange platforms to the island. Technological innovations surrounding the DLT may provide new growth opportunities for Malta, but these developments exacerbate existing risks and create new ones, particularly financial integrity risks, as the enforcement of the AML/CFT framework is more challenging when virtual financial assets are involved. Given the relatively high ML/TF risk associated with these new activities, the authorities should ensure that virtual financial asset service providers implement AML/CFT requirements in effective manner and are supervised in line with the Financial Action Task Force standards.

Authorities’ Views

17. The authorities remain committed to safeguard financial stability and integrity. They acknowledged that the effective implementation of the AML/CFT framework is crucial, especially for banks to retain their correspondent banking relationships. The authorities reiterated their commitment to improve the understanding of ML/TF risks and enhance their identification through risk-based supervision and are closely cooperating with the European Banking Authority towards this goal. In line with FSAP recommendations, the FIAU and the MFSA have recently institutionalized their collaboration in a memorandum of understanding, and plan to conduct joint on-site inspections of high-risk cases. Both outsourcing and foreign hiring are considered given important skill shortages in the domestic labor market. To safeguard the operational independence of the MFSA, Cabinet has approved that future funding of the MFSA will be sourced through an overhaul of the MFSA’s fee structure coupled with government’s budgetary support. While embracing blockchain technology, the authorities agreed that the risks associated with crypto-asset-related activities warrant a robust regulatory framework and require significant supervisory resources and expertise. In this light, the Government has enacted a robust regulatory legislation. They stressed that no services providers had yet been licensed. since the due diligence process is underway.

B. Contain Housing Market Pressures

Rapidly rising house prices and rents may eventuaiiy pose financial stability risks while putting some vulnerable households at risk of poverty. Policies that help mitigate the rapid increase of house prices and make rents more affordable while strengthening households and banks’ balance sheets should be encouraged.

18. Strong demand for housing has continued to push up property prices. While some signs of overvaluation have started to emerge, recent house price trends can largely be explained by fundamentals such as e.g., strong immigration flows, rising disposable income, portfolio rebalancing towards property investment and a delayed supply response. Other factors such as the extension of the first-time home-buyer stamp duty relief, the reduced tax rate on rental income, surging demand for tourist accommodation and, for the high-end segment, the IIP may also have played a role (but are not directly controlled for in the empirical analysis conducted in Annex I).

Residential Property Prices

(Year-on-year percent change; 4-quarter moving average)

Sources: Central Bank of Malta, Eurostat, and IMF staff.

Development Permits for Dwellings

(Number of units)

Sources: Central Bank of Malta and IMF staff calculations.

19. Banks’ exposure to housing-market-related risks is high and increasing, and the introduction of macroprudential measures should proceed as planned. All the more so that households’ indebtedness is relatively high, low income households are vulnerable to housing price corrections and flexible interest rate on mortgages are prevalent7 Against this backdrop, recent efforts to close data gaps (loan-level data collection) and the planned introduction of borrower-based macroprudential measures such as caps to loan-to-value (LTV) ratios at origin, stressed debt-service-to-income (DSTI) limits, and amortization requirements are steps in the right direction (see text table).

20. To be more effective, the new borrower-based measures could be refined in due course and exemptions to the LTV limit could be narrowed. To avoid excessive risk concentration, speed limits should be defined in terms of the total value of new loans, not in terms of the number of new loans, and speed limits for loans against secondary and buy-to-let properties, the likely most speculative segment, should be lowered as soon as concerns about any initial disruptions dissipate.8 Finally, the scope of the new borrower-based measures should be extended to also cover non-bank mortgage loans.9

Malta: Borrower Based Macroprudential Measures
LTV-O 2/DSTI-O 2/Maturity
Category I Borrowers 1/90 percent LTV-O cap with a “speed limit” of 10 percent on the volume of loans, for loans with a market value in excess of €175,000.A stressed DSTI-O of 40 percent for loans with a market value in excess of €175,000 with a shock to interest rates of 150 bps.A maturity term of 40 years or the official retirement age, whichever occurs first.
Category II Borrowers 1/1st year:85 percent LTV-O cap with a “speed limit” of 20percent on the volume of loans.A stressed DSTI-O of 40 percent with a shock to interest rates of 150 bps .A maturity term of 20 years or the official retirement age, whichever occurs first.
2nd+ year:75 percent LTV-O cap with a “speed limit” of 20 percent on the volume of loans.

Category I comprises borrowers purchasing their primary residential property and Category II comprises borrowers purchasing their second or additional residential property or buy-to-let properties.

LTV-O refers to the Loan-to-Value-at-Origination ratios. DSTI-O refers to the Debt-Service-to-Income-at-Origination ratios.

Source: CBM

Category I comprises borrowers purchasing their primary residential property and Category II comprises borrowers purchasing their second or additional residential property or buy-to-let properties.

LTV-O refers to the Loan-to-Value-at-Origination ratios. DSTI-O refers to the Debt-Service-to-Income-at-Origination ratios.

Source: CBM

21. Rapidly rising housing costs are affecting vulnerable households. The government recently relaxed the eligibility requirements for rent subsidies, but the scheme should be periodically reviewed to ensure it remains targeted on low-income households. Further efforts should also be envisaged to accelerate the provision of social housing, including by fiscally incentivizing private investments.

Authorities’ Views

22. Rapidly rising property prices are viewed by the authorities as mainly reflecting economic fundamentals. Inflows of foreign labor and higher income in general are fueling housing demand. The authorities also see the impact of tax benefits for first and second-time home buyers, the reduced tax rate on rental income and the IIP as marginal. They stressed that the planned borrower-based macroprudential measures were carefully calibrated to have minimal market impact upon their introduction. The authorities have agreed that there is room for refinement, in due course, and emphasized that they can easily recalibrate the measures to mitigate financial stability risks emanating from the housing market in a timely and effective manner. The authorities also recognize the growing importance of making housing more affordable for vulnerable households. They emphasized the progressive nature of the new rent subsidy scheme. Projects are underway to increase the stock of social and affordable housing.

C. Maintain Prudent but Growth Enhancing Fiscal Policy

Fiscal policy needs to shift the balance of expenditures towards infrastructure, contain long-term fiscal risks, improve public investment management and risk analysis, and strengthen revenue collection.

23. The government is expected to over-achieve its budget target in 2018. Outturns as of November 2018 suggest another year of fiscal surplus, owing to buoyant tax revenues and IIP proceeds. Allowing for an expected acceleration of public investment (including EU-funded investment) in the second half of the year, staff projects an overall balance of 0.9 percent of GDP in 2018, well above the initial government surplus target of 0.5 percent of GDP. The debt-to-GDP ratio is estimated to moderate further to 45 percent at the end of 2018. Excluding the IIP proceeds, the balance would be a deficit of 0.7 percent of GDP (1.2 percent of potential GDP in structural terms).

Public Debt and Fiscal Balance

(Percent of GDP)

Sources: Eurostat; and IMF staff’s calculations.

The Structural Balance and Output Gap

(Percent of potential GDP)

Source: IMF staff.

24. Plans to reach fiscal balance without relying on net IIP appear appropriate and within reach in the medium term. On the expenditure side, the 2019 budget envisages marginal declines in employee compensations, social payments and interest expenditure as a share of GDP. The tax burden is also reduced for targeted groups (such as low-income earners, single part-time workers, and first-time home buyers). In the short to medium term, the government aims for a positive structural balance, which seems appropriate given the currently favorable cyclical position, still elevated contingent liabilities related to financially weak SOEs and strong demographic pressures. Public debt appears sustainable and is projected to reach 30 percent of GDP in 2023, but remains vulnerable to contingent liability shocks (see DSA Annex VIII) and long-term prospective increases in age-related spending (see text chart). Overall, staff projects a deficit of 0.9 percent for the structural balance net of IIP in 2019 and a convergence to a structural balance net of IIP proceeds by 2022 (see text table).

Malta: Fiscal Estimates and Projections(Percent of GDP)
Staff Projections
201820192020202120222023
Revenue38.237.537.337.037.136.0
Expenditure37.336.936.736.336.435.4
Overall balance0.90.60.60.70.70.6
Structural balance0.40.30.40.70.80.7
Structural balance, excl. IIP proceeds-1.2-0.9-0.6-0.20.00.2
Public debt45.442.439.035.632.130.0
Source: IMF staff.
Source: IMF staff.

25. Efforts to contain fiscal risks and shift the balance of expenditure towards growth enhancing public investment should remain the priority over the coming years. To ensure space for much needed, long-term growth-enhancing investment in infrastructure (transportation, energy, water-resource and waste-management) and inclusion-promoting measures (see section D), continued effort is needed to strengthen the structural fiscal position ex-IIP proceeds. The planned institutionalization of the comprehensive spending reviews should help identify further saving opportunities. Moreover, given large projected demographic pressures, further incentives to deter early retirement and increase the take-up of private pension schemes should be explored. On the revenue side, Malta’s high reliance on the IIP and corporate tax makes it vulnerable to possible regime changes. Positive steps have been made to help combat tax evasion and avoidance and increase VAT compliance, including the introduction of an electronic tax filing system, a framework to write-off legacy arrears, and the transposition into national law of the EU anti-tax avoidance measures planned over 2019–2022. Further avenues for broadening the tax base should be explored.

Corporate Income Tax Revenue, 2017

(Percent of total revenue)

Sources: Eurostat and IMF staff.

Change in Age Related Spending, 2016–70

(Percent of GDP)

Source: European Commission The 2018 Ageing Report.

Note: The age-related spending is updated given new populations statistics.

New estimates will likely yield lower expected expenditure.

26. Improving fiscal transparency would also help manage fiscal risks. An IMF Fiscal Transparency Evaluation, conducted in May 2018, assessed Malta’s fiscal transparency practices (see Annex VI). Overall, Malta meets many of the fiscal transparency principles at good or advanced level, but there remain gaps to be closed. In substance, the coverage of fiscal reports should be extended to the entire public sector and the reporting on tax expenditures, extrabudgetary units, and performance information should be improved. Presentations across reports could be better harmonized and changes to previous forecasts better explained. Staff also recommended improving public investment management and risk analysis by introducing a cost-benefit analysis and publishing annual fiscal risk statements. The institutional framework for managing fiscal risks should also be strengthened, notably in relation to public corporations. This would help better monitor and advance the restructuring of financially weak SOEs.

Authorities’ Views

27. The authorities reiterated their commitment to maintain prudent fiscal policy. They expect continued fiscal surpluses supported by high tax revenues reflecting the strong economy. Prudent spending and lower debt are also expected to gradually create additional space for investment and social transfers. The government’s ability to further conduct spending reviews and implement recommendations is being strengthened through staff training partially financed by an EU grant. It is to be noted that in 2017, the Government achieved its fiscal targets net of IIP revenue. While revenues from the IIP are expected to remain sizable, the authorities expect to achieve their medium-term fiscal targets without relying on IIP proceeds, bolstering fiscal sustainability and maneuverability. The government stressed that addressing infrastructure gaps and social challenges arising from rapid growth remain its priority. Finally, work is underway to start publishing fiscal data with a wider coverage of the public sector in 2019, in line with the recommendation of the FTE conducted by the IMF in 2018.

D. Promote High and Inclusive Growth

Addressing remaining structural weaknesses will help sustain Malta’s strong growth momentum while promoting inclusiveness. To boost the economy’s productive capacity and improve labor productivity, priority areas should include public infrastructure, access to finance, judicial reforms, innovation, labor force participation and skills gaps.

28. The authorities’ focus on upgrading road infrastructure is appropriate. Weak road quality has led to severe congestion, with adverse impact on productivity and health. While a €700 million, seven-year plan to upgrade roads is already underway, it is important to ensure that some attention is also given to efficiency aspects for maximizing output gains. Public investment efficiency could be improved by reviewing administrative procedures and avoiding bottlenecks, for instance by removing overlapping responsibilities and moving towards a holistic public investment management approach across government departments. Better planning could also improve the implementation of projects co-financed by EU funds or the private sector through PPP and avoid bottlenecks. To address some of these issues, a new entity was recently created to implement and maintain public infrastructure projects in roads and other sectors.10

29. SMEs’ enhanced access to finance may help boost innovation and investment. R&D expenditure indicators remain low in comparison to the EU average. The prevalence of SMEs in Malta—which tend to have a limited capacity to grow due to their constrained access to finance, among other factors—may partly explain why innovation activity tends to lag European peers. Strengthening innovation would help boost productivity growth, and the authorities’ focus on startups, for example through financial support provided by Malta Enterprise to innovative businesses and programs involving tax credit incentives (Seed Investment Scheme) should be encouraged. The Malta Development Bank is also expected to start providing investment finance to SMEs in coming months, which could contribute to offset the recent decline of private banks’ lending to SMEs. Ensuring prudent risk assessment and robust governance structures will be key. Furthermore, improvements in the judicial system’s efficiency, especially for insolvency proceedings, could help increase credit provision to SMEs by accelerating the necessary clean-up of firms’ and banks’ balance sheets. Despite recent progress, the time needed to resolve civil, commercial, administrative and other cases in Malta is still among the highest in the EU (see 2018 EU Justice Scoreboard).

R&D intensity 1/

(Percent of GDP)

Source: Eurostat

1/ Defined as expenditure on R&D as % of GDP.

Time Needed to Resolve Civil, Administrative, Commercial and Other Cases, 2016

(1st instance/in days)

Source: 2018 EU Justice Scoreboard.

30. Promoting social inclusion may help boost long-term output. The share of the population at risk of poverty is relatively stable and below the European average, but it is high and has been increasing for subgroups of the population: female single earners, low-skilled part-time workers, unemployed and the elderly. For the most vulnerable, the situation is made worse by the rapid increase of housing costs, in particular rental costs. Tenants are often low-skilled, single earners, unemployed or elderly. The authorities have introduced many programs to address social exclusion, but recent trends suggest that there is scope for more actions. Staff analysis (see SIP) suggests that measures that aim to incentivize female labor market participation, align retirement age with life expectancy and enhance workers’ skills would foster inclusion and, at the same time, boost long-term output, thereby mitigating the long-term burden on public finances of these measures.

  • There is scope to further increase female and elderly participation in the labor market. Recent government initiatives to “make work pay,” including free childcare, in-work benefits, and the tapering of benefits for those entering employment, have been instrumental in increasing female labor force participation. But continuous efforts are needed to reduce the remaining gender gap, especially for older cohorts, and the increasing pay gap. While part of the remaining gap should decline over time as younger cohorts mature and older cohorts reach retirement age, further initiatives such as introducing some compensation for parental leave or increasing leave entitlement for fathers could help ensure full convergence to EU average. Also, while the statutory retirement age is scheduled to increase gradually to 65 years by 2026, there is scope to better align the effective retirement age to life expectancy by incentivizing later retirement, including through penalties for early retirement and sponsoring of lifelong learning. The government’s plan to extend to public sector employees the private-sector’s delayed pension incentives is a step in the right direction.

  • Upskilling and reskilling workers remains a priority. Policies to improve human capital would help strengthen the effects on growth of enhanced innovation and investment. Although Malta invests heavily in education, basic skills attainment among young people is still weak and strongly influenced by socio-economic status. Also, large gaps vis-à-vis the EU average remain in terms of the early school leaving rate and tertiary educational attainment. These weaknesses underpin widespread skills shortages, which have become a barrier to investment according to survey evidence, as well as the increasing dependence on higher-skilled foreign workers. The new Work-based Learning and Apprenticeship Act came into force in March 2018, creating a legal framework for vocational education and training focused on school-leavers, and aiming to address skills shortages. This act will simplify data collection on training programs, which should help improve outcome-based evaluation.

At Risk of Poverty Rate /1

(Percent of population)

Source: Eurostat.

1/ Defined as 60 percent of the median equivalized income and for the age class 18 years or over.

Labor Force Participation and Gender Gap 1/

(Percent)

Source: Eurostat

1/ Defined as the gap in participation rate between men and women.

Early School Leaving Rates

(Percent of population aged 18–24)

Sources: Eurostat and IMF staff calculations.

Education Spending and Outcome

Sources: OECD, Eurostat, and IMF staff calculations.

The Most Pressing Problems that Maltese Firms Face

(Percent)

Source: Survey on the Access to Finance of Enterprises (SAFE), European Central Bank.

Education Attainment and Labor Productivity

Sources: OECD, WEO, and IMF staff calculations.

Authorities’ Views

31. The authorities stressed that there is no reform fatigue in Malta. Infrastructure works related to roads, health, education, and waste management are ongoing and a new entity, tasked with increasing public investment efficiency in the implementation of infrastructure projects, has been created. They indicated that the Malta Development Bank is coordinating with commercial banks on new co-financing and loan guarantee schemes for SMEs, while also taking steps to ensure strong governance and increasing its capacity. The authorities stressed ongoing judicial reforms aimed at further reducing the length of proceedings and strengthening the insolvency framework. Policies to increase female labor participation are still in place, and new implemented educational measures are expected to help further reduce the rate of early school leavers. A number of measures have been implemented to tackle pension adequacy whilst safeguarding the long-term pension sustainability. Efforts are also underway to diversify retirement income, in particular through the strengthening of tax incentives associated with contributions to voluntary occupational and third pillar pensions as well as measures to enable home equity release. The government also underscored recent training initiatives for refugees as well as their “equal pay for equal job” policy that should support better integration.

Staff Appraisal

32. Growth remains strong in Malta. Prudent policies and reform efforts have contributed to strengthening balance sheets, while steady job creation has driven unemployment to historically low levels. Growth remained strong during 2018, supported by large inflows of foreign workers, but mounting pressure on infrastructure, rapidly rising housing costs, and labor and skills shortages increasingly pose challenges. Risks to the outlook are broadly balanced, and the external position is assessed to be moderately stronger than fundamentals.

33. Sustained efforts are needed to safeguard financial integrity and stability. Given Malta’s large and internationally connected financial sector, the strong demand for the IIP and remote gaming, and the envisaged expansion of blockchain-related activities, it is crucial to mitigate ML/FT risks through sustained reforms. Immediate action is required to close gaps in supervisory and enforcement capacity, while steps should be taken to improve the understanding of risks and enhance their identification through intrusive, risk-based supervision. It is also crucial to apply timely and adequate sanctions in case of breaches. The authorities should also ensure that virtual financial asset service providers effectively implement AML/CFT requirements, and are supervised in line with the Financial Action Task Force standards.

34. Remaining supervisory capacity constraints and deficiencies in the regulatory framework should be addressed. The increasing number of financial entities under supervision, the rapid development of new products, the evolving regulatory environment and the tight labor market have put the MFSA under considerable strain. To improve the effectiveness of the supervisory and crisis management frameworks, the long-term financial and operational independence of the MFSA needs to be guaranteed. Moreover, supervisory actions should not be delayed through judicial appeals, and an administrative bank insolvency regime should be adopted.

35. Rapid diversification of corporate financing calls for more comprehensive risk monitoring. Intercompany loans have become the main source of funding for firms. Direct issuance of debt securities and credit from non-bank financial institutions have also grown rapidly, albeit from a low base. While the diversification of funding sources has served Maltese firms well, this development calls for strengthening data quality and management to better monitor contagion risks and enhancing the analytical tools for risk assessment of the non-bank financial sector.

36. The planned introduction of housing-related macroprudential instruments is appropriate given the rising exposure of banks to real estate risks. The new measures – comprising LTV and DSTI limits, as well as amortization requirements – are expected to address the build-up of vulnerabilities in the residential real estate market and improve balance sheets’ resilience to a reversal in housing market conditions. To improve their effectiveness, these measures could be refined in due course, including by narrowing the exemptions from the LTV and DSTI limits for loans against secondary and buy-to-let properties. The tax treatment of rental income should be aligned with that of other sources of income to avoid amplifying house price cycles.

37. Reducing fiscal risks and shifting the balance of expenditure towards growth-enhancing public investment should remain priorities. To ensure space for infrastructure investment, it is important to identify measures that would strengthen the structural fiscal position ex-IIP proceeds. Financially vulnerable SOEs should be restructured, and public investment management and risk analysis strengthened, notably by introducing cost-benefit analysis and publishing fiscal risk statements. The planned institutionalization of the comprehensive spending reviews should help identify further saving opportunities. Given large projected demographic pressures, additional incentives to deter early retirement and increase the take-up of private pension schemes should be explored. On the revenue side, Malta’s high reliance on the IIP and corporate tax makes it vulnerable to potential regime changes. Recent measures to combat tax evasion and avoidance and increase VAT compliance are adequate, but further avenues for broadening the tax base should be explored.

38. Sustaining the reform drive is key to foster strong and inclusive long-term growth. Attention should be given to addressing infrastructure gaps, upskilling and reskilling the labor force, further encouraging female and elderly participation in the labor market, stimulating innovation (including by easing SME’s access to financing), and making housing more affordable for low-income households.

39. Staff proposes that the next Article IV consultation with Malta follows the standard 12-month cycle.

Figure 6.Malta: Labor Market and Income Inequality Developments

Sources: National Statistics Office, Eurostat, Haver Analytics, and IMF staff.

Table 1.Malta: Selected Economic Indicators, 2016–24(Year on year percent change, unless otherwise indicated)
Population (millions):0.5Per capita income (2017, euros):24,538
Quota (as of Oct. 31, 2018; millions of SDRs):168.3At-risk-of-poverty rate 1/16.8
Projections
201620172018 Est.201920202021202220232024
(Year on year percent change)
Real GDP5.76.66.45.24.43.83.53.33.2
Domestic demand1.1-1.56.05.34.43.33.02.82.7
Consumption1.23.46.34.63.93.43.23.02.8
Private consumption2.73.66.44.54.03.53.33.02.8
Public consumption-2.82.86.05.03.73.23.03.03.0
Fixed investment-0.1-7.70.57.66.43.12.52.12.0
Exports of goods and services4.45.31.62.22.22.22.22.12.1
Imports of goods and services1.4-0.10.51.91.91.71.71.61.6
Contribution to growth(Percent)
Domestic demand1.0-1.64.64.33.62.72.42.22.1
Foreign balance4.78.31.80.90.91.11.01.01.0
Potential GDP growth7.26.86.25.44.74.13.63.33.2
Output gap (% potential GDP)0.80.60.80.60.30.0-0.1-0.1-0.1
HICP (period average)0.91.31.72.02.12.12.02.02.0
GDP deflator1.52.42.22.22.32.22.22.22.1
Unemployment rate EU stand.4.74.04.04.14.34.54.74.74.7
Employment growth3.27.85.43.52.52.12.02.02.0
Gross national savings (percent of GDP)27.929.729.128.928.828.528.227.827.6
Gross capital formation (percent of GDP)24.419.319.119.620.019.919.919.719.6
Public finance(Percent of GDP)
Net lending/borrowing (overall balance)0.93.50.90.60.60.70.70.60.6
Structural overall balance (% potential GDP)0.63.40.40.30.40.70.80.70.7
General government debt55.450.245.442.439.035.632.130.028.1
Balance of payments(Percent of GDP)
Current account balance3.410.410.19.38.88.58.38.18.0
Trade balance (Goods and services)13.220.921.421.421.421.822.122.522.9
Exports of goods and services150.8150.0142.8138.3134.8132.3130.2128.3126.6
Imports of goods and services137.6129.0121.4117.0113.4110.5108.0105.8103.7
Goods balance-18.9-13.1-13.8-14.6-14.5-14.0-13.6-13.1-12.7
Services balance32.134.035.235.935.935.835.735.635.6
Primary income, net-8.6-9.4-10.2-10.9-11.5-12.1-12.7-13.3-13.8
Secondary income, net-1.1-1.1-1.1-1.1-1.1-1.1-1.1-1.1-1.1
Financial account, net8.111.410.69.99.39.18.88.68.5
Financial sector
Credit to the private sector (% GDP)84.479.4
Credit growth, private sector3.72.7
Memorandum item:
Nominal GDP (millions of euros)10343.011294.912276.913203.114105.814964.95830.216710.417607.6
Nominal GDP growth7.39.28.77.56.86.15.85.65.4
Sources: Maltese authorities; and IMF staff projections.

Share of population with an equivalised disposable income (including social transfers) below the threshold of 60 percent of the national median equivalised disposable income after social transfers. Data is as of 2017.

Sources: Maltese authorities; and IMF staff projections.

Share of population with an equivalised disposable income (including social transfers) below the threshold of 60 percent of the national median equivalised disposable income after social transfers. Data is as of 2017.

Table 2.Malta: Fiscal Developments and Projections, 2016–24(Percent of GDP, unless otherwise indicated)
Projections
201620172018 Est.201920202021202220232024
Revenue37.439.238.237.537.337.037.136.036.0
Taxes25.726.526.526.426.326.326.326.326.3
Indirect taxes12.212.412.412.312.312.312.312.312.3
Direct taxes13.413.913.913.913.813.813.813.813.8
Other taxes (capital taxes)0.20.20.20.20.20.20.20.20.2
Social contributions6.26.26.26.16.05.95.95.95.9
Grants and Capital revenue0.50.61.01.21.51.51.50.40.4
Other revenue5.15.84.53.83.63.33.43.43.4
Expenditure36.535.737.336.936.736.336.435.435.4
Expense34.033.534.433.933.332.932.932.932.8
Compensation of Employees11.411.311.411.411.411.411.411.411.4
Use of goods and services6.16.46.46.46.46.46.46.46.4
Interest2.11.81.61.41.31.21.21.21.2
Subsidies1.31.21.41.41.41.21.21.21.2
Social benefits10.510.19.99.99.79.69.69.69.6
Other expense2.72.73.83.43.23.13.13.13.1
Net acquisition of nonfinancial assets2.42.22.93.03.43.43.52.52.5
Gross Operating Balance3.45.73.73.74.14.14.23.13.1
Net lending/borrowing (overall balance)0.93.50.90.60.60.70.70.60.6
Memorandum items:
Overall balance excl. one-offs0.93.70.80.50.50.70.70.60.6
Overall balance excl. IIP proceeds-0.71.3-0.7-0.6-0.4-0.2-0.10.10.3
Cyclically adjusted overall balance0.63.20.50.40.50.70.80.70.7
Structural balance 1/0.63.40.40.30.40.70.80.70.7
Structural balance excl. IIP proceeds 1/-1.11.3-1.2-0.9-0.6-0.20.00.20.3
Cyclically adjusted primary balance2.75.02.11.81.81.92.01.91.9
Structural primary balance 1/2.75.22.01.71.71.92.01.91.9
Structural primary balance excl. IIP proceeds 1/1.03.10.40.50.71.11.21.41.6
Primary balance3.05.32.52.01.91.92.01.81.8
One-offs0.0-0.20.10.10.10.00.00.00.0
Public debt55.450.245.442.439.035.632.130.028.1
Government guaranteed debt13.59.58.98.37.77.36.96.56.2
Nominal GDP (millions of euros)10,34311,29512,27713,20314,10614,96515,83016,71017,608
Sources: Maltese authorities; and IMF staff projections.

As a percentage of Nominal Potential GDP.

Sources: Maltese authorities; and IMF staff projections.

As a percentage of Nominal Potential GDP.

Table 3.Malta: Balance of Payments, 2016–24
Projections
201620172018 Est.201920202021202220232024
(Millions of euros)
Current account balance3571,1741,2351,2311,2351,2791,3161,3561,404
Trade balance (Goods and services)1,3622,3642,6272,8203,0173,2593,5063,7684,033
Goods balance-1,960-1,478-1,691-1,926-2,043-2,093-2,151-2,189-2,235
Exports2,5773,0022,9532,9133,0003,0893,2153,3823,517
Imports4,5374,4804,6444,8405,0425,1825,3665,5715,752
Services balance3,3213,8424,3174,7465,0605,3525,6575,9576,268
Exports13,01713,93514,58215,34916,01616,71317,39318,05818,776
Imports9,69610,09310,26510,60310,95611,36111,73612,10112,508
Current income, net-894-1,062-1,252-1,439-1,622-1,811-2,011-2,223-2,430
Current transfers, net-111-128-139-150-160-170-179-189-200
Private-115-129-140-151-161-171-181-191-201
Public411111111
Capital account, net326065707580848994
Financial account, net8351,2891,3001,3011,3101,3581,4011,4451,497
Direct investment-8,587-9,427-10,688-11,495-12,281-13,029-13,782-14,548-15,329
Portfolio investment4,7576,7207,3047,8558,3928,9049,4189,94210,476
Other investment4,5843,9564,8015,0665,3325,6255,9146,2106,518
Reserves ( – inflow; + outflow)881460000000
Errors and omissions446550000000
(Percent of GDP)
Current account balance3.410.410.19.38.88.58.38.18.0
Trade balance (Goods and services)13.220.921.421.421.421.822.122.522.9
Goods balance-18.9-13.1-13.8-14.6-14.5-14.0-13.6-13.1-12.7
Exports24.926.624.122.121.320.620.320.220.0
Imports43.939.737.836.735.734.633.933.332.7
Services balance32.134.035.235.935.935.835.735.635.6
Exports125.9123.4118.8116.3113.5111.7109.9108.1106.6
Imports93.789.483.680.377.775.974.172.471.0
Primary income, net-8.6-9.4-10.2-10.9-11.5-12.1-12.7-13.3-13.8
Secondary income, net-1.1-1.1-1.1-1.1-1.1-1.1-1.1-1.1-1.1
Private-1.1-1.1-1.1-1.1-1.1-1.1-1.1-1.1-1.1
Public0.00.00.00.00.00.00.00.00.0
Capital account, net0.30.50.50.50.50.50.50.50.5
Financial account, net8.111.410.69.99.39.18.88.68.5
Direct investment-83.0-83.5-87.1-87.1-87.1-87.1-87.1-87.1-87.1
Portfolio investment46.059.559.559.559.559.559.559.559.5
Assets46.560.560.560.560.560.560.560.560.5
Liabilities0.51.01.01.01.01.01.01.01.0
Other investment44.335.039.138.437.837.637.437.237.0
Assets-0.970.270.270.270.270.270.270.270.2
Liabilities-45.235.231.131.832.432.632.833.033.2
Reserves ( – inflow; + outflow)0.91.30.00.00.00.00.00.00.0
Errors and omissions4.30.50.00.00.00.00.00.00.0
Memorandum items:
Gross external debt (Percent of GDP)866.0822.3766.6722.1684.7653.9626.5601.6578.9
Net external debt (Percent of GDP)-204.8-207.5-210.3-213.1-215.8-218.7-221.6-224.6-227.8
Sources: National Statistics Office of Malta; and IMF staff projections.
Sources: National Statistics Office of Malta; and IMF staff projections.
Table 4.Malta: Financial Soundness Indicators, 2014–18H1/1(Percent, unless otherwise indicated)
Core Domestic BanksNon-Core Domestic BanksInternational BanksTotal Banks
20142015201620172018H120142015201620172018H120142015201620172018H120142015201620172018H1
CoreFSIs
Regulatory capital to risk weighted assets14.415.016.217.317.017.422.115.516.717.369.256.349.247.250.825.721.821.221.621.8
Regulatory Tier 1 capital to risk-weighted assets11.512.213.615.215.317.118.612.313.316.969.156.246.444.548.223.619.217.519.320.1
Non-performing loans net of provisions to capital41.044.220.422.424.77.77.912.06.94.63.05.79.312.610.518.225.019.118.218.3
Non-performing loans to total gross loans7.67.25.44.14.24.44.03.52.32.10.71.22.21.71.84.04.74.13.13.1
Return on assets0.70.70.80.70.6-1.30.20.30.30.20.91.01.01.50.90.70.90.81.00.7
Return on equity9.89.810.19.27.6-6.41.43.42.91.92.43.43.74.93.93.65.96.77.36.0
Interest margin to gross income64.864.562.370.868.946.343.531.231.129.9201.9137.892.678.887.6115.193.073.073.375.5
Non-interest expenses to gross income51.254.252.258.871.256.173.466.578.372.011.924.831.928.137.436.843.344.744.055.9
Non-interest income to gross income35.235.537.829.231.253.756.568.868.970.1-101.9-37.87.421.212.4-15.17.027.026.724.5
Liquid assets to total assets28.331.836.538.628.231.736.331.638.823.519.722.730.133.128.827.331.235.438.027.9
Liquid assets to short-term liabilities50.450.255.843.541.877.963.362.737.427.984.783.696.343.765.553.952.658.343.042.0
Other FSIs
Total Coverage ratio (total provisions to NPLs as per BR/09)40.443.545.945.243.577.165.253.965.983.140.550.454.842.361.337.540.048.045.349.0
Domestic debt securities to total assets9.69.37.97.07.04.67.74.93.22.30.00.20.10.20.13.94.54.03.63.7
Foreign debt securities to total assets23.321.820.616.817.019.512.515.011.912.152.450.446.942.734.439.936.032.828.924.4
Unsecured loans to total lending29.027.425.427.729.465.270.965.467.272.248.430.726.716.215.937.730.828.225.026.8
Assets to total capital and reserves14.113.713.312.012.28.48.412.111.59.01.72.02.93.43.06.48.09.69.38.9
Large exposure to total own funds103.496.5110.887.8103.6339.9157.6268.6275.8274.345.3129.9129.9133.093.088.9115.8130.5115.6114.7
Gross asset position in financial derivatives to total own funds1.11.31.70.90.90.80.30.60.30.715.767.2104.4131.2174.38.925.941.042.757.8
Gross liability position in financial derivatives to total own funds4.52.02.01.01.12.20.33.60.30.110.415.969.280.2111.710.415.322.626.437.3
Personnel expenses to non-interest expenses50.851.248.848.138.845.042.549.745.648.927.423.219.916.214.947.444.040.537.632.2
Customer loans to customer deposits64.058.256.058.961.175.760.746.547.151.993.1104.1108.1111.6105.871.867.965.770.471.0
Net open position in equities to total own funds14.415.414.013.112.745.081.8146.8139.0109.70.32.71.53.40.99.018.121.918.617.1

Banks’ total assets amounted to 395 percent of GDP (about €46 billion) at 2018H1. About 44 percent of these assets are owned by international banks, which have limited or no linkages to the domestic economy. Core domestic banks, which account for 50 percent of the banking sector’s total assets, are tightly linked to domestic activity as they rely mainly on domestic deposits and provide the bulk of lending to residents. The remainder of the assets are held by non-core domestic banks, which maintain small exposure to residents.

Source: Central Bank of Malta.

Banks’ total assets amounted to 395 percent of GDP (about €46 billion) at 2018H1. About 44 percent of these assets are owned by international banks, which have limited or no linkages to the domestic economy. Core domestic banks, which account for 50 percent of the banking sector’s total assets, are tightly linked to domestic activity as they rely mainly on domestic deposits and provide the bulk of lending to residents. The remainder of the assets are held by non-core domestic banks, which maintain small exposure to residents.

Source: Central Bank of Malta.
Annex I. Housing Price Valuation

A battery of indicators and empirical models suggests some signs of overvaluation in the housing market, but the uncertainty surrounding both price measures and model estimates is large. However, given the prevalence of floating interest rate mortgages in Malta, the strong acceleration of house prices over the last three years calls for close monitoring of housing developments and supports the introduction of borrower-based macroprudential measures.

Price-to-income and price-to-rent ratios are picking up, but point to different conclusions. The house price-to-income ratio increased slightly but remained about 5 percent below its historical average, indicating a small undervaluation. In contrast – and despite growing pressure in the rental market – the price-to-rent ratio continued to increase fast, and stood at over 20 percent above its long-term average (10 percentage point above its previous peak) in 2017:Q4, suggesting significant overvaluation. This may partly reflect the fact that a high share of tenants continues to benefit from fixed rent contracts.

Price-to-Income and Price-to-Rent Ratios

(Percent deviations from historical means, 4-quarter moving average)

Source: Global Property Guide, IFS, and IMF staff.

Model-based analysis points to some signs of overvaluation of housing prices, but there is considerable uncertainty surrounding these estimates. Accelerating property prices have been accompanied by strong immigration flows, rising disposable income and large portfolio rebalancing towards property investment, suggesting that a significant part of recent price increases may be due to fundamental factors. To assess valuation gaps with respect to fundamental factors, we consider two different approaches. The first model, developed by the IMF’s research department (RES), introduces house prices in growth rate as a function of traditional demand factors (population, income, interest rate and credit) and a simple long-term relationship between house prices and income per capita. The model is estimated using price data from the Global Property Guide Price Index, and suggests modest overvaluation. An alternative approach, developed by the Euopean department (EUR) introduces house prices in levels and exploits the long-term cointegration relationships between the price and demand fundamentals, allowing for supply side factors in the analysis. Since credit is not statistically significant in the EUR model, it has been left out. The degree of overvaluation in this model is much smaller and does not suggest significant price misalignment. Since 2017:Q4, advertised prices increased by more than 9 percent, while transaction prices dropped by close to 1.3 percent.

House Price Valuation, 2017Q4

(Deviation from equilibrium price, in percent)

Source: IMF staff calculations.

Note: Two different house price indices are used in the EUR model. The price index published by the CBM is based on advertised prices of the residential property, while the price index published by the NSO is based on actual market transactions.

Annex II. Current Account Surplus: Drivers and Sustainability1

This note summarizes key stylized facts and analyzes drivers of recent current account surpluses in Malta. These drivers include the economy’s rapid structural rebalancing toward export-oriented services and a related decline in import intensity, the rising saving rate, and price competitiveness gains experienced until recently. As several drivers are seemingly structural, large and persistent surpluses may be expected in coming years. Importantly, the current account balance is strongly affected by the cross-border activity of internationally-oriented firms operating in Malta, which also likely gives rise to measurement biases.

A. Current Account Components

1. Malta has recorded current account (CA) surpluses in recent years. The surpluses have recently become large, increasing to above 10 percent of GDP in 2017 from an average of nearly 5 percent of GDP in 2014–16. Looking at the CA components, the main driver of this rising trend was the surplus in services, which over the last decade increased from roughly 20 percent of GDP to 34 percent of GDP. In addition, the oil trade deficit declined substantially over the same period.

Current Account Components

(percent of GDP)

Sources: IMF BOP Statistics and IMF staff calculations.

2. The trade balance has greatly improved due to the performance of services. The trade deficit in goods hovered around 17 percent of GDP since 2005, falling below 13 percent of GDP in 2017 on the back of a contraction in imports. Both exports and imports of goods, as shares of GDP, declined since around 2013 compared to previous years. Meanwhile, the trade surplus in services rose fast since 2006, initially because of booming exports and more recently also because of a moderate import contraction.

Exports and Imports of Goods

(Percent of GDP)

Sources: Haver Analytics, IMF staff calculations.

Exports and Imports of Services

(Percent of GDP)

Sources: Haver Analytics, IMF staff calculations.

B. Assessing the Underlying Drivers of the Current Account Surplus

Cyclical Factors

3. The cyclical component of the CA has been relatively small. This component is estimated as the sum of the contributions from two variables included in the IMF’s EBA-Lite CA model: the detrended terms of trade of goods interacted with trade openness, and the output gap. Both are measured relative to their world averages. For Malta, the cyclical component has been generally small relative to the size of the CA balances. In 2015 that component turned positive and since then it positively contributed to the CA surplus, but on average by less than 0.5 percent of GDP.

Current Account: Cyclical Component 1/

(Percent of GDP)

1/ Based on IMF’s EBA-Lite model. Reflects contributions of terms of trade of goods (times trade openness) and output gap, both relative to world averages. Sources: IMF staff calculations.

Traditional Drivers of the Current Account

4. Recent competitiveness gains have been partly overturned but may have contributed somewhat to the CA surplus. Following a depreciation between 2013 and 2015, the real effective exchange rate (REER) stabilized and more recently appreciated. Despite the ongoing economic boom, the growth of Maltese unit labor costs (ULC) has remained subdued compared both to previous years and to that of trading partners. To assess the role of price competitiveness shocks and two other traditional drivers of the CA, a simple model-based analysis relying on pairwise correlations between the CA, the output gap, and the (change in the) ULC-based REER, suggests that the evolution of competitiveness since 2012, on average, has played some role in the increase of the CA balance.2 This correlation analysis also suggests that neither foreign demand shocks nor domestic demand shocks were key contributors to Malta’s rising CA balance.

Malta: Real Effective Exchange Rate

(2005=100; based on 37 trading partners and seasonally-adjusted)

Sources: Haver Analytics, Eurostat, IMF staff calculations.

ULC by Sector

(2005=100)

Sources: Haver Analytics, IMF staff calculations.

Saving-Investment Gap

5. The CA surplus mainly reflects rising saving. The saving rate increased from below 20 percent of GDP in 2012 to almost 30 percent of GDP in 2016. The rise in saving is mostly explained by the private sector, particularly households, which could reflect the rising share of second earners (as female labor force participation grew) and a stronger propensity to save for retirement. Government saving has also gradually increased, especially since 2014. Although total investment expanded in 2015–2016, its growth was smaller than that of saving.

Net Lending/Borrowing of the Total Economy

(Percent of GDP)

Sources: Haver Analytics, IMF BOP Statistics, and IMF staff calculations.

Saving Ratio by Sector

(Percent of GDP)

Source : Haver Analytics, Central Bank of Malta, IMF staff calculations.

Structural Changes

6. In recent years, the economy underwent a rapid structural rebalancing toward services. The remote gaming industry has been a key engine of this transformation, becoming one of the largest and most dynamic sectors in Malta, boosted by foreign-owned companies. The gaming industry (included in the Personal/Cultural/Recreation sector) is highly export-oriented: it accounts for more than one-fifth of the economy’s total exports and its trade surplus is close to 30 percent of GDP. While its domestic inter-industry linkages are relatively limited, the gaming sector accounts for about 12 percent of Malta’s nominal gross value added, and for a roughly similar share of total employment as other important sectors such as finance and construction.3

Trade Balance: Services

(Percent of GDP)

7. Import intensity has declined rapidly reflecting the structural shift toward services and energy sector reforms. As the share of services in economic activity rose, including gaming and other sectors which are relatively low-capital intensive, the import content of GDP expenditure items (gross fixed capital formation, exports, and consumption) declined, according to OECD data available until 2011. Moreover, Malta has implemented energy reforms to upgrade the sector’s productivity and to diversify the energy mix. It completed an electricity connector with Italy, upgraded the energy infrastructure, and switched electricity production from oil to gas. As a result, the dependence on imported oil has moderated.

Malta: Import Intensities of GDP Expenditure Items

(Percent of each expenditure item)

Sources: OECD Input-Output Tables, Maltese authorities.

Energy Productivity in the EU

Sources: Eurostat and IMF staff calculations.

Measurement Issues and the Influence of Internationally-Oriented Firms

8. Malta is a small financial center and hosts many multinationals. In small financial centers and, more generally, in countries that host many multinational companies, the CA is strongly influenced by the cross-border activity of internationally-oriented firms. Trade, income and financial flows associated with those firms may be mainly driven by factors outside the country. Moreover, relevant income flows could be over or under-recorded in case of shortcomings at identifying ultimate ownership. Biases can also arise because of accounting issues in measuring investment income, particularly in connection to retained earnings on portfolio equity (which are not recorded in the income balance) and to income from debt instruments (which is recorded in nominal terms, thus inducing an inflation bias).4 While Malta does not produce data on its “underlying CA”, i.e. excluding the influence of internationally-oriented firms, and estimates on Malta-specific biases are not available, some evidence suggests that measurement issues could be significant. For example, there are many captive financial institutions and money lenders, including several thousand special purpose entities (SPEs) in the financial sector alone, with total assets equivalent to more than 16 times Malta’s GDP and almost entirely invested outside of the country, underlining Malta’s role as a financial center.5 Also, valuation changes embedded in the Net International Investment Position (NIIP)—a rough indicator of measurement distortions in CA balances—tend to be sizable, amounting on average to 8 percent of GDP over 2012–2017.6

Captive Financial Institutions and Money Lenders in the Financial System: Assets

(Multiples of GDP)

Sources: Central Bank of Malta, IMF staff calculations..

NIIP Valuation Changes

(Percent of GDP)

Sources: Haver Analytics, IMF staff calculations.

C. Common Drivers of Current Account Surplus Reversals

9. Looking at some common drivers of CA surplus reversals sheds light on why Malta has not experienced such a reversal. A recent IMF staff’s case-study analysis found that, on average, significant and sustained reversals from large and persistent CA surpluses have been historically associated with REER appreciation, fiscal expansion, terms of trade deterioration, increase in private credit, and a reduction in saving rather than a rise in investment.7 In line with the continued CA surpluses in Malta so far, none of the aforementioned common drivers of reversals are yet visible in the Maltese data except for a recent moderate REER appreciation. The same study also found that reversals have been rare, especially among advanced economies, and that they tend to happen when CA surpluses become very large, averaging around 9 percent of GDP in the three years prior to the reversal.

Annex III. Implementation of IMF Recommendations
2017 Art. IV AdviceActions since 2017 Art. IV
Fiscal issuesContinue building fiscal buffers, strengthening revenue collection and identifying further structural measures.The medium-term fiscal strategy aims to maintain a structural balance net of Individual Investor Program (IIP) revenues and related expenditures, and to further reduce the public debt ratio. A Joint Enforcement Task Force is addressing VAT evasion.
Reduce fiscal risks by improving the financial health of SOEs and containing long-term, age-related spending pressures.Policy recommendations from the in-depth spending review of health, social security and education carried out in 2015 -2016 are being implemented.
Raise public investment in a budget-neutral manner.The government’s capital expenditure is envisaged to increase between 2018 and 2021, financed by both EU and own funds. Targeted sectors include roads, the environment, health, and education.
Housing market and financial sector issuesClose data gaps, deploy macroprudential measures, and review fiscal incentives related to the property market.The Central Bank of Malta drafted a Directive to introduce borrower-based measures, including limits on the loan-to-value (LTV) ratio, the debt-service-to-income (DSTI) ratio, and to restrict the maturities for residential real estate loans provided by banks. A new White Paper on rents was launched in October 2018 with proposals on reforms to the rental market.
Facilitate continued resolution of legacy NPLs and improve the insolvency process.Recent regulation mandating banks to reduce NPL ratios below 6 percent within 5 years, is being implemented. NPL resolution plans of small banks with relatively weak asset quality continue to be monitored.
Ensure strong governance and well-designed origination rules of the Malta Development Bank’s operations.The MDB’s Audit Committee was created. The formation of a Risk Committee and the drafting of a Code of Professional Conduct and Ethics are under way.
Ensure adequate resources for the financial supervisor and strengthen oversight of nonbank lending.Per the new funding structure of the Malta Financial Service Authority (MFSA), any funding shortfalls of the agency should be provided by the government. A new intercompany loan dataset was recently compiled.
Ensure robust implementation and effective enforcement of the AML/CFT framework.The recently revised ML/FT National Risk Assessment led to an action plan to strengthen Malta’s AML/CFT framework, which is currently being implemented. The MFSA and the Financial Intelligence Analysis Unit have institutionalized their collaboration in a memorandum of understanding and adopted joint supervisory procedures.
Structural reformsFurther increase female labor force participation and address skills gap problem.Recent make-work-pay policies, including free childcare scheme, in-work benefits, and tapering of benefits for those entering employment are in place. The new Work-based Learning and Apprenticeship Act came into force, providing a standardized legal framework for vocational education and training.
Strengthen innovation, including by upgrading research infrastructure and upscaling the public support for innovationMalta Enterprise has launched several incentives to support businesses in upgrading investment in research and development. Legislation was enacted to help boost Fintech-related industries.
Annex IV. External Sector Assessment

The external position of Malta in 2018 was assessed to be moderately stronger than fundamentals and desirable policy settings. While the recorded current account surplus was sizable, staff’s judgment takes into account that Malta is a small financial center, hosts many special purpose entities and other multinationals—compounding measurement issues related to the current account—and is undergoing rapid structural changes. Based on external developments until 2018:Q3, staff’s assessment remains unchanged.

Foreign Asset and Liability Position

1. Malta is a small financial center and hosts a large number of multinationals. Its net international investment position (NIIP) is therefore strongly influenced by cross-border transactions of internationally-oriented firms, including many special purpose entities in the financial sector. The NIIP rose to 66 percent of GDP at end-2017, improving by almost 40 percentage points since 2013, mostly reflecting sustained current account surpluses over the period. Gross assets and liabilities are very large, with particularly sizable positions in portfolio investment assets (1000 percent of GDP) and direct investment liabilities (1639 percent of GDP). Most of the gross liabilities are in the form of equity. While valuation effects tend to be large and volatile, the considerable share of intra-company lending stands as a mitigation factor to possible risks. The NIIP is expected to remain highly positive over the medium term, in line with projected current account surpluses.

International Investment Position

(Percent of GDP)

Sources: Haver Analytics, Eurostat, IMF staff calculations.

Net International Investment Position (NIIP) Components

(Percent of GDP)

Sources: Haver Analytics, Eurostat, IMF staff calculations.

Current Account

2. The current account (CA) surplus significantly widened to 10.4 percent of GDP in 2017, mainly due to lower imports of capital goods and a higher surplus in services compared to 2016. Strong and rising net exports of services, which continue to largely reflect proceeds of remote gaming and tourism, account for the bulk of the CA improvement in recent years. The oil trade deficit remained subdued, thanks in part to recent energy sector reforms. More generally, the economy’s structural shift toward services has been associated with a reduction in import intensity. The CA has recorded sustained surpluses since 2012, averaging around 6 percent of GDP over 2013–17. Continued surpluses, though gradually declining, are expected over the medium term. As of 2018:Q3, the CA surplus remained close to 11 percent of GDP.

Current Account Components

(Percent of GDP)

Sources: IMF BOP Statistics and IMF staff calculations.

3. The EBA-lite CA model points to a large CA gap of 10 percent in 2018, a norm of nearly 0 percent and a policy gap of 0.3 percent (Table 1). However, staff consider that the large unexplained residual of 10.1 percent of GDP could be at least partially explained by a number of idiosyncratic factors:

  • First, as a small financial center, Malta’s CA balance is strongly influenced by cross-border trade and income flows reflecting operations from special purpose entities and multinationals with limited links to the domestic economy. These factors compound CA measurement issues, including biases due to retained earnings on portfolio equity (which are not recorded in the income balance) and to interest payments on debt assets (which are recorded in nominal terms, departing from the relevant economic notion of real income and hence inducing an inflation bias). Previous IMF staff analysis estimated that the joint biases due to retained earnings and inflation distortions overstated the CA balance of a financial center by as much as 3 percent of GDP.1 Extrapolating that upper-bound estimate to Malta, a highly tentative measure of its “underlying” CA surplus would be about 7 percent of GDP.

  • Second, the CA balance reflects the revenues from the government’s Individual Investor Program (IIP), which is recorded in national accounts as exports of services. The authorities estimate that annual IIP export receipts amounted to roughly 1 percent of GDP over 2015–2017, on average. Since this program is not envisaged to last permanently, discounting this temporary factor (subtracting IIP export receipts) from the CA balance further reduces the surplus to around 6 percent of GDP.

  • Third, the EBA-Lite CA model has undergone several changes compared to last year, which significantly brought down Malta’s CA norm. Those changes included the removal of a financial center dummy variable which contributed with more than 4 percent of GDP to Malta’s CA norm. Moreover, a new explanatory variable proxying for remittances inflows introduces a large negative contribution to the norm of about minus 3 percent of GDP. However, it can be argued that in the case of a high-income country like Malta, the contribution of remittances to the CA could be positive if they were associated with higher saving and hence higher CA balances. This would potentially raise (rather than lower) the CA norm by about 3 percentage points, bringing it to nearly 3 percent of GDP.

  • Fourth, the economy has undergone a rapid structural rebalancing towards exports of services, especially the remote gaming industry, whose export flows are largely unrelated to competitiveness changes.2 In addition, the CA surplus largely reflects the high corporate saving of foreign-owned firms based in Malta, including gaming and financial companies as well as other multinationals. Taking these factors into account would bring the CA norm to a potentially higher level than 3 percent of GDP.

Table 1.Results Based on IMF’s EBA Lite Methodology
Malta: Results Based on IMF’s EBA-Lite Methodology, 2018
Current account approach 1/REER approach
Actual CA (percent of GDP)6.1Ln(REER), actual4.6
Cyclically-adjusted CA6.4Ln(REER), norm4.5
Cyclically-adjusted CA norm2.7REER gap (percent)3.7
Multilaterally consistent cyc.-adj. norm3.2Policy gap (percent)-0.8
CA gap3.2Residual (percent)4.3
Policy gap0.3
Residual3.1
Implied REER gap (percent)-3.5

The “actual CA” includes an adjustment of around -4 percent of GDP for measurement issues and temporary factors. The “CA norm” includes an adjustment of about +3 percent of GDP for the likely different impact of remittances in a high-income country. See text for details.

The contributions from a “natural disasters and conflicts” dummy are not shown.Source: IMF staff calculations.

The “actual CA” includes an adjustment of around -4 percent of GDP for measurement issues and temporary factors. The “CA norm” includes an adjustment of about +3 percent of GDP for the likely different impact of remittances in a high-income country. See text for details.

The contributions from a “natural disasters and conflicts” dummy are not shown.Source: IMF staff calculations.

4. In sum, staff assess the CA gap as close to 3 percent of GDP, but the size of this gap is subject to considerable uncertainty in light of CA measurement problems and other idiosyncratic factors characteristic of Malta’s pro-business tax regime and its situation as a small financial center. Thus, the external assessment also relies on the results from the REER model, described below.

Real Exchange Rate

5. Both the ULC-based REER and the CPI- based REER appreciated by around 1 percent in 2017. Compared to their 2017 averages, as of 2018:Q3 they further appreciated by about 2 percent. While the two measures have been broadly stable over the last decade, the competitiveness gains in 2013–15 (particularly those implied by the ULC-based REER) may have played some role in the increase of the trade surplus. The EBA-lite REER model reaches a different conclusion than the CA model (Table 1) and points to a modest REER overvaluation of about 4 percent.

Malta: Real Effective Exchange Rate

(2005 = 100; based on 37 trading partners and seasonally-adjusted)

Sources: Haver Analytics, Eurostat, IMF staff calculations.

6. To summarize the external assessment, the CA gap is estimated at nearly 3 percent of GDP, with an implied undervaluation of 3.5 percent but it is particularly uncertain, whereas the REER model suggests a modest overvaluation of 4 percent. Together, staff assess that the external position in 2018 was moderately stronger than fundamentals. Staff will continue work to deepen its understanding of Malta’s underlying external position.

Capital and Financial Flows

7. Gross and net financial flows tend to be large relative to GDP. These flows are strongly influenced by cross-border transactions of the several internationally-oriented firms that Malta hosts, including special purpose entities. Net FDI inflows and net portfolio investment outflows are particularly sizable. In recent years, the sum of net outflows accounted for by portfolio investment and other investment have exceeded the amount of net FDI inflows.

Financial Account Components

(Percent of GDP)

Sources: Haver Analytics, Eurostat, IMF staff calculations.

Annex V. Risk Assessment Matrix1
Source of RisksRelative Likelihood1Impact if Realized
Weaker-than-expected global growth.MediumMedium

Since Malta is a highly open economy, weaker external demand, accompanied by lower FDI inflows, would have adverse effects on domestic growth prospects. Higher-than-envisaged gains from recent large-scale infrastructure projects and labor market reforms may mitigate adverse spillovers.
Policy response: Allow automatic stabilizers to operate in the short run if growth disappoints. Improve infrastructure quality and maintain structural reform momentum to remove supply-side bottlenecks, spur investment, and promote higher productivity growth. Continue diversifying trade activities. Fiscal policy could be used to mitigate the impact on vulnerable groups.
Unsustainable macroeconomic policies.MediumMedium

In Europe, unsustainable policies at the national level could undermine regional cohesion, while inappropriate policies in other systemically important economies could exacerbate vulnerabilities and even backfire by hurting confidence and global growth. Potential adverse effects on growth in Malta through lower investment and trade, are likely to be contained given Malta’s trade diversification and excess demand in the tourism sector. If economic deceleration is significant enough, banks’ profitability could be negatively affected by increasing asset impairment.
Policy response: Allow automatic stabilizers to operate if growth disappoints. Monitor developments and develop contingency plan to mitigate adverse effects. Continue close supervision and further improve banks’ asset quality to increase the banking system’s loss absorption capacity. Fiscal policy could be used to mitigate the impact on vulnerable groups.
Sharp tightening of global financial conditions.HighMedium/Low

Malta should be relatively insulated from direct international financial market contagion given public and private sector’s high reliance on domestic financing. However, it is still vulnerable to weaker external demand, lower FDI inflows and potential financial contagion through cross-border and cross-sectoral interlinkages. Additionally, continued monetary policy normalization and abrupt change in global risk appetite could lead to sudden, sharp increases in interest rates as term premia decompress, and associated tightening of financial conditions. Loss of market confidence and increases in risk premia would lead to declines in assets prices, and cause valuation losses and higher funding cost for banks.
Policy response: Continue to reduce fiscal and financial vulnerabilities to ensure stability, and further diversify trade activities. Continue close financial supervision and further improve banks’ asset quality to increase the banking system’s loss absorption capacity, and further enhance crisis management framework. The authorities should stand ready to cooperate with the ECB in providing liquidity support if needed. Remove remaining structural impediments to growth.
Rising protectionism and retreat from multilateralism.HighMedium

As a small open economy, Malta is vulnerable to external shocks through trade linkages. In the short term, escalating trade tensions, including a no-deal Brexit, could increase uncertainty about growth leading to higher financial market volatility with potential negative consequences for investment and growth. Direct financial spillovers should be limited given the relatively high reliance of government and core domestic banks on domestic funding. Possible relocation of firms that service the EU from the UK to Malta may also support FDI inflows over the medium term.
Policy response: Participate in a coordinated policy response at the European level. Allow automatic stabilizers to operate. Maintain structural reform momentum and improve infrastructure to remove impediments to growth. Continue diversifying trade activities. Fiscal policy could be used to mitigate the impact on vulnerable groups.
Slow progress in addressing structural weaknesses.MediumMedium/Low

While the positive impact of recent structural reforms is likely to persist over the medium term, delayed implementation of the planned initiatives, including on infrastructure and labor market, would negatively affect competitiveness and long-term growth, and increase long-term fiscal risks.
Policy response: Sustain and monitor the implementation of structural reforms, particularly in education, labor market and infrastructure, while safeguarding long-term fiscal sustainability and improving the quality of public finances.
Slow progress in effectively implementing the AML/CFT framework.MediumMedium

Failure to effectively implement the AML/CFT framework would weaken Malta’s attractiveness as a financial and business location, with adverse effects on tax revenues, foreign investment, jobs, and the external position.
Policy response: Effectively and swiftly implement and enforce the AML/CFT framework, address supervisory capacity constraints, and improve collaboration between the National Competent Authorities (NCAs).
Sharp correction in housing prices.MediumMedium

Property-related loans account for a significant fraction of the loan portfolio of core domestic banks, thus increasing their vulnerability to possible property market shocks. Significantly lower house prices could weaken bank and household balance sheets—particularly if accompanied by broader economic slowdown and an increase in unemployment—and lead to widespread distress through an adverse feedback loop of decreased lending and investment affecting financial stability and growth. However, mitigating factors include banks’ strong capital and liquidity positions as well as households’ high financial wealth, low default rates, and the low share of population with mortgages and negative equity.
Policy response: Monitor risks and implement targeted macro-prudential measures. Limit exposure of banks to property-related loans if a bubble begins to emerge. Ensure that fiscal measures related to the property market, including the Individual Investor Program and the reduce tax rate on income rental, do not exacerbate imbalances, and address potential constraints to housing supply.
Possible changes in international corporate and personal taxation.Medium/LowHigh/Medium

Malta’s attractiveness as a financial and business location may weaken, and demand for its Individual Investor Program (IIP) could decrease, with adverse effect on tax revenues, auxiliary financial services, foreign investment, and the external position.
Policy response: Continue diversifying the economy and accelerate structural reform implementation to remove impediments to growth, boost productivity and enhance competitiveness. Strengthen the quality of public finances, improve spending efficiency, and enhance revenue collection to reduce the heavy reliance on CIT and IIP revenues.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

Annex VI. Fiscal Transparency Evaluation

The IMF conducted a Fiscal Transparency Evaluation in Malta. The IMF’s Fiscal Transparency Code is the international standard for disclosure of information about public finances. The Code comprises a set of principles built around the four pillars (i) fiscal reporting, (ii) fiscal forecasting & budgeting, (iii) fiscal risk analysis & management, and (iv) resource revenue management. For each transparency principle, the Code differentiates between basic, good, and advanced practices to provide countries with clear milestones toward full compliance. The first three pillars are currently operational, while the fourth pillar is being developed and expected to be finalized by January 2019. Upon request of the authorities, an IMF technical assistance team visited Malta on April 30-May 14, 2018 to conduct a Fiscal Transparency Evaluation (FTE).

Overall, Malta meets many of the fiscal transparency principles at good or advanced level. Malta meets the good or advanced practice in 21 out of 35 principles of the Fiscal Transparency Code. It meets the basic practice on 12 principles. The principle related to natural resources was not assessed. Practices are stronger in the areas of fiscal reporting and fiscal forecasting & budgeting, which are largely covered by the EU’s comprehensive reporting framework. In the fiscal risk analysis & management area, Malta’s practices are generally found weaker.

Fiscal reporting of public corporations could be improved. Fiscal reporting is mostly deemed good or advanced, and reports are published in a timely manner and are comparable to each other. Statistics are prepared by the professionally independent National Statistics Office and government financial statements are audited by an independent audit office. However, a consolidated reporting on public corporations, as well as reporting of nonfinancial assets and employment-related pension entitlements are lacking. Moreover, tax expenditures could be more comprehensively reported.

Fiscal forecasting & budgeting exhibits gaps for extrabudgetary units and public investment. Fiscal forecasting & budgeting is found largely good or advanced. Budget documentation includes medium-term macroeconomic forecasts, and fiscal policy objectives are embedded in a medium-term budget framework. An independent fiscal council evaluates macro and fiscal forecasts. However, extrabudgetary units are not sufficiently documented. Information and cost-benefit analysis related to public investment projects is limited. Performance information and consistency of presentations could be improved.

Fiscal risk analysis & management fall short of or meets only the basic practice of the Code. While advanced in the areas of macroeconomic scenarios and public debt, risk analysis of government assets is limited. Reporting on the overall performance of public corporations and a common framework for exercising ownership functions and monitoring performance are absent. Another important gap pertains to the lack of a summary report on specific risks to the fiscal forecast, which would include enhanced reporting on long-term fiscal sustainability, government guarantees, and public-private partnerships.

The evaluation provides seven recommendations.

1. Gradually expand the coverage of fiscal reports to the public sector;

2. Better report on and control tax expenditures;

3. Improve budget documentation in relation to extrabudgetary units and performance information;

4. Harmonize presentations across reports and explain changes to previous forecasts;

5. Strengthen the framework for public investment management;

6. Publish an annual fiscal risk statement;

7. Strengthen the institutional framework for managing fiscal risks, notably on public corporations.

Annex VII. Main FSAP Recommendations1/
Risk Analysis
1. Strengthen the risk analysis by incorporating new dimensions in liquidity stress testing, conducting regular sensitivity analysis on selected vulnerabilities, and enhancing data management (CBM, MFSA)
Macroprudential Policy
2. Close remaining data gaps, and enhance analytical tools (CBM, NSO, MFSA)
3. Refine and introduce the planned borrower-based instruments to address possible buildup of vulnerability in the housing and household sectors. (CBM)
Financial Sector Supervisory Resources and Independence
4. Ensure stable funding for the MFSA, grant it full autonomy over its recruitment and maintain a dedicated statutory committee on supervisory issues. (MFSA, Government)
5. Address the significant gap in supervisory and enforcement capacity by increasing staff and broadening the skill set. (MFSA)
Banking Regulation and Supervision
6. Increase the number and risk orientation of onsite inspections of LSIs. Enhance supervision of third country branches. (MFSA)
7. Take timely supervisory actions (including for ML/TF) and increase the use of monetary fines. Ensure supervisory action is not delayed through judicial appeal, including by amending the law, if needed. (MFSA, FAIU, Government)
Insurance and Securities Regulation and Supervision
8. Strengthen conduct supervision and enhance the sectoral risk-based supervision framework. (MFSA)
AML/CFT
9. Improve the authorities’ assessment and understanding of ML/TF risks and strengthen the national coordination. (National Coordination Committee)
10. Adopt a multi-prong strategy that includes: (i) ensuring that banks appropriately apply preventive measures; (ii) fully implementing a risk-based AML/CFT supervision; and (iii) applying timely, dissuasive, and proportionate sanctions and effective fit-and-proper tests. (MFSA, FIAU, ROC, Government)
11. Support establishing an EU-level arrangement responsible for AML/CFT supervision. (Government)
Safety Nets and Crisis Management
12. Adopt an administrative bank insolvency regime with explicit powers to transfer assets/liabilities. Clarify the creditor hierarchy. (Government)
13. Shift responsibility for decisions on bank insolvency and liquidation, post-license revocation, from the MFSA’s supervisory function to its resolution function (MFSA)
14. Review the adequacy of the Resolution Unit’s staffing and increase its resources accordingly (MFSA)
Annex VIII. Debt Sustainability Analysis

Malta’s debt sustainability has been improving in recent years, thanks to prudent fiscal policy, strong growth, and favorable financing conditions. The debt is expected to remain sustainable and its dynamics are robust to most of standard adverse macroeconomic shocks, but vulnerabilities may arise from large contingent liabilities and a loss of fiscal revenues from IIP. Malta’s external debt sustainability appears robust to various shocks.

Public Debt Sustainability

1. Malta’s public debt ratio has remained on a rapid downward path. The gross public debt declined to 50.2 percent of GDP in 2017, from 55.4 percent of GDP in 2016, reflecting strong nominal GDP growth and a higher primary fiscal balance. In a baseline scenario, this path continues against the background of strong fiscal surplus supported by strong economic activity, continued IIP proceeds, and reduced interest payment burdens. The public debt is projected to decline to 45 percent of GDP in 2018 and continue a downward trajectory to 30percent in 2023.

2. Contingent liabilities declined moderately but are still significant. The stock of government guarantees stood at 10 percent of GDP in 2017, down from 14 percent in 2016. Much of them are provided to non-financial state-owned enterprises (SOEs) whose liabilities represent 21 percent of GDP in 2016. Contingent liabilities related to public-private partnerships accounts for 1 percent of GDP. Overall, these contingent liabilities can represent more than 20 percent of GDP.

3. The debt sustainability is resilient to most of standard adverse macroeconomic shocks, while it is more vulnerable to low growth.

  • Growth shock: The scenario envisages a reduction of GDP growth by 3.7 percentage points (equivalent to one standard deviation of growth over the past ten years) and a 0.9 percentage points drop in inflation rate relative to the baseline in 2019 and 2020. Nominal interest rates increase by 41 and 83 basis points, respectively, in 2019 and 2020 reflecting higher risk premiums. The debt would increase to 48 percent of GDP by 2020, 9 percentage points higher than the baseline, then follows a declined path thereafter to reach 38 percent of GDP in 2023.

  • Primary balance shock: A cumulative reduction of 1.8 percentage points (equivalent to one standard deviation shock) in primary balance, coupled with a 25 basis point increase in interest rate, in 2019 and 2020 would increase the debt ratio by about 2 percentage points relative to the baseline.

  • Interest rate shock: A sustained increase of 200 basis points in spread throughout the projection period would slow down the debt reduction modestly, by about 0.5 percentage point of GDP by 2023.

  • Real exchange rate shock: A 13 percent real exchange rate depreciation with pass-through to the inflation rate is applied to 2019. Given that the almost all public debt is denominated in the local currency, this scenario would decelerate the debt reduction only negligibly.

  • Combined macro-fiscal shock: The scenario combines above-mentioned shocks to the growth, the primary balance, the interest rate, and the exchange rate. The debt ratio would rise to 48 percent by 2020, 9 percentage points higher than the baseline, then fall thereafter to 39 percent of GDP in 2023.

4. The debt sustainability could be seriously affected by government’s contingent liabilities and realization of IIP proceeds.

  • Financial contingent liability shock: The scenario analyzes the impact of a one-time increase in non-interest expenditures equivalent to 10 percent of the size of the banking sector, coupled with slower real GDP growth (a one standard deviation reduction in the growth rate over 2019–20), inflation decreasing by 0.25 percentage points for every one percent point reduction growth, and interest rate spread rising by 0.25 basis points for every one percent of GDP deterioration in the primary balance. While the revenue-to-GDP ratio is assumed to remain the same as the baseline, the shock would deteriorate the primary balance to -33 percent of GDP, largely reflecting banks’ large gross foreign assets. The debt ratio is project to rise sharply to 80 percent of GDP in 2019 and peak at 81 percent of GDP in 2020, 42 percentage points higher than the baseline. It would decline to 74 percent of GDP at the end of the projection horizon.

  • Government guarantee shock: This scenario analyzes a contingency liability risk from SOEs and other government guaranteed debt, by assuming a one-time increase in expenditures equivalent to 50 percent of SOE liabilities. The other shocks follow the same assumptions as for financial contingent liability shock above, and include slower growth, higher inflation and higher interest rate spreads. With these shocks combined, the debt-to-GDP ratio would increase to 55 percent of GDP in 2019, 12 percentage points higher than the baseline. The debt ratio would resume the declining trend thereafter to reach 43 percent of GDP at the end of the projection period.

  • IIP proceed shock: The sustainability of the debt without the IIP revenues is analyzed by excluding the IIP revenues from non-interest revenues and assuming modest increase in interest rate spreads. The rate of decline in the debt ratio decelerate relative to the baseline, while the debt ratio still declines to 33 percent of GDP at the end of the projection period, 3 percentage points higher compared to the baseline.

External Debt Sustainability

5. Malta’s external position remains strong with large holdings of external assets. Gross external debt is large at 822 percent of GDP at the end of 2017, but this is more than covered by large amount of external assets. The external debt largely represents stable intercompany lending and liabilities of offshore financial institutions that have limited links to the domestic economy. The total net external debt is about minus 208 percent of GDP at end-2017, and is projected to fall gradually over the medium term on the back of expected current account surplus. Standard tests suggest that Malta’s external position would be robust to most adverse shocks.

Figure 1.Malta: Public DSA Risk Assessment

Source: IMF staff.

1/ The cell is highlighted in green if debt burden benchmark of 85 percent is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

2/ The cell is highlighted in green if gross financing needs benchmark of 20 percent is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.

3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 400 and 600 basis points for bond spreads; 17 and 25 percent of GDP for external financing requirement; 1 and 1.5 percent for change in the share of short-term debt; 30 and 45 percent for the public debt held by non-residents.

4/ Long-term bond spread over German bonds, an average over the last 3 months, July 25, 2018 through October 23, 2018.

5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.

Figure 2.Malta: Public DSA – Realism of Baseline Assumptions

Source: IMF Staff.

1/ Plotted distribution includes surveillance countries, percentile rank refers to all countries.

2/ Projections made in the spring WEO vintage of the preceding year.

3/ Malta has had a positive output gap for 3 consecutive years, 2015–2017. For Malta, t corresponds to 2018; for the distribution, t corresponds to the first year of the crisis.

4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.

Figure 3.Malta: Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(in percent of GDP unless otherwise indicated)

Source: IMF staff.

1/ Public sector is defined as general government.

2/ Based on available data.

3/ Long-term bond spread over German bonds.

4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

5/ Derived as [(r - π(1 +g) – g + ae(1 +r)]/(1 + g + π + gπ)) times previous period debt ratio, with r = interest rate; π = 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).

6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π(1 + g) and the real growth contribution as -g.

7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1 +r).

8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period. 9/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.

Figure 4.Malta: Public DSA – Composition of Public Debt and Alternative Scenarios

Source: IMF staff.

Figure 5.Malta: Public DSA – Stress Tests

Source: IMF staff.

Figure 6.Malta: External Debt Sustainability: Bound Tests 1/2/

(Net external debt in percent of GDP)

Sources: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2017.

Table 1.Malta: External Debt Sustainability Framework, 2013–2023(Net external debt, in percent of GDP unless otherwise indicated)
ActualProjections
20132014201520162017201820192020202120222023Debt-stabilizing non-interest current account 6/
Baseline: External debt-375.0-300.3-237.2-204.8-207.5-209.5-208.8-211.0-213.8-216.2-219.1-9.2
Change in external debt102.274.863.132.3-2.7-1.90.7-2.2-2.8-2.4-2.9
Identified external debt-creating flows (4+8+9)-57.3-20.9-2.823.4-4.6-17.5-15.0-15.4-15.9-15.8-15.6
Current account deficit, excluding interest payments9.90.74.31.6-6.1-5.1-3.8-2.7-2.2-1.9-1.6
Deficit in balance of goods and services-6.3-11.9-9.0-13.2-20.9-21.3-20.9-20.9-21.3-21.6-22.0
Exports157.0147.9153.0150.8150.0142.3135.6131.8129.4127.0125.2
Imports150.7136.0144.0137.6129.0121.0114.6110.9108.1105.4103.2
Net non-debt creating capital inflows (negative)-84.0-50.1-37.010.8-11.4-19.1-16.1-15.4-15.0-14.6-14.3
Automatic debt dynamics 1/16.828.529.911.012.96.74.92.71.30.70.3
Contribution from nominal interest rate-12.5-9.4-6.6-5.1-4.3-4.9-5.4-5.8-6.2-6.3-6.3
Contribution from real GDP growth19.829.033.512.612.211.610.28.67.46.96.6
Contribution from price and exchange rate changes 2/9.58.93.13.45.0
Residual, incl. change in gross foreign assets (2–3) 3/159.595.765.98.91.915.515.713.213.113.412.7
External debt-to-exports ratio (in percent)-238.9-203.0-155.0-135.9-138.4-147.2-154.0-160.1-165.3-170.2-175.1
Gross external financing need (in billions of US dollars) 4/6.67.718.08.81.0-3.7-3.8-4.5-5.0-5.6-6.2
in percent of GDP65.268.1168.076.87.810-Year10-Year-25.4-24.4 -26.8-28.2 -29.4-30.5
Scenario with key variables at their historical averages 5/-209.5-240.8-279.8-316.3-352.7-387.8-54.6
Key Macroeconomic Assumptions Underlying BaselineHistorical

Average
Standard

Deviation
Real GDP growth (in percent)4.68.610.65.76.64.53.76.45.24.43.83.53.3
GDP deflator in US dollars (change in percent)5.42.5-14.41.24.50.77.17.30.93.72.83.12.7
Nominal external interest rate (in percent)2.92.82.12.32.32.91.02.72.73.03.13.13.1
Growth of exports (US dollar terms, in percent)4.64.9-2.15.410.84.16.28.31.15.34.74.74.5
Growth of imports (US dollar terms, in percent)3.40.50.32.24.512.326.77.00.64.74.04.03.8
Current account balance, excluding interest payments-9.9-0.7-4.3-1.66.1-11.412.75.13.82.72.21.91.6
Net non-debt creating capital inflows84.050.137.0-10.811.461.344.519.116.115.415.014.614.3

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 US 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).

For projection, line includes the impact of price and exchange rate changes.

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 non-interest current account and non-debt 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 non-debt inflows in percent of GDP) remain at their levels of the last projection year.

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 US 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).

For projection, line includes the impact of price and exchange rate changes.

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 non-interest current account and non-debt 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 non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Household leverage includes non-profit institutions serving the household sector.

See Annex VIII: FSAP’s Main Recommendations.

The sample banks cover 93.4 percent of system assets (excluding non-EU branches).

The EBA’s assessment was relayed in a formal opinion by the European Commission on November 8, 2018.

See euro area FSAP, 2018.

The bills establish the regulatory regime on Initial Coin Offerings (ICOs) and crypto-currency exchanges (Virtual Financial Asset Act or VFAA), the registration and certification regimes for DLT platforms (Innovative Technology Arrangements and Services Act, and the Digital Innovation Authority (Malta Digital Innovation Act) in charge of certification and registration of innovative technology arrangements. The Malta Financial Stability Authority (MFSA) is responsible for the licensing of VFA service providers (e.g., crypto-exchanges) in accordance with the VFAA which came into force on November 1, 2018. It stipulates that VFA agents, issuers and license holders are subject persons in terms of the AML/CFT national regulation. See MFSA and FIAU for detailed guidance and FSSA, Annex IV.

See Malta FSAP 2019 Technical Note on Risk Analysis.

Category I comprises borrowers purchasing their primary residential property and category II comprises borrowers purchasing their second or additional residential property or buy-to-let properties.

See 2019 Malta FSAP Technical Note on Macroprudential Policy Framework and Tools for more discussions.

Selected issues paper, Malta staff report, IMF 2018.

Prepared by Jorge Salas. Yuanchen Cai provided excellent research assistance.

Over 2012–17, there was a positive correlation between the current account and the output gap, and negative correlations between the REER and both the CA and the output gap. The analysis is based on a graphical representation of income determination and the trade balance, originally proposed by Rudi Dornbusch. See Wyplosz, C, 2013, “Europe’s Quest for Fiscal Discipline”, European Economy Economic Papers 498, European Commission.

See IMF, 2018, “The Gaming Industry in Malta”. Malta: Selected Issues, IMF Country Reports 18/20.

See Technical Supplement Box 1 in IMF, 2018, “2018 External Sector Report—Technical Supplement”.

A link between SPEs and biases in foreign direct investment data has also been documented. See, e.g., Damgaard, J. and T. Elkjaer, 2017, “The Global FDI Network: Searching for Ultimate Investors”, IMF Working Paper No. 17/258.

Valuation changes reflect the difference between the change in the NIIP and the current account. While valuation changes generally reflect shifts in exchange rates and asset prices, among other factors they can also convey information on the degree to which CA balances are distorted due to measurement biases.

IMF, 2017. “2017 External Sector Report” – Special Feature: A Focus on Current Account Surpluses.

See Technical Supplement Box 1 in IMF, 2018, “2018 External Sector Report—Technical Supplement”.

The trade surplus of the sector which includes the gaming industry has increased by about 11 percent of GDP over 2013–17, reaching 35 percent of GDP.

Please refer to Malta Financial System Stability Assessment 2019 for the full set of FSAP recommendations.

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