The Maltese authorities thank staff for a very constructive and valuable dialogue. The Report for the 2014 Article IV Consultation is well-balanced and comprehensive. It conveys the message that consistent structural, fiscal, and financial policies allowed Malta to weather the global economic crisis well and resume a path of strong economic growth. On all these fronts they are delivering steady and progressive results. The authorities are in broad agreement with staff’s assessment and policy recommendations.
II. Economic Outlook and Structural Policies
Since the onset of the crisis, Malta’s GDP growth outpaced that of the euro area and output is currently around 14 percent higher than in 2008. This performance reflects strong fundamentals, sound and prudent macroeconomic policies, and a resilient and well-supervised financial sector. The remarkable diversification achieved by the Maltese productive system has also strengthened the capacity of the economy to weather negative external shocks. In particular, recent years have witnessed the sustained growth – in terms of both value added and employment – of financial services, internet-related services, and aviation services, compounded by the reorientation of more traditional sectors such as manufacturing and tourism (for example, the latter is benefiting from the tapping of new source markets).
While the flexibility and adaptability of the productive structure makes investing in Malta attractive (operating surpluses as a percentage of gross value added is well above the average in the euro area), the authorities agree with staff that continued efforts are needed to prevent the Maltese competitive edge from being eroded. In this respect, it is reassuring that the priorities established by the National Reform Plan – and on which work has already been in progress for a few years – largely overlap with staff’s recommendations. The steady increase of the participation rate – particularly of the female component – is the result of a number of recent initiatives (Free Childcare, among others). Together with the renewed efforts on youth education and vocational training (Youth Guarantee scheme), it will help reducing skill gaps. Ongoing progress in reforming the energy sector – including through the well-advanced restructuring of Enemalta and the diversification of energy sources (gas, renewables, interconnector to Sicily) – will contribute enhancing the country’s infrastructures and its business environment. The latter will also benefit from the ongoing judicial reform, with positive spillovers to the credit market, and the reduction of bureaucracy which is underway. On these and other fronts the authorities are committed to deliver steady progress to sustain productivity and attract further investment.
III. Fiscal Policy
Building on the important results achieved in recent years, the authorities remain committed to prudent fiscal policies. Despite some skepticism on the side of staff (Report for the 2013 Art. IV Consultation), the 2013 target of a deficit below 3 percent was achieved with a sizeable margin (2.7 percent). The authorities expect the 2014 deficit to have decreased to 2.1 percent, and target its further decline to 1.6 percent of GDP in 2015. They note that staff projects a somewhat larger deficit in 2015. While believing the measures undertaken so far are sufficient to achieve the target, the authorities stand ready to revise the fiscal strategy as developments unfold to comply with the fiscal targets committed in the Stability Programme and later confirmed in the Budget estimates for 2015. To this purpose, revenue and expenditure outcomes will continue being monitored closely, on a monthly basis, also in line with the new monitoring requirements established by virtue of the Fiscal Responsibility Act and under the scrutiny of the newly established Fiscal Council. In particular, as for the expenditure side, the authorities take careful note of staff’s suggestions and observe that the budgetary targets are based on a three-year medium term framework for expenditure commitments, complemented by the Comprehensive Spending Review which is conducted at each Ministry level and should ensure a continuous scrutiny of spending activities.
According to the latest estimates – based upon an updated information set made available after the cut-off date of the staff Report and which includes payment of arrears as well as other factors – after peaking at around 69.5 percent in 2013, public debt-to-GDP is estimated to have declined to 68.2 percent in 2014 and the reduction is expected to continue steadily in the following years, reaching 64.4 percent in 2017. Though with some more caution, a sustained fall in both the deficit and the debt ratios is projected also by the recently published Winter Forecasts of the European Commission. The latter bode well for the upcoming Excessive Deficit Procedure Decision.
The authorities remain vigilant also to ensure the long-term sustainability of aging-related expenditures. As staff described, initial important steps have been already taken on health care to enhance the efficiency of spending. A review of the medicines and medical devices procurement and distribution processes got underway with a view to reducing wastage. Looking forward, the increased focus of the administration on primary care should also provide an important contribution to sustainability.
Careful attention is also being paid to the pension system with the recent introduction of the third pillar – the so-called Personal Retirement Scheme – supplemented by the Individual Savings Account scheme. Both schemes are supported by fiscal incentives to encourage savings for retirement. As correctly reported by staff, before considering if additional measures are needed, the authorities prefer to wait for the availability of the updated pension projections to be published in the 2015 Ageing Report of the European Commission (envisaged in May 2015). The authorities are committed to ensure the long-term sustainability of the system and stand ready to introduce, where necessary, further reforms to the first pillar. A Pension Strategy Group (PSG) was set up in 2013 to assess and recommend how reforms can be introduced in the pension system. The PSG has delivered its report to Government and a presentation with the proposals is expected to be delivered shortly to the Cabinet.
There are plans to realign the national parliamentary programme closer to the European Semester. This might imply that the Government would initiate the budget process at an earlier stage, allowing the finalisation of the national budget closer to the submission of the draft budget plan. This should ensure a better evaluation by the European Commission.
IV. Financial Sector
The resilience of the financial sector is a key ingredient of Malta’s competitiveness. The core domestic banks continue to rely on a cautious business model, based on stable retail deposit funding and locally-oriented lending, with a low loan-to-deposit ratio. The international banking sector – though sizeable – has virtually no links with the domestic economy, and continues to be profitable. Solvency and liquidity indicators compare broadly well with the average of the European Union both for the domestic and the international banking sectors. The recent ECB’s Comprehensive Assessment did not identify any capital shortfalls for the three participating banks that operate in Malta. Continuous efforts are needed to preserve the resilience and reputation of the system, to diversify funding sources, and to reduce exposure to non-performing loans.
In this context, as staff pointed out, the amendments to Banking Rules 09 and 12 adopted by the Joint Financial Stability Board are aimed at improving the banks’ overall coverage ratios and provisioning practices, further strengthening the capital base, and enhancing governance structures and risk oversight. These same amendments should also contribute to mitigating potential risks from the exposure to the real estate sector, although we would recall – as we did last year – that this kind of exposure, particularly in terms of collateral, is to some extent unavoidable given the small dimension of the country. It is also pertinent to mention that although advertised residential property prices have picked up recently, this follows a period of modest growth. There are currently no signs of stress in the housing market.
The authorities will monitor closely the effectiveness of the adopted measures and the developments of the broad financial system, standing ready to intervene as appropriate to continue safeguarding financial stability.
As to staff’s recommendations, the authorities confirmed that the supervising institutions will continue to be endowed with adequate resources and that the alignment of local definitions of impairment triggers and forbearance with those used by the European Banking Authority and the SSM has been already implemented through the amended Banking Rule 09 which became effective in December 2013. Furthermore the Maltese authorities will be requesting an FSAP to be undertaken by the second half of 2016.
The relative soundness of the banking sector should allow a gradual recovery of bank credit growth, which, as staff pointed out, remains low. The authorities are tackling this issue through different initiatives. A credit register administered by the Central Bank of Malta is being introduced and will contribute easing informational asymmetries and lowering risk premia. At the same time an assessment of potential market failures influencing access to finance is under way, while the authorities are also considering the establishment of a Development Bank which would complement lending activities undertaken by existing domestic banks. According to the authorities, weak credit growth is partly attributable to a relatively high cost of capital, particularly to SMEs, that could be addressed by a more diversified funding base by banks to lower the cost of funding, and to some extent also by a stronger degree of competition in the banking market. The judicial reform being undertaken to expedite liquidation of collateral, and hence the resolution of non-performing loans, would also contribute to lower interest rates. The authorities are also seeking to widen the possibilities of access to more diversified capital markets for SMEs; actions in this direction include the setting up of a venture capital initiative.