Malta: Staff Report for the 2014 Article IV Consultation
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This 2014 Article IV Consultation highlights that Malta’s economy continues to weather the global crisis well. Real GDP growth has been one of the highest in the euro area since the beginning of the crisis, supported by relatively diversified exports, a recent recovery in domestic demand, and a stable banking sector. Unemployment is close to historical lows and among the lowest in the euro area. The external position is strong, and progress has been achieved in reducing the budget deficit. The macroeconomic outlook is favorable. Growth is expected to remain robust in 2015–16, supported by domestic demand. Inflation is projected to remain subdued. The current account surplus will likely persist.

Abstract

This 2014 Article IV Consultation highlights that Malta’s economy continues to weather the global crisis well. Real GDP growth has been one of the highest in the euro area since the beginning of the crisis, supported by relatively diversified exports, a recent recovery in domestic demand, and a stable banking sector. Unemployment is close to historical lows and among the lowest in the euro area. The external position is strong, and progress has been achieved in reducing the budget deficit. The macroeconomic outlook is favorable. Growth is expected to remain robust in 2015–16, supported by domestic demand. Inflation is projected to remain subdued. The current account surplus will likely persist.

Context and Outlook: Resilient Economy

1. Malta’s economy has remained resilient since the global crisis. Spillovers from turmoil in financial markets have been contained because of low reliance on external finance by domestic banks and the government. Real GDP has increased at one of the highest rates in the euro area since the crisis, supported by relatively diversified exports and, more recently, by domestic demand. At the same time, unemployment has declined close to its historical lows—among the lowest in the euro area—despite increasing labor participation rates.

A01ufig01

Annual Growth Rate 1/

(Percent)

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Source: IMF, World Economic Outlook.1/ Shaded area represents maximum and minimum.

2. Growth is strong while inflation has declined along with the euro area trend (Table 1). The economy expanded by 2.5 percent in 2013, driven by domestic demand. Growth further accelerated to 3.6 percent (y-o-y) in the first nine months of 2014, supported by investment in large scale energy infrastructure projects and consumption. Inflation remained subdued at around 0.75 percent, reflecting lower oil prices, a decline in electricity tariffs, and low inflation in the euro area. Core inflation has been running higher, at about 1.5 percent, reflecting a closed output gap.

Table 1.

Malta: Selected Economic Indicators, 2010–16

(Year on year percent change, unless otherwise indicated)

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

Includes statistical discrepancy.

A01ufig02

Malta: Contributions to GDP Growth

(percent change, year-on-year)

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Source: National authorities
A01ufig03

Annual HICP Inflation

(percent, SA)

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Source: Haver Analytics and IMF staff calculations

3. Malta has made impressive strides in improving its external balances, but unit labor costs are rising faster than in trading partners (Figure 5, Appendix 1). The trade balance reverted from a deficit of 2.5 percent of GDP in 2009 to a surplus of 9.2 percent of GDP in the first three quarters of 2014. Robust export growth after the crisis has reflected a diversified export base, both geographically and across sectors, and rapidly growing exports of services. Exports, however, grew only marginally in 2014, partly reflecting a drop in the semiconductor sector. The current account remained positive at 8.1 percent of GDP, mainly driven by lower goods imports and a shrinking deficit in the primary income account. At the same time, unit labor costs have been increasing at one of the fastest rates in the euro area, posing risks for competitiveness when many euro area neighbors are undertaking structural reforms and internal devaluations.

Figure 1.
Figure 1.

Malta: Non-Performing Exposures, 2014

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Source: ECB and IMF staff calculations
Figure 2.
Figure 2.

Malta: Economic Indicators, 2003–2016

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Sources: Central Bank of Malta; Eurostat; IMF World Economic Outlook; and IMF staff calculations.
Figure 3.
Figure 3.

Malta: Short-Term Indicators, 2008–2014

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Sources: European Central Bank; Central Bank of Malta; European Commission; and IMF staff calculations.
Figure 4.
Figure 4.

Malta: Fiscal Developments, 2005–2014

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Sources: Eurostat, IMF World Economic Outlook; and IMF staff calculations.1/ Data are ESA1995, since ESA2010 data are not yet available for Belgium, Cyprus, Spain and Slovakia.
Figure 5.
Figure 5.

Malta: External Sector, 2001–2014

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Sources: Central Bank of Malta; Eurostat; Malta NSO, UNCTAD, and IMF staff calculations.1/ Real exchange rate measures disseminated by the Eurostat differ from those used in CGER calculations (based on INS data). Eurostat exchange rates assign greater weight to euro area trading partners making the impact of recent euro nominal depreciation appear more muted.2/ All available real exchange measures use weights that are based on trade in goods only. For Malta, whose primary exports are in services they should be interpreted with caution.3/ The decline in other services is driven by insurance and pension services and the use of intellectual property.
A01ufig04

Current Account Balance 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Source: IMF, World Economic Outlook.1/ Shaded area represents maximum and minimum.
A01ufig05

Unit Labor Costs

(2005=100)

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Source: Eurostat

4. Despite a growing economy, credit to corporations has remained weak, and the cost of capital has remained relatively high. Loans to non-financial corporations (NFCs) had been declining and only recently have stabilized at around a zero growth rate. At the same time, NFCs’ lending rates have remained high relative the euro area average—despite the decline in ECB policy rates and a sound banking system—making it difficult for viable firms, particularly smaller ones, to access credit. High lending rates could reflect various factors, including higher funding cost of banks (relative to the ECB policy rates), limited competition, high level of NPL ratios, and relatively high corporate sector leverage, particularly for smaller firms and in certain sectors (Appendices 2 and 3).

A01ufig06

Loans to NFCs1/

(percent change, SA)

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

1/ Outstanding amounts.Source: Haver Analytics and IMF staff calculations.
A01ufig07

Lending Rates on Loans to NFCs1/

(percent)

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

1/ Outstanding amounts; EA, Total: EA16, excluding Estonia and Latvia.Source: Haver Analytics.

5. Overall, the baseline outlook is strong. In particular:

  • Growth is projected to remain robust, at around 3 percent in 2015–16. The output gap is slightly positive and is expected to close over the next two years. Domestic demand is supported by large scale investment projects in the energy sector and strong household income from rising wages and employment. Lower oil prices are expected to raise growth marginally in 2015. Over the medium-term growth is projected at 2.6 percent, slightly higher than the average since the EU accession on account of increased labor force participation.

  • Inflation is projected to rise slowly as upward pressures from a small positive output gap and higher unit labor costs are expected to be dampened by planned reduction in energy tariffs, the pass-through of lower global oil prices and euro area inflation.

  • The current account surplus will persist, supported by lower oil prices in 2015, the projected gradual recovery in external demand, Malta’s continued competitiveness in the services sector, and the planned transfers of EU structural funds, despite the uncertainty surrounding the primary income account reflecting transactions of international banks (Table 3).

Table 2.

Malta: Fiscal Developments and Projections, 2010–16

(Percent of GDP, unless otherwise indicated)

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Sources: Maltese authorities and IMF staff projections.
Table 3.

Malta: Balance of Payments, 2010–16

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Sources: National Statistics Office of Malta; and IMF staff projections.

6. Risks to the outlook are balanced (Risk Assessment Matrix). In the short-term, prolonged stagnation and deflation in the euro area would reduce external demand and make fiscal adjustment more challenging. Medium-term risks of delays in implementing energy infrastructure projects and restructuring state-owned enterprises are balanced by the possibility of positive spillovers to private investment and consumption from ongoing large scale investment projects. Broader than expected changes in the EU regulatory framework and tax reforms could erode Malta’s competitiveness especially if implementation of structural reforms in Malta is delayed while many other euro area countries continue to reduce their unit labor costs. Fiscal slippages and a further increase in public debt could feed into higher financing costs, crowding out private investment.

Exchange Rate Assessment

Since the last Article IV consultation, the real effective exchange rate (REER based on INS), is depreciated by about 1.5 percent. Real effective exchange rates remain elevated relative to trading partners, and the gap between the ULC and CPI based REER persists (Figure 5).

Nevertheless, estimates of exchange rate valuation are broadly in line with fundamentals. While the macro balance and external sustainability approaches show a small undervaluation, the equilibrium exchange rate approach points at an overvaluation of about 6 percent.

Estimates of Exchange Rate Valuation 1/

(Percent)

article image
Sources: IMF article IV staff reports; and IMF staff estimates.

+/− indicates exchange rate over/undervaluation; see IMF Occasional Paper No. 261 for details on the methodology underlying the estimates in this table. Numbers are not comparable with previous Art IV due to data revisions.

To compute the medium term RER we use data up to October 2014.

Authorities’ views

7. The authorities broadly agreed with the outlook and risks. Staff’s growth projections are marginally more optimistic than the Central Bank’s, reflecting recent oil price and exchange rate developments, while the Ministry of Finance expected higher growth rates in 2015 and 2016 (3.5 and 3.4 percent, respectively) on account of more favorable external assumptions. Continued strong performance of the tourism industry was also expected to support growth. The authorities saw the external environment as one of the main sources of downside risks, including for the recovery of semiconductor exports. They noted that the downside risk of investment project delays is balanced by the possibility of stronger than expected consumption due to improved confidence and labor market conditions. The risk of loss of competitiveness from changes in regulation and tax reform was seen as modest as the authorities emphasized still-relatively-low labor costs, flexibility and availability of skilled labor, and Malta’s overall diversification and dynamism as the main sources of competitiveness.

Policy Discussions: Sustaining Growth and Reducing Vulnerabilities

8. Despite the broadly favorable outlook, Malta faces important challenges: public debt is still high; non-performing loans are elevated; the cost of capital is relatively high despite abundant liquidity; and maintaining competitiveness is increasingly difficult. To raise growth in a sustainable manner and reduce vulnerabilities, the policy agenda should focus on: 1) strengthening fiscal sustainability; 2) maintaining financial stability; and 3) enhancing competitiveness and reducing the cost of capital.

A. Strengthening Fiscal Sustainability

9. Malta has made significant progress in reducing its overall deficit and strengthening fiscal governance since the last Article IV consultation. Stronger than expected growth helped lower the fiscal deficit by almost 1 percentage point to 2.7 percent of GDP in 2013, and debt reached 69.5 percent of GDP, partly reflecting stock-flow adjustments. Fiscal consolidation has continued in 2014, despite rapidly growing current expenditures, financed by stronger-than-expected revenues. Staff estimates the fiscal deficit to decline to 2.2 percent in 2014. The authorities enacted the Fiscal Responsibility Act (FRA) over the summer, introducing i) a balanced-budget rule and a debt rule in line with EU requirements; ii) an independent fiscal council to monitor fiscal rules; iii) the Medium Term Fiscal Policy Statement and the Fiscal Policy Strategy; iv) a fiscal risk statement; and v) a contingency reserve to be built over the next five years.

Staff’s views

10. The budgetary targets for 2015-2017 are welcome but meeting them will be challenging. The authorities aim at bringing the structural deficit to -0.4 percent in 2017, implying an annual average fiscal consolidation of about 0.6 percent of GDP. The implied pace of adjustment strikes an appropriate balance between adjusting towards the MTO of balanced budget in structural terms and limiting its impact on growth. However, the authorities’ target for 2015 (-1.6 percent of GDP) is based almost entirely on revenue measures, and the underlying growth projections rely on favorable external assumptions. To ensure that the proposed fiscal targets are met, additional expenditure measures should be considered. These measures should be designed to contain the fast growth in current spending—including through prudent wage agreements and further restraint on public sector employment—while preserving incentives for labor participation and education, and capital spending. Given weaker growth assumptions, possible slippages in the wage bill and subsidies relative to the targets, and lack of specific measures beyond 2015, staff project an overall deficit of 1.9 percent of GDP in 2015 and 1.5 percent for 2017 (Table 2). Staff project debt to reach 69.8 percent in 2015, gradually declining to around 62 percent of GDP by 2020. Low inflation and growth, and contingent liabilities are the key risks (DSA Annex).

11. Broad-based reforms—on expenditures, pension, and healthcare—are critical to contain fiscal pressures going forward. The authorities have started a Public Expenditure Review (PER) process, and the main progress has been made in social security spending. Building on this initiative, a comprehensive spending review would help prioritize and contain spending. In addition, such a review would facilitate improvements in the efficiency of spending, for example on education and health, where outcomes remain weak despite high spending levels. On pension reforms, while a private third pillar pension scheme was introduced in 2014, progress has been limited. Further measures—such as accelerating the planned increase in the retirement age and linking pensionable income to a longer period of working years—are needed to curb the projected increase in public pension outlays.1 On health care, initial steps in improving medical procurement have been taken, increasing access to drugs and controlling costs. The government is also planning to establish cost centers within hospitals aiming to enhance management practices. However, progress in reforms and its impact on the budget are expected to be modest and gradual. Accelerating the implementation of planned health care measures—such as increasing the administrative efficiency and strengthening primary care—will help contain spending growth.

A01ufig08

Efficiency of Tertiary Education, 2011

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Source: Eurostat, OECD, WDI, and IMF staff calculations
A01ufig09

Change in Age-related Spending, 2010-60

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Source: EurostatNote: The age-related spending is going to be updated given new populations statistics. New estimates will likely yield lower expected expenditure.

12. The authorities should continue to push forward with restructuring of state-owned corporations and overall fiscal reforms. Given the extent of ongoing restructuring efforts and implications on the budget, it is important to disclose, analyze, and manage risks to public finances from the state owned enterprises in a consolidated manner. Enemalta’s (the utility company) restructuring, once completed as planned, will bolster public finances, reduce guaranteed debt (16 percent of GDP in 2014, about 60 percent of which is due to Enemalta) and help lower energy costs.2 As the privatization agreement is at its final stages, a part of the proceeds has been already used to cover the tax arrears, and the rest is going to be used to reduce bank loans. Regarding the infrastructure projects—essential to reduce production costs—the interconnector to Sicily is almost complete, but the completion of one of the power plants, originally scheduled for 2015, is now delayed to 2016. To ensure a sustainable financial position, tariff reductions should be backed by cost containment. The restructuring of Airmalta is continuing (involving a total government injection of €130 million, about 1¾ percent of GDP, to be completed by 2016), but the company is facing challenges in breaking even as planned. Recent nationalization of the public transport company has led to an increase in subsidies (about 1/3 percent of GDP). The authorities are in the process of its re-privatization. Staff encouraged the full implementation of the FRA for the next budget period, which would help manage risks, including from the SOEs, in a multi-year framework. In addition, ongoing initiatives to integrate the revenue administration agencies will help improve the overall budgetary process.

Authorities’ views

13. The authorities acknowledged the risks, but were confident that their deficit targets would be met. They noted that the fiscal deficit declined by 1 percentage point in 2013, and additional expenditures in 2014 were concentrated on priority areas, such as health care and education. On SOEs, the authorities anticipate that the expected cost and efficiency gains from Enemalta’s restructuring would cover the tariff reductions implemented in 2014 and 2015. In addition, they noted that SOEs are subject to public scrutiny individually. On pension reforms, the authorities noted that they would wait for the results of the updated projections for pension spending based on new population statistics before taking any additional measures. On fiscal reforms, the authorities intend to implement the FRA for the next budget period, starting with the appointment of a fiscal council. They also noted that the National Audit Office reviewed the macro and fiscal projections for the 2015 budget. On spending review, they emphasized that progress has been made on social security, and they are considering expanding it to other sectors, including through technical assistance by the IMF.

B. Financial Sector Policies

14. The Maltese financial system remains resilient. Solvency and liquidity of banks remain well above regulatory requirements, and profitability is good (Table 5). Solid performance of core domestic banks reflects their conservative business model, particularly limited external assets and liabilities and relatively low loan-to-value ratios. As a result, the largest banks passed the ECB’s recent Comprehensive Assessment (CA) without a need to raise additional capital. The large segment of international banks has very limited links with domestic residents, and as a result the recent significant deleveraging of some of these banks had minimal impact on the local economy (Box 2)3. While there may be some spillovers to domestic financial system from stronger cross-border deleveraging and/or regulatory changes elsewhere, the impact on the economy is likely to be limited.

Table 4.

Malta: General Government Financial Balance Sheet

(Millions of euros)

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Sources: Eurostat; National Statistics Office of Malta; and IMF staff calculations.
Table 5.

Malta: Financial Soundness Indicators, 2010–13

(Percent, unless otherwise indicated)

article image
Source: CBM/MFSA

Malta: Results of the ECB’s Comprehensive Assessment

(Percent)

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Malta: Overview of the Financial Sector

The Maltese financial sector is very large compared to the size of its economy. As of mid-2014, assets of banks were close to 7 times GDP and assets of non-bank financial institutions (insurance companies and investment funds) were around 2 times GDP. The financial institutions in each of these groups can be classified as either domestic or international, depending on the scope of their involvement in activities with residents. Risks and vulnerabilities related to domestic institutions differ substantially from those related to international institutions. For banks, the Central Bank of Malta (CBM) also separates the category of domestic institutions into core domestic banks and non-core domestic banks.

  • Core domestic banks have a traditional business model of attracting household and corporate deposits and providing loans to the economy. These banks have limited external assets and liabilities, provide around 97 percent of bank lending to residents in Malta, and collect around 94 percent of resident deposits. Two banks account for over 90 percent of both loans to and deposits from residents. Core domestic banks that are subsidiaries of big foreign parent banks have not relied on parent funding for their operations in Malta. As of end-June 2014, the core domestic banks had an aggregate capital adequacy ratio of 14.9 percent and liquidity ratio (liquid assets to short-term liabilities) of 42.6 percent, well above the minimum requirements of 8 percent and 30 percent, respectively.

  • International banks rely mostly on wholesale (including intra-group) funding and nonresident deposits of relatively long maturities. These banks concentrate on activities for the group (custodian services, trade finance, investment banking). While international banks are particularly large compared to the size of the economy, risks to systemic financial stability arising from these banks are rather low. With negligible direct balance sheet links to the domestic economy both from the assets and the liabilities sides, the systemic financial implications in the event of materialization of solvency or liquidity risk affecting international banks would be contained. Furthermore, with abundant capital and liquidity, these banks should be able to absorb significant pressures before the point of non viability.

  • Non-core domestic banks have limited links with the domestic economy and are funded primarily from wholesale markets and non-resident deposits. Unlike the international banks, these banks have some (albeit still small) exposure to residents in the form of loans and deposits. Around 9 percent of assets and 12 percent of liabilities are respectively claims on and due to residents. Therefore, the main risks related to these banks stem from possible cross-border deleveraging pressures and claims on the local deposit compensation scheme in the event of bank failure.

The non-bank financial institutions are relatively small, and the main systemic risk arising from these institutions relates to their interconnectedness with core domestic banks. Around one third of insurance companies (with assets of €2.4 billion as of end-2013) and investment funds (with assets of €0.8 billion) are classified as domestic. The insurance sector is dominated by one company, which has a market share of around 60 percent in terms of assets. Assets of insurance companies and investment funds mainly consist of shares and equity holdings, of which over one half is issued outside Malta. Core domestic banks hold a significant shareholding in several domestic insurance companies, while over 10 percent of insurers’ assets consist of deposits held with the Maltese banks. The investment funds have significant investments in local bank equity.

15. The regulatory and supervisory frameworks have recently been strengthened in several areas (Box 3). In late 2013, the Malta Financial Supervisory Authority (MFSA) amended the regulation on loan provisioning, requiring banks to allocate higher provisions for nonperforming loans. As a result, the coverage ratio increased from 39.5 percent in 2013 to 40.3 percent in June 2014, and expected to increase further. The CBM Act was also amended in late 2013, adding the formulation and implementation of macro-prudential policy as an explicit objective of the CBM. In this context, work on developing a macro-prudential toolkit has started. At present, the CBM and the MFSA are conducting research on the macro-prudential toolkit, such as possible use of broad-based and sector-based capital buffers for banks. The Joint Financial Stability Board (JFSB) has enhanced inter-agency cooperation on financial stability. In November 2014, the supervision of the largest banks was transferred from the MFSA to the Single Supervisory Mechanism (SSM).

Malta: Bank Regulatory and Supervisory Frameworks

The Malta Financial Supervisory Authority (MFSA) is a unified supervisor of all financial institutions and markets. The MFSA periodically conducts internal audits or commissions external experts to review compliance of its regulatory and supervisory arrangements with the best international standards. However, there has been no Financial Sector Assessment Program (FSAP) in Malta since 2003.

In response to the past recommendations of staff and the EC, the authorities have taken measures to increase loan loss provisions. Following a consultation with stakeholders, the new regulations (Banking Rule BR/09) became effective as of end-2013. The amended regulations require banks to allocate a higher amount of provisions for NPLs, by allocating reserves of 2.5 percent of a bank’s NPLs.

The institutional set up for macro-prudential policymaking has been recently strengthened. The amendments to the CBM Act of November 2013 augmented the responsibilities of the CBM by adding the formulation and implementation of macro-prudential policies to the functions of the CBM. A second deputy governor was appointed with a focus on financial sector issues. The amendments also gave a legal status to the JFSB that was set up in early 2013 and made up of representatives from the CBM, MFSA, and Ministry of Finance, the latter as observer.1

1 The main objective of the JFSB is to facilitate cooperation between domestic authorities in matters related to systemic financial stability, including the identification and assessment of macro-prudential policy instruments.

Staff’s views

16. While noting solid performance of the Maltese banks and welcoming recent legal and regulatory changes, staff pointed to several areas where resilience could be further strengthened. In particular:

  • Although the two largest banks were found to be adequately capitalized under the ECB’s CA, their NPL ratios were revised substantially upwards, suggesting that the NPL ratio for the rest of the banking sector could also be higher under stricter loan classification rules. Swift implementation of the action plans resulting from the CA would be essential. Of particular importance is the need to align definitions of impairment triggers and forbearance used by individual banks with those used by the European Banking Authority and the SSM, and continued efforts to boost provisioning.

  • The MFSA should maintain sufficient resources as needed by the intensity of the regulatory and supervisory work, including in the AML/CFT area. The transfer of supervision of the largest banks from the MFSA to the SSM has been smooth. Continued close cooperation between the MFSA and the SSM is needed to ensure no reduction in supervision of these banks.

  • Enhanced focus of the MFSA on smaller banks is now appropriate, given forthcoming changes in ownership. Two mid-sized core domestic banks (Banif and Lombard) are in the process of ownership change.4

  • One of the main risks facing core domestic banks relates to their exposure to the real estate sector. Around two thirds of loans extended by banks are secured with real estate collateral, and mortgages are one of the few segments of bank loans which have been increasing recently (unlike loans to NFCs). It is important to continue mitigating the risk of exposure concentration to the real estate sector by the application of a cautious collateral valuation and conservative loan-to-value ratios. There is also room to enhance the loan foreclosure process by advancing judicial reform.5 This risk can be exacerbated by the weak performance of the EU countries, generating negative spill-over effects on the Maltese economy and its financial sector.

  • The contingency framework should be strengthened in line with reforms at the EU level. This includes boosting the ex-ante funds of the deposit compensation scheme while lowering the share of banks’ special contribution (ex-post payment commitments).6 Also, legal amendments are needed to implement the EU Bank Recovery and Resolution Directive, establishing a resolution fund and introducing a bail-in requirement.

  • The MFSA and FIAU should continue to aim for high standards in the AML/CFT framework, particularly in light of the large financial and online gaming sectors.

  • To get a fuller assessment of the financial sector’s condition and oversight, an update of the FSAP—which took place in 2003—would be appropriate.

Authorities’ views

17. The authorities agreed with staff on the need to adapt the financial sector policy framework to the changing environment. They intend to maintain local laws and regulations on loan classification, macroprudential oversight, deposit insurance, and bank resolution in line with the EU requirements, and stressed that work is under way in all these areas. In particular, there are plans to amend the MFSA Act with the aim to establish a Resolution Board under the auspices of the MFSA. The authorities were positive about the move toward a banking union in the EU, and both MFSA and the ECB emphasized the importance of close cooperation in supervising the largest banks. The MFSA noted that two mid-sized banks are now in the process of asset quality review similar to the one conducted for the largest banks under the ECB’s auspices, and two more banks will be subject to a similar review in 2015. The authorities agreed with the recommendation to ensure high standards in the AML/CFT framework, and indicated that efforts are under way in several areas to address shortcomings noted by the 2012 MONEVAL report. The authorities stated that they would soon request an FSAP update.

18. The authorities broadly shared staff’s views on possible sources of risk to the financial sector. They noted that a slow economic recovery in the EU represents a risk to the domestic economy and financial sector. While they agreed that high NPL ratios are an important challenge for core domestic banks, they expected a reduction going forward as growth picks up. The authorities were less concerned than staff about the exposure of banks to the real estate sector. They were of the view that delinquency rates on mortgages have traditionally been one of the lowest, the exposure of banks to speculative property trading is very small, and household income (the main source of vulnerability for mortgages) is growing at a healthy rate.

C. Structural Policies

19. The authorities are making progress in a number of structural reform areas—energy, judicial reform, and labor market. These priorities are outlined in the National Reform Program (NRP), which aims at increasing competitiveness of the economy and ensuring long-term fiscal sustainability. These steps should help address the low female participation, skill gaps in the labor market, difficulties of early school leavers, Malta’s dependency on oil as the main energy source, and inefficiencies of public procurement.

20. The government is implementing a three year plan for judicial reform based on the recommendations of the Justice Reform Commission. The first year focused on amendments to criminal law, with improvements to civil and commercial law planned in the upcoming year. Planned reforms include: increasing the number of courts assistants, greater use of information technology in court administration, raising the thresholds for streamlined judicial procedures, and introducing alternative dispute resolution mechanisms such as mediation.

21. A number of labor market and education reforms have been aimed at increasing labor participation and enhancing skills. The authorities have improved incentives to work by introducing free childcare for working mothers, and gradual tapering of social benefits for those entering employment. The government is improving search and matching efficiency by introducing electronic platforms for job vacancies and involving the private sector in finding jobs for youth. Planned measures on education include compiling an employability index for higher education courses to assess how they correspond to labor market requirements, and introducing private tuition support for youth experiencing difficulties in primary education.

Staff’s views

22. Maintaining Malta’s competitiveness will require sustained productivity and value-added growth. In global competitiveness assessments, Malta is lagging behind in some key areas, such as ease of starting a business, access to credit, and legal rights. While Malta’s comparative advantage in the services sector has helped support its exports, some sectors (e.g. remote gaming) remain vulnerable to regulatory and tax changes elsewhere. Competitiveness may also be threatened by increased mismatch between wages and productivity growth, especially when many euro area neighbors continue to reduce their unit labor costs (Appendix 1). At the same time, Malta’s dynamic economy should be supported by affordable lending to viable firms (Appendices 2 and 3). The following areas are priorities for structural reforms.

  • Skills upgrading: Ensuring sufficient growth in labor productivity requires better upgrading and utilization of skills. Malta has one of the lowest tertiary education enrollment rates and one of the highest drop-out rates in the EU. Measures to boost tertiary education enrollment and the quality of vocational training need to continue in order to reduce skills mismatches and improve the quality of labor.

  • Female labor participation: Female labor force participation has increased, helped by government policies, but it is still one of the lowest in the euro area. With growth increasingly dependent on financial and niche services, the authorities need to ensure ample and well-qualified labor force. Budget measures that incentivize labor participation, especially female participation, should be prioritized over other forms of current spending. Vocational education should be strengthened further by identifying and expanding programs that deliver best employment outcomes.

  • Judicial reforms: While Malta has made some progress in reducing the time needed for dispute resolution, including insolvency proceedings, it remains high compared to EU peers (see e.g. the 2014 EU Justice Scoreboard). The government should continue planned judicial reforms and monitor their outcomes focusing on the speed of resolving judicial cases and the use of alternative dispute resolution mechanisms such as mediation. Encouraging greater use of the insolvency regime, as well as more out-of-court workouts, accelerating collateral recovery, and reforming bankruptcy procedures are crucial for the resolution of the growing stock of nonperforming loans on bank balance sheets and dealing with the debt overhang of some SMEs.

  • Reducing the cost of capital: A number of measures should be considered to reduce the relatively high cost of capital.

    • Creating a credit registry, as planned by the authorities, should help reduce financing costs and, in the medium-term, help facilitate other forms of market financing, such as securitization. This would complement initiatives to jump start markets for risk capital. Full benefits of the credit registry can be obtained if it is comprehensive (collecting data also from non-financial institutions) and includes not only indebtedness information, but also payment history (including positive history).

    • High NPLs are contributing to high interest rates, particularly in certain sectors, as implied by the correlation between NPL ratios (and relatively high corporate leverage) and lending rates on new loans (Appendix 3). There is a need for a strategy for NPL resolution. Such a strategy should include accelerating NPL write-offs, encouraging greater use of the insolvency regime, faster enforcement of creditor rights, and developing options for out-of-court workouts.

    • While the reliance on domestic funding across sectors (government, banks, and corporates) has helped shield Malta from the global financial crisis, encouraging a moderate increase in cross-border financing should help lower funding costs across the economy.

    • A development bank—which is being considered by the authorities—could in principle help stimulate markets for long-term financing of risky projects and stimulate nascent markets. However, it should not be in direct competition with commercial banks, should have a clear and periodically re-evaluated mandate, be effectively supervised, and have strong governance.

A01ufig10

Early Leavers from Education and Training, 2013

(percent total, ages 18 to 24 years)

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Source: Eurostat
A01ufig11

Female Labor Participation

(Percent)

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Source: Eurostat
A01ufig12

NPL Ratios and Interest Spread on New Loans

(Percent)

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Source: ECB; CBM; NPL ratio is non-performing loans to gross loans and is interpolated from quarterly data on FSI indicators.

Authorities’ views

23. The authorities agreed with staff on the importance of structural reforms. Specific areas such as judicial reform and labor market improvements are priorities for the government. The authorities emphasized that reforms would take some time owing to a large amount of institutional changes requiring consensus building, approval by Parliament, and a cultural change in some cases.

24. The authorities agreed that the cost of capital is relatively high. They expected positive results from the planned credit registry and tax measures to stimulate venture capital investments. On credit registry, the authorities expected to finalize the consultation with banks in early 2015 and introduce the registry in two stages. The first stage is expected to be completed by mid 2015, in line with data requirements at the euro area level (the ECB’s Anacredit project with a deadline of December 2017). They saw the influence of NPLs as limited only to certain sectors such as construction. The authorities agreed that there may be scope to facilitate increased cross-border financing, but pointed to a number of structural obstacles and trade-offs with financial stability, particularly the small size of issuance and high resulting liquidity premiums.

Staff Appraisal

25. Malta continues to weather the global crisis well. Real GDP growth has been one of the highest in the euro area since the crisis and remains solid going into 2015. The external position has stayed strong, and unemployment is close to historical lows and among the lowest in the euro area. These developments reflect a relatively diversified economy and a stable banking sector.

26. The economic outlook is strong and risks are balanced. Staff project continued robust real GDP growth in 2015–16, driven by domestic demand. Inflation is projected to remain subdued. In the short-term, a prolonged stagnation and deflation in the euro area would reduce external demand and make fiscal adjustment more challenging. While risks related to the delays in restructuring of various state owned enterprises remain, there are potential positive spillovers to private investment and consumption from large infrastructure projects. In the longer term, Malta’s competitiveness could be eroded if Malta falls behind in implementing structural reforms while many euro area countries continue to reduce their unit labor costs, including through stepped up regulatory and tax reforms elsewhere.

27. Now is an opportune time to push forward with policies to raise growth in the medium-term in a sustainable manner and reduce vulnerabilities. Despite a robust outlook, Malta faces important challenges: public debt is still high; non-performing loans are elevated; the cost of capital is relatively high despite abundant liquidity; and maintaining competitiveness is increasingly challenging. The policy agenda, therefore, should focus on three areas: (i) strengthening fiscal sustainability; (ii) maintaining financial stability; and (iii) enhancing competitiveness and reducing the cost of capital.

28. The budgetary targets for 2015-2017 are welcome but meeting them will be challenging. The fiscal deficit declined to 2.7 percent of GDP in 2013, and with the output gap closed, there is a window of opportunity to reduce public debt. The consolidation measures proposed by the government for 2015 are mostly on the revenue side, and the underlying growth projections rely on favorable external assumptions. To ensure that the proposed fiscal targets are met, additional expenditure measures should be considered. These measures should be designed to contain the fast growth in current spending while preserving incentives for labor participation and education, and capital spending. If revenues turn out to be higher than projected, they should be used for debt reduction. In this context, full implementation of the comprehensive spending review would help prioritize and contain spending, while increasing efficiency.

29. Broad-based reforms—on pension, healthcare, and public corporations—are critical to contain fiscal pressures going forward. Further measures are needed to curb the projected increase in public pension outlays and health care spending. Authorities should continue to push forward with restructuring of state-owned corporations. More generally, it is important to disclose, analyze, and manage risks to public finances from state owned enterprises in a consolidated manner.

30. The government’s efforts to strengthen fiscal governance are welcome. The full implementation of the FRA for the next budget period is encouraged. Ongoing initiatives to integrate the revenue administration agencies will help improve the budgetary process.

31. Overall, the financial sector remains stable. Malta continues to host a relatively large financial sector without exposing itself to excessive risk. The regulatory and supervisory frameworks have recently been strengthened. A fuller assessment of the financial sector’s condition under the Financial Sector Assessment Program would be useful.

32. Remaining financial sector vulnerabilities stem from the relatively high level of NPLs and exposure to the property market. The NPL ratios of the largest banks were revised upwards under the AQR. At the same time, exposure of the core domestic banks to the property market remains substantial, leaving the banking sector vulnerable to developments in the real estate sector, particularly in the case of direct exposure to the construction sector.

33. Efforts are needed to further boost the resilience of Maltese banks and ensure robust supervisory and contingency arrangements. Policies should focus on: (i) a swift implementation of the action plans resulting from the ECB’s comprehensive assessment, and applying the same standards across the rest of the banking sector; (ii) strengthening the contingency framework in line with reforms at the EU level, including by boosting the resources of the deposit compensation scheme and lowering the share of banks’ special contribution; (iii) following through legal amendments needed to implement the EU Bank Recovery and Resolution Directive, establishing a resolution fund and introducing a bail-in requirement; and (iv) continuing to aim for high standards in the AML/CFT framework.

34. Maintaining Malta’s competitiveness will require sustained productivity growth. The priorities include improving labor participation and productivity, and reforming the judicial system to improve the business environment. Malta’s dynamic economy should be supported by affordable lending to viable small firms. Therefore, policy actions are needed to reduce the cost of capital, including by developing a strategy for NPL resolution, implementing the planned credit registry, and encouraging a moderate increase in cross-border financing.

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

Malta: Risk Assessment Matrix1

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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 of risks listed 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 of 30 percent or more). 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.

Figure 6.
Figure 6.

Malta: Financial Soundness Indicators

Citation: IMF Staff Country Reports 2015, 046; 10.5089/9781498318280.002.A001

Sources: Central Bank of Malta; and Malta Financial Services Authority.

Annex I. Implementation of IMF Recommendations

The Maltese authorities have taken on board the majority of policy recommendations made by the Fund in previous Article IV consultations (Annex Table 1).

Table 1.

Implementation of IMF Recommendations

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