Statement by Carlo Cottarelli, Executive Director for Malta and Antonio Bassanetti, Senior Advisor to the Executive Director, February 17, 2017

Malta has recorded robust growth in recent years. Vibrant domestic demand, favorable external conditions, and further progress with structural reforms supported solid job creation, particularly in services, and reduced unemployment to record-lows. This strong performance, together with fiscal discipline, contributed to continued deficit and public debt reduction while solid profitability and adequate capitalization have kept the banking system stable and resilient.

Abstract

Malta has recorded robust growth in recent years. Vibrant domestic demand, favorable external conditions, and further progress with structural reforms supported solid job creation, particularly in services, and reduced unemployment to record-lows. This strong performance, together with fiscal discipline, contributed to continued deficit and public debt reduction while solid profitability and adequate capitalization have kept the banking system stable and resilient.

The authorities of Malta express their appreciation to the Fund staff for very constructive consultations, based on open dialogue, mutual trust and careful consideration of each other’s point of view. Pursuing such an approach over the years allowed the Fund to be considered as a trusted advisor in Malta, as testified by the very high degree of implementation of the policy recommendations made in previous Article IV consultations.

The authorities of Malta are in broad agreement with the thrust of the 2016 Article IV Report, and would like to provide the following comments.

Macroeconomic outlook

As clearly described in the Report, over the last few years Malta has experienced strong growth, low unemployment, contained inflation, and a buoyant external position. Such a performance is neither the result of a post-crisis rebound – Malta weathered well both the global financial crisis and the euro area sovereign crisis – nor of an unbalanced growth model. Rather it reflects the continued strengthening of fundamentals through a proactive approach to macroeconomic, structural, and financial policies. Beyond being beneficial per se, the authorities’ policy strategy allowed the country to take full advantage also of the improving external environment.

Since joining the euro in 2008, Malta has halved its per capita GDP gap with respect to both the EU and the euro area average, with the latter gap closing from around 74 to 87 percent (in purchasing power standards). Malta is thus a leading example of European integration. Going forward, the authorities’ assessment of the outlook is broadly in line with that of the IMF staff, though they see risks as being more balanced, rather than tilted to the downside.

Regarding external risks, Malta has already demonstrated its resilience in recent years, despite the severe negative shocks that hit its regional context. Malta is well placed to respond to future shocks by relying on an even stronger set of fundamentals, including and increasingly attractive business environment, a well-diversified economy, and sounder public finances. On the domestic side, there is broad consensus that the capacity to deliver on sound policies and relevant structural reforms is a critical competitive advantage of the country, and that – as proven by the recent performance – there is a premium in ‘staying ahead of the curve’ when tackling potential vulnerabilities.

The Maltese authorities agree that the main challenge now facing Malta is consolidating the recent achievements, which would then form the basis for further leveraging its development prospects. This requires addressing the main bottlenecks in the country’s production capacity: labor supply should rise faster, skill mismatches should be overcome, innovative capability should be improved, and infrastructure should be strengthened – particularly in the transport sector. The authorities are determined to pursue these objectives, while persevering with a sound, balanced and cautious approach to macroeconomic policies.

Economic structure

All available estimates point to a sharp increase of Malta’s potential output growth since the global financial crisis. It is now time to push for a further breakthrough in each single component – labor, capital, productivity – in order to ensure continued progress.

Labor supply. Since 2010, the labor market participation in Malta has increased by around 7 percentage points, to 67.6 percent, mainly on the back of the steep positive trend in female participation. The measures introduced in recent years – like free childcare for working parents, tax deductions for the use of private child care centers, free early and after school opening, and fiscal incentives for females returning to the labor market – have thus proven to be very effective. Yet, both the remaining gap with the European average – though more than halved in the last five years – and the labor shortages that are being experienced, point to the need for further improvements in labor supply.

The authorities rank this among the highest priorities and are confident that many recent measures undertaken on several fronts will deliver results in the coming years. Such measures include, among others, the 2016 pension reform which provides incentives for remaining active in the labor market beyond the statutory retirement age; the tapering of some social benefits to stimulate the search for employment; the in-work benefit scheme to help low-income working parents staying employed; the progressive reduction of personal income tax spread over 2013-2015 and the raising of the tax-free income tax thresholds.

The Maltese authorities also recognize the need to enhance the quality of labor supply. The goal is for educational attainments and vocational training to be better attuned to the rapidly changing structure of the Maltese economy. Reflections are ongoing on ways to enhance both teaching and learning, including through the recently concluded in-depth review of the education system. Vocational training is also being pursued through the Youth Guarantee Scheme – in place since a few years – and the educational grants for unemployed single parents.

Capital stock. In recent years the capital stock has been boosted by the implementation of some large projects, particularly in the energy sector (building of new gas plants, realization of an interconnector with Sicily, among others). A substantial contribution came also from strong government investment, which in turn benefitted from the authorities’ capacity to ensure full absorption of the country’s entitlements to EU structural funds.

However, like in the case of the labor supply, the infrastructure development is not matching the pace of a fast growing economy, particularly when it comes to the transport sector. Tackling these bottlenecks inevitably takes some time. The very small dimension of the island and its morphology add complexity to the issue. However, apart from substantial infrastructural investments in major road arteries to ease traffic flows, the authorities have increased substantially the subsidy contribution to the Public Transport operator, a measure that has contributed to enhance the service leading to greater use. This year those turning 18 years old have been granted free entitlement to unlimited public transport use to get them used to it before buying a private car, 18 being the legal driving age. There are also plans for expansion of the Airport terminal by the private operator and the construction of a breakwater to Valletta’s second harbor is being considered for financing under the EFSI Junker Plan.

Productivity. The authorities are aware that there is significant room for improving productivity. Besides the focus on the education and vocational systems, measures are being taken to facilitate access to finance, particularly for SMEs, as a precondition to foster investment and innovations; particular care is also taken to assist firms to internationalize and to ensure continued improvements in the business environment. More specifically:

  • - As for SMEs: (i) the so-called Microinvest scheme – which proved very effective in recent years by envisaging a tax rebate for investment activity – has been extended to 2020; (ii) in 2016 the B-Start scheme has been launched to support innovative startups; (iii) since a couple of years, Malta Enterprise – the national development corporation – is offering a microguarantee scheme for loans to SMEs; (iv) the recent launch of the Credit Register will reduce asymmetries of information; (v) the Development Bank should become operational this year with the objective of facilitating access to credit for SMEs and financing infrastructure investments; (vi) finally Trade Malta will provide support to SMEs in their internationalization efforts.

  • - As for the business environment, Malta Enterprise has recently overhauled the procedures for setting up a business, thereby reducing the required days from 32 to just 2 or 3 by filling out a short electronic form on an online portal following a two-steps procedure. A similarly sharp decrease in the costs of setting up a business has also been achieved (down to around €100 from more than €1,000). Self-employed could start operations by following a simple and free one step procedure which can be completed in one day. The time needed to open up the utilities accounts (electricity, water, etc.) decreased by around 60 percent. For the coming years, Malta Enterprise is working on further simplification of the procedures for both running and closing a business.

  • - In order to favor a healthier corporate sector, the amendment to the Companies’ Act – envisaging substantial modifications to the insolvency regime – is being discussed by Parliament. Among the proposed changes, the new regime foresees a short period of time – just four months – to complete the insolvency procedures (extendable to twelve months only under exceptional circumstances). An out-of-court mediation mechanism is also envisaged under specific circumstances. Finally, a “second chance” principle would be introduced. These measures should contribute to a quick repair of businesses’ balance sheets, thereby saving jobs and enhancing recovery ratios.

  • - As reported by staff, many measures have been adopted in recent years to improve the judicial systems. Efficiency indicators are providing some encouraging evidence. The average disposition time has decreased from 834 days in 2013 to 668 in 2015; at the same time, the clearance rate has substantially increased and, by standing above 100 percent since a couple of years, allows the gradual reduction of the backlog. Measures are also being considered to hasten contract enforcement by licensed credit and financial institutions as this will help reducing their NPL levels.

Fiscal policy

The strengthening of fiscal accounts achieved in recent years has been notable. The primary surplus improved and is estimated to have reached 1.5 percent of GDP in 2016. The overall deficit is estimated to have declined to 0.7 percent of GDP, well below the original target, and the public debt-to-GDP ratio fell from the peak of 69 percent in 2013 to an estimated 60 percent in 2016. Going forward, the authorities are determined to continue building fiscal buffers. They plan reaching a surplus of 0.1 percent of GDP by 2019, corresponding to an improvement of 1.5 percentage points in structural terms, thereby reaching the MTO of a balanced budget as planned. This would imply a further sharp decrease of the debt ratio, to close to 55 percent of GDP.

The authorities take note that – in the absence of a full specification of measures – staff projects a slower adjustment pace. At the same time, they would like to reiterate the credibility of their commitment – won by delivering on the sizeable adjustment of recent years – and would recall the strong and broad political support for further enhancing fiscal fundamentals. Their intention is to continue intervening on both sides of the budget, in the context of prudent revenue projections.

On the revenue side, and as reported by staff, the authorities have been adopting measures to improve the efficiency of revenue administration. On the expenditure side, they will further pursue expenditure control and rationalization, relying – among other things – on the evidence provided by the in-depth spending reviews conducted in the last three years in the critical areas of social benefits, health, and education.

The authorities agree with staff’s suggestion to restrain current spending growth. This said, Malta’s current expenditure as a ratio to GDP decreased from 38.4 to 37.1 percent in the last three years and is significantly lower than the average for the euro area (44.4 percent). As for the risk of spending overruns, in recent years expenditure in priority areas such as health and education was adjusted only in so far as revenues exceeded expectations. In any case, the authorities agree on the need to exercise restraint.

Aging-related pressures are also on their radar screen. The pension reform adopted in 2016 – inspired by the principle of enhancing both adequacy and sustainability – aimed at balancing contributions and benefits through a number of initiatives, mainly through an increase in the contributory period from 40 to 41 years for persons born after 1968, and including an increase in minimum pensions, as well as measures and incentives to delay retirement and increase voluntary savings. The envisaged 5-year monitoring of the results will allow a calibration of the system, if needed, with a view to maintain a stable proportion between the contribution periods and the periods of time during which it is expected that the pension will be paid.

Financial system

As reported by staff, the Maltese financial system is strongly capitalized, highly liquid, profitable, well supervised, and represents one of the points of strength of Malta’s economy. These features apply to all the segments of the system, including the core domestic banks, which have the strongest linkages to the domestic economy. The authorities are traditionally taking a proactive approach to further strengthen resilience.

While on a decreasing trend – which is expected to continue on the back of improved creditworthiness of both NFCs and households – NPLs of core domestic banks (5.6 percent as at September 2016, down from the peak of 9.0 percent in 2013) continue to be closely monitored. The authorities believe that – besides the continued increase of provisions and the significant collateral coverage – building up further buffers is warranted. Thus, they (i) suggest restraint in dividend distribution; (ii) introduced the Other Systemically Important Institutions capital buffers to preserve a strong capital position in the most systemically important banks for the domestic economy; (iii) launched the Countercyclical Capital Buffer to be activated in case of excessive credit growth; and (iv) proposed a change in Banking Rule 9 aimed at establishing concrete plans for banks with NPLs higher than 6 percent to reduce such stock over a 5 year period (in case of failure to deliver on the plans, banks will be required to accumulate additional reserves).

The staff Report points to the high exposure of the banking sector to the real estate industry, which is somehow a structural feature of the Maltese system given the small dimension of the country and the prevailing social and cultural preferences. Bank lending to other sectors is constrained by the extent of foreign direct investment, particularly in manufacturing, where reliance on domestic bank financing is more limited. Furthermore, the shift of the economy towards services, which is less capital intensive, tends to magnify the share of real estate lending. Given the very high home ownership culture, banks’ exposure to the real estate sector is mostly through retail mortgages, where the NPL performance is quite positive. Lending to developers is much more guarded and restrained.

Relatedly, the authorities agree with staff that currently there are no misalignments in property prices. Concerning household debt, the authorities would take a more nuanced view compared to staff, as most of the rise of the debt as a ratio of disposable income occurred prior to 2009-10, with the ratio being broadly stable ever since (as shown also by the chart in the main Report and in the SIP). In other words, in the last six years, mortgage growth has been broadly in line with growth in household disposable income. Furthermore, some mitigating factors further reduce risks, as acknowledged also by staff, such as the sizeable households’ financial wealth and their very low default rate. Also, while mortgage loans are concentrated in a small fraction of highly exposed households, the latter mostly belong to younger cohorts, with a relatively high level of education and – thus – favorable perspectives in terms of disposable income. In any case, the authorities are monitoring the situation closely – for example by enhancing data collection on banks’ exposure to the real estate sector and on credit standards (which remain prudent with low loan-to-value and debt-servicing-to-income ratios), or by running stress tests assuming sharp drops in housing prices (in the order of 20 to 30 percent). They stand ready to intervene through macro-prudential measures, if needed. In this respect, the European Systemic Risk Board has recently concluded that no further measures are currently needed in Malta.

Malta: 2016 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Malta
Author: International Monetary Fund. European Dept.