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

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

Abstract

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

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.

uA01fig01

Key Economic Indicators

(2000Q1=100, seasonally adjusted)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Source: Haver Analytics.
uA01fig02

Employment by Citizenship

(Thousands)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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.

uA01fig03

Quality of Roads

(1-7, 7=best)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Source: World Economic Forum.
uA01fig04

Monthly Rent of 2-bedroom Flats 1/

(2003–2017 percent change; deflated by CPI)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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.

uA01fig05

Contributions to GDP Growth

(Percentage points; year-on-year)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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.

uA01fig06

Inflation and Labor Cost

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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.
Figure 1.

Malta: Economic Indicators

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: Central Bank of Malta; Eurostat; IMF World Economic Outlook; and IMF staff calculations.
Figure 2.
Figure 2.

Malta: Short-Term Indicators

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: European Central Bank; Central Bank of Malta; European Commission; and IMF staff calculations.
Figure 3.
Figure 3.

Malta: Fiscal Developments

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: Eurostat, Haver Analytics, and IMF staff.
Figure 4.
Figure 4.

Malta: Financial Soundness Indicators 1/

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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.
Figure 5.

Malta: External Sector

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: Haver Analytics; Eurostat; UNCTAD; IMF World Economic Outlook; and IMF staff.
uA01fig07

Current Account Components

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: IMF BOP Statistics and IMF staff calculations.
uA01fig08

Unit Labor Cost

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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.

uA01fig09

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

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Source: Central Bank of Malta and ECB.1/ Core domestic banks.2/ All domestic banks. The reporting framework is FINREP since 2014Q4.
uA01fig10

Credit to Domestic Economy

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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.

uA01fig11

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

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: WEO and IMF staff calculations.
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Malta: Contributions to Potential GDP Growth

(Percentage points)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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.

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Maltese Domestic Banks: Profits and Losses

(Percent of assets)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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.

uA01fig14

Corporate Loans

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: ECB and IMF staff calculations.
uA01fig15

Corporate Sector Financing

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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).

uA01fig16

Residential Property Prices

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

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: Central Bank of Malta, Eurostat, and IMF staff.
uA01fig17

Development Permits for Dwellings

(Number of units)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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

article image

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).

uA01fig18

Public Debt and Fiscal Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: Eurostat; and IMF staff’s calculations.
uA01fig19

The Structural Balance and Output Gap

(Percent of potential GDP)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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)

article image
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.

uA01fig20

Corporate Income Tax Revenue, 2017

(Percent of total revenue)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: Eurostat and IMF staff.
uA01fig21

Change in Age Related Spending, 2016–70

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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).

uA01fig22

R&D intensity 1/

(Percent of GDP)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Source: Eurostat1/ Defined as expenditure on R&D as % of GDP.
uA01fig23

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

(1st instance/in days)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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.

uA01fig24

At Risk of Poverty Rate /1

(Percent of population)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Source: Eurostat.1/ Defined as 60 percent of the median equivalized income and for the age class 18 years or over.
uA01fig25

Labor Force Participation and Gender Gap 1/

(Percent)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Source: Eurostat1/ Defined as the gap in participation rate between men and women.
uA01fig26

Early School Leaving Rates

(Percent of population aged 18–24)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: Eurostat and IMF staff calculations.
uA01fig27

Education Spending and Outcome

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Sources: OECD, Eurostat, and IMF staff calculations.
uA01fig28

The Most Pressing Problems that Maltese Firms Face

(Percent)

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

Source: Survey on the Access to Finance of Enterprises (SAFE), European Central Bank.
uA01fig29

Education Attainment and Labor Productivity

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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.
Figure 6.

Malta: Labor Market and Income Inequality Developments

Citation: IMF Staff Country Reports 2019, 068; 10.5089/9781498300605.002.A001

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)

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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)

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Sources: Maltese authorities; and IMF staff projections.

As a percentage of Nominal Potential GDP.

Table 3.

Malta: Balance of Payments, 2016–24

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Sources: National Statistics Office of Malta; and IMF staff projections.
Table 4.

Malta: Financial Soundness Indicators, 2014–18H1/1

(Percent, unless otherwise indicated)

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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.