IMF underscores need for consolidation of public finances

The International Monetary Fund in a report on Malta has stressed that continued consolidation of Malta's public finances "remains a key priority" which, if not addressed "will threaten macroeconoic stability and weaken the credibility of the exchange rate."

The Malta Staff Report for this year was drawn up after an IMF consultation visit to Malta between April 27 and May 9.

It makes an analysis of the state of the economy and commends Malta for pursuing policies that concurred with its advice in areas such as the opening of markets to international competition, consolidation of the fiscal accounts, the accelerated pace of privatisation and parastatal reform, deregulation of interest rates, the strengthening of the independence of the Central Bank of Malta, liberalisation of capital movements and the entry of the Maltese lira into ERM II.

In its analysis, the report mentions the government's efforts to address macroeconomic imbalances, particularly its commitment to fiscal consolidation, which in the medium term would deliver growth-enhancing benefits.

In this regard, the report says, the ongoing privatisation programme would also contribute by improving economic efficiency and reducing the high level of debt. These policies would enable Malta to move a step closer to reaping the full benefits of EU membership.

It also highlights some negative trends, such as the sluggish growth of the economy last year, saying that in the near term growth could remain moderate as the external environment continued to pose a threat to the tourism and semiconductor industries.

The report, therefore, stresses the need for further structural reform to complement fiscal consolidation. In this regard, it also mentions the need to establish a vibrant business environment by streamlining public bureaucracy and lowering the costs of operating in Malta.

In view of Malta's strong linkages with the EU, the report says that adoption of the euro will serve to lower transactions costs, reduce exchange risk and expand the range of trading opportunities.

Finally, the report focuses on the financial system and remarks that while this is strong and well supervised, its exposure to a narrow economic base and a booming housing market necessitate vigilance by the supervisory authorities.

In its assessment of the report, the IMF Executive Board welcomed Malta's successful accession to the EU and the smooth initial transition to a lira/euro peg in the context of ERM II.

The board noted that commendable progress had also been achieved in strengthening macroeconomic management, including the substantial reduction of the fiscal deficit last year despite weak economic growth, and in reforming the parastatal sector.

It observed that Malta was well positioned to derive the full benefits of euro adoption, provided continued progress was made in consolidating fiscal accounts and reforming the economy to promote private sector-led growth.

Although short-term growth prospects remained moderate, the board stressed that continued consolidation of Malta's public finances remains a key priority in light of the sharp increase in public debt, which - if not addressed - would threaten macroeconomic stability and weaken the credibility of the exchange rate.

Achieving this year's budget target will thus be essential, and the board encouraged the authorities to identify proactively areas where current spending could be contained.

The board also underscored the importance of high-quality fiscal adjustment to reduce the deficit further, while protecting capital spending in priority areas.

While welcoming the authorities' commitment under the medium-term fiscal programme and ongoing efforts to improve tax administration, the board stressed that durable adjustment should entail lowering expenditure by, among others, reducing public sector employment, shifting part of the financial burden of health care to the end user and reforming the welfare system to enhance its effectiveness as a social safety net.

The IMF board saw the reforms envisaged in the White Paper on the pension system as important steps that would bolster long-run fiscal stability by addressing the fiscal consequences of population aging.

In particular, they highlighted the importance of raising the statutory retirement age to secure the pension system's financial integrity and establishing a compulsory, privately-funded second pillar. The board also called for prompt implementation of the reforms to ensure that measures can be phased in gradually.

To revitalise economic growth and enhance competitiveness, the board stressed the need for reforms aimed at developing human capital and raising labour productivity.

While acknowledging recent efforts to align student grants and stipends more closely with the needs of the economy, they saw room for further strengthening incentives for education, including through reforms to increase wage dispersion. They also underscored the importance of improving labour utilization and welcomed efforts to eliminate barriers to female participation in the labour market.

The board stressed that a business-friendly environment will be key to boosting investment and fostering job creation. They welcomed the authorities' commitment to the ambitious privatisation plan, and looked forward to its expeditious implementation. They also encouraged further efforts to streamline bureaucracy, eliminate outdated regulations and, more generally, lower the cost of operating on the island.

The board welcomed the authorities' decision to increase domestic interest rates in the run-up to ERM II, and noted that markets have so far judged the interest rate premium on the Maltese lira as being appropriate. Going forward, they considered that Malta is well poised to benefit from euro adoption.

They nevertheless emphasised that Malta's significant current account deficit underscores the need to persevere with fiscal consolidation and step up structural reforms to boost the economy's competitiveness, including through greater attention to labour market flexibility and wage moderation.

The board finally noted that Malta's financial system appears to be sound and well supervised. The highly capitalised banking system should be able to absorb economic shocks, as well as the new prudential requirements associated with Basel II standards.

They cautioned, however, that the increasing bank exposure to the booming housing market calls for close monitoring and urged the authorities to tighten prudential regulations to discourage banks from extending credit with high loan-to-value ratios.

They also underscored the need to address the problems affecting the housing market, in particular by reforming the legal framework.