Governor calls for priority policy to contain local costs

Central Bank Governor Michael C. Bonello has insisted that containing local costs should be a priority policy objective, complaining that price levels appear not to have benefited sufficiently from the liberalised trading environment following EU membership.

Mr Bonello said in the bank's annual report, published yesterday, that smooth participation in ERM II needed to be accompanied by similar progress in satisfying the other conditions for adopting the euro.

While meeting the deficit targets appeared to be on course, meeting the inflation criterion for adopting the euro constituted an equally important policy challenge, particularly in the light of the sharp rise in oil prices during last year. This factor inevitably led to markedly higher domestic energy and fuel costs, and these were duly reflected in consumer price indices.

"Price levels also appear not to have benefited sufficiently from the liberalised trading environment following EU membership, particularly in the case of some essential commodities. As a result, the HICP index tended to exceed the Maastricht reference value during the year. In these circumstances, containing local costs should be a priority policy objective. A more proactive stance is also called for on the part of the agencies whose responsibility it is to ensure that competition and price transparency prevail."

The Governor said that if the opportunities offered by membership of the EMU were to be fully exploited, the ongoing efforts to achieve nominal convergence needed to be complemented with supply side reforms that would enable the economy to narrow the existing output gap and to achieve, and sustain, higher rates of growth.

While initial estimates suggested that a 2.5 per cent real GDP growth rate was recorded last year, this positive outcome was nevertheless preceded by two consecutive years of contraction. The latter partly reflected the short-term costs of fiscal consolidation. With the effect of this factor expected to ease progressively, and if the incipient recovery in exports observed towards the end of last year persisted, the economy should continue to register positive growth rates.

Mr Bonello said a remaining source of uncertainty in this regard was the price of imported oil and its effect on production costs and consumer prices. This factor had a marked impact on GDP growth and on the balance of payments last year, contributing to a three-and-a-half percentage-point deterioration in the current account deficit to GDP ratio. In addition, the demand for exports remained sensitive not only to the pressures of international competition, but also to non-economic factors such as international political crises and the possible outbreak of a flu pandemic.

"While the forecast recovery over the next few years is welcome, the expected average growth rate of around two per cent efficiency is not sufficient to enable the economy to meet simultaneously the challenges of demographic change and faster convergence to EU average income levels. It is estimated that one percentage point of the annual GDP growth rate over the next 20 years will be absorbed by the increase in the dependency ratio associated with population ageing. Consequently, the economy must expand at a faster rate for per capita income to rise."

Mr Bonello said attention needed to be focused on the structural constraints that were reducing the efficiency of resource deployment in the economy. This, in turn, was impeding private operators from taking advantage of the additional resource capacity that was becoming available as a result of the contraction of the public sector. These constraints were also curtailing the economy's ability to exploit the opportunities of EU membership and to build up the necessary resilience to external shocks.

"The constraints on growth that the economy faces are well known. While useful measures were announced in the budget for 2006 designed to improve resource management and efficiency in the public service, for example, considerations of accountability and sustainability in the management of public resources are still not developed enough. This applies in particular to the areas of social welfare, health and unemployment benefits. There is also a need to further streamline bureaucratic procedures and to reduce government-induced costs for economic operators."

In the wider economy, more remained to be done to render product and labour markets more price-sensitive and flexible, Mr Bonello said. In particular, priority needed to be given to productivity-enhancing measures. Enhanced efforts must also be made to strengthen the country's scientific and technological base and to further develop and diversify the skills of the labour force.

"Success in overcoming the challenges identified above will require a concerted effort to identify concrete solutions that are economically sustainable and socially equitable" he said.The report shows that the Central Bank made a profit of Lm10.8 million, against Lm14.9 million in 2004.