ECB: Malta credit growth needs to be carefully monitored
The European Central Bank last week issued a report that examined Malta's economic performance and projections for the future as part of its assessment of Malta's preparedness for euro adoption. The study was issued along with the convergence report produced by the European Commission, which recommended that Malta should join the eurozone this January 1. Here are highlights from the report.
Inflation
Over the reference period, Malta achieved a 12-month average rate of (Harmonised Index of Computer Prices) HICP inflation of 2.2 per cent, which is well below the reference value of three per cent as stipulated by the Treaty. On the basis of the most recent information, the 12-month average rate of HICP inflation is expected to decline further in the coming months.
Looking back over a longer period, HICP inflation in Malta has been relatively stable, fluctuating mostly between two per cent and three per cent during the years 1999-2006. The fact that inflation has remained relatively stable over a long period reflects a number of important policy choices, most notably the decision to maintain a pegged exchange rate arrangement since Malta became independent in 1964, for most of the period against a basket of currencies.
Since May 2, 2005, the Maltese lira has been participating in ERM II and has thereby been pegged to the euro. Fiscal policy has become more supportive of the achievement of price stability over the past few years.
Following a period of strong economic growth in the 1990s, output growth, on average, was sluggish from 2001 onwards, with two years of output contraction being recorded. This economic stagnation reflected a combination of external weakness, partly associated with increased competition in Malta's main export markets, and domestic factors such as the temporary effects of restructuring operations in the manufacturing sector.
Looking at recent developments, a gradual economic recovery started in 2005 and continued in 2006, but price pressures from the demand side of the economy have remained limited. The annual rate of HICP inflation declined notably towards the end of 2006 and remained subdued in early 2007. After reaching a peak of around 3.5 per cent in mid-2006, it declined to less than 1 per cent in the last two months of that year, to stand at 0.5 per cent in March 2007. The decline in inflation in late 2006 was largely due to the unwinding of the impact of the earlier energy price increase, which had affected inflation in Malta relatively strongly.
Looking ahead, the latest available inflation forecasts from major international institutions range from 1.4 per cent to 2.4 per cent for 2007 and from 2.1 per cent to 2.3 per cent for 2008. Upside risks to inflation prospects are mainly associated with a potential renewed increase in world energy prices.
In addition, although it is not as strong as in other countries with less developed financial markets, the ongoing rapid rise in the growth of credit needs to be carefully monitored. Downside risks to the inflation projections are related to the effects of increasing competition in some product markets, such as the food retailing and the airline industry, and ongoing efforts to streamline regulatory and administrative procedures in the public sector.
The deficit
Malta is at present subject to an EU Council decision on the existence of an excessive deficit. However, in the reference year 2006 it recorded a fiscal deficit of 2.6 per cent of GDP, i.e. below the reference value. Temporary fiscal policy measures had a deficit-reducing effect of 0.7 per cent of GDP in 2006. Without these measures, the 2006 deficit would have amounted to 3.3 per cent of GDP. A decrease in the deficit to 2.1 per cent of GDP is forecast by the European Commission for 2007.
The general government debt-to-GDP ratio declined to 66.5 per cent in 2006 and is forecast to be 65.9 per cent in 2007, thus remaining above the 60 per cent reference value. Further consolidation is required if Malta is to comply with the medium-term objective specified in the Stability and Growth Pact, which is quantified in the convergence programme of December 2006 as a balanced budget in cyclically adjusted terms and net of temporary measures. With regard to other fiscal factors, the deficit ratio did not exceed the ratio of public investment expenditure to GDP in 2006.
According to the projections by the EU's Economic Policy Committee and the European Commission, Malta is expected to experience an increase of 2.2 percentage points of GDP in age-related public expenditure in the years to 2020, which then declines to an increase of 0.3 percentage point by 2050. While these projections do not take into account the public pension reform adopted by the House of Representatives in December 2006, a preliminary assessment by the European Commission suggests that the reform has not improved the prospects for the long-term sustainability of public finances. Coping with the burden will be facilitated if sufficient room for manoeuvre is created in public finances before the demographic situation worsens.
Currency stability
The Maltese lira has been participating in ERM II with effect from May 2, 2005, i.e. for the two-year reference period between May 2005 and April 2007. The central rate for the currency was set at 0.429300 lira per euro - the market rate at the time of entry - with a standard fluctuation band of ±15 per cent. Upon entry into the mechanism, the Maltese lira was re-pegged to the euro from its previous basket arrangement (involving the euro, the pound sterling and the dollar). The agreement on participation in ERM II was based on firm commitments by the Maltese authorities in various policy areas. As initially declared, since ERM II entry the Maltese authorities have maintained the exchange rate of the Maltese lira at the central rate against the euro.
Short-term interest rate differentials against the three-month EURIBOR narrowed in 2006 and stood at 0.2 percentage point in the three-month period ending in March 2007. Both bilaterally against the euro and in effective terms, the real exchange rate of the Maltese lira was in March 2007 close to historical averages as calculated from January 1996 and since the launch of the euro in 1999.
As regards other external developments, Malta has, since 1997, reported deficits in the combined current and capital account of the balance of payments that have, at times, been large. In 2004 and 2005, this deficit stood at 4.9 per cent of GDP, before declining to 3.3 per cent in 2006. Since 2003 direct investment flows have more than offset this deficit and capital inflows in the form of "other investments" have been largely offset by strong net portfolio outflows. In both 2005 and 2006 Malta experienced an accumulation of official reserve assets.
The level of long-term interest rates in Malta was 4.3 per cent over the reference period and thus stood well below the 6.4 per cent reference value for the interest rate criterion. In recent years, Maltese long-term interest rates and their differential with government bond yields in the euro area have generally declined.
Overall, looking ahead, it will be important for Malta to continue on a sustainable and credible path of fiscal consolidation and to improve its fiscal performance by tangibly reducing its high debt ratio. It will be important, in both the public and the private sector, to maintain moderate wage developments that take into account labour productivity growth, labour market conditions and developments in competitor countries. Attention must also focus on overcoming the structural constraints on economic growth and job creation, notably by fostering labour participation. The strengthening of competition in product markets and improvements in the functioning of the labour market are key elements in this regard. Such measures will also help to make these markets more flexible, thereby facilitating adjustment in the face of possible country or industry-specific shocks.
The ability to absorb such shocks is particularly important in view of the economy's relatively high degree of specialisation. These measures will help to achieve an environment conducive to price stability, as well as to promote competitiveness and employment growth.
Following the recent amendments to the Central Bank of Malta Act, the Central Bank of Malta's statutes are compatible with Treaty and Statute requirements for stage three of Economic and Monetary Union.
• The ECB's Convergence Report can be obtained from the ECB's website http://www.ecb.int
Over the reference period, Malta achieved a 12-month average rate of (Harmonised Index of Computer Prices) HICP inflation of 2.2 per cent, which is well below the reference value of three per cent as stipulated by the Treaty. On the basis of the most recent information, the 12-month average rate of HICP inflation is expected to decline further in the coming months.
Looking back over a longer period, HICP inflation in Malta has been relatively stable, fluctuating mostly between two per cent and three per cent during the years 1999-2006. The fact that inflation has remained relatively stable over a long period reflects a number of important policy choices, most notably the decision to maintain a pegged exchange rate arrangement since Malta became independent in 1964, for most of the period against a basket of currencies.
Since May 2, 2005, the Maltese lira has been participating in ERM II and has thereby been pegged to the euro. Fiscal policy has become more supportive of the achievement of price stability over the past few years.
Following a period of strong economic growth in the 1990s, output growth, on average, was sluggish from 2001 onwards, with two years of output contraction being recorded. This economic stagnation reflected a combination of external weakness, partly associated with increased competition in Malta's main export markets, and domestic factors such as the temporary effects of restructuring operations in the manufacturing sector.
Looking at recent developments, a gradual economic recovery started in 2005 and continued in 2006, but price pressures from the demand side of the economy have remained limited. The annual rate of HICP inflation declined notably towards the end of 2006 and remained subdued in early 2007. After reaching a peak of around 3.5 per cent in mid-2006, it declined to less than 1 per cent in the last two months of that year, to stand at 0.5 per cent in March 2007. The decline in inflation in late 2006 was largely due to the unwinding of the impact of the earlier energy price increase, which had affected inflation in Malta relatively strongly.
Looking ahead, the latest available inflation forecasts from major international institutions range from 1.4 per cent to 2.4 per cent for 2007 and from 2.1 per cent to 2.3 per cent for 2008. Upside risks to inflation prospects are mainly associated with a potential renewed increase in world energy prices.
In addition, although it is not as strong as in other countries with less developed financial markets, the ongoing rapid rise in the growth of credit needs to be carefully monitored. Downside risks to the inflation projections are related to the effects of increasing competition in some product markets, such as the food retailing and the airline industry, and ongoing efforts to streamline regulatory and administrative procedures in the public sector.
The deficit
Malta is at present subject to an EU Council decision on the existence of an excessive deficit. However, in the reference year 2006 it recorded a fiscal deficit of 2.6 per cent of GDP, i.e. below the reference value. Temporary fiscal policy measures had a deficit-reducing effect of 0.7 per cent of GDP in 2006. Without these measures, the 2006 deficit would have amounted to 3.3 per cent of GDP. A decrease in the deficit to 2.1 per cent of GDP is forecast by the European Commission for 2007.
The general government debt-to-GDP ratio declined to 66.5 per cent in 2006 and is forecast to be 65.9 per cent in 2007, thus remaining above the 60 per cent reference value. Further consolidation is required if Malta is to comply with the medium-term objective specified in the Stability and Growth Pact, which is quantified in the convergence programme of December 2006 as a balanced budget in cyclically adjusted terms and net of temporary measures. With regard to other fiscal factors, the deficit ratio did not exceed the ratio of public investment expenditure to GDP in 2006.
According to the projections by the EU's Economic Policy Committee and the European Commission, Malta is expected to experience an increase of 2.2 percentage points of GDP in age-related public expenditure in the years to 2020, which then declines to an increase of 0.3 percentage point by 2050. While these projections do not take into account the public pension reform adopted by the House of Representatives in December 2006, a preliminary assessment by the European Commission suggests that the reform has not improved the prospects for the long-term sustainability of public finances. Coping with the burden will be facilitated if sufficient room for manoeuvre is created in public finances before the demographic situation worsens.
Currency stability
The Maltese lira has been participating in ERM II with effect from May 2, 2005, i.e. for the two-year reference period between May 2005 and April 2007. The central rate for the currency was set at 0.429300 lira per euro - the market rate at the time of entry - with a standard fluctuation band of ±15 per cent. Upon entry into the mechanism, the Maltese lira was re-pegged to the euro from its previous basket arrangement (involving the euro, the pound sterling and the dollar). The agreement on participation in ERM II was based on firm commitments by the Maltese authorities in various policy areas. As initially declared, since ERM II entry the Maltese authorities have maintained the exchange rate of the Maltese lira at the central rate against the euro.
Short-term interest rate differentials against the three-month EURIBOR narrowed in 2006 and stood at 0.2 percentage point in the three-month period ending in March 2007. Both bilaterally against the euro and in effective terms, the real exchange rate of the Maltese lira was in March 2007 close to historical averages as calculated from January 1996 and since the launch of the euro in 1999.
As regards other external developments, Malta has, since 1997, reported deficits in the combined current and capital account of the balance of payments that have, at times, been large. In 2004 and 2005, this deficit stood at 4.9 per cent of GDP, before declining to 3.3 per cent in 2006. Since 2003 direct investment flows have more than offset this deficit and capital inflows in the form of "other investments" have been largely offset by strong net portfolio outflows. In both 2005 and 2006 Malta experienced an accumulation of official reserve assets.
The level of long-term interest rates in Malta was 4.3 per cent over the reference period and thus stood well below the 6.4 per cent reference value for the interest rate criterion. In recent years, Maltese long-term interest rates and their differential with government bond yields in the euro area have generally declined.
Overall, looking ahead, it will be important for Malta to continue on a sustainable and credible path of fiscal consolidation and to improve its fiscal performance by tangibly reducing its high debt ratio. It will be important, in both the public and the private sector, to maintain moderate wage developments that take into account labour productivity growth, labour market conditions and developments in competitor countries. Attention must also focus on overcoming the structural constraints on economic growth and job creation, notably by fostering labour participation. The strengthening of competition in product markets and improvements in the functioning of the labour market are key elements in this regard. Such measures will also help to make these markets more flexible, thereby facilitating adjustment in the face of possible country or industry-specific shocks.
The ability to absorb such shocks is particularly important in view of the economy's relatively high degree of specialisation. These measures will help to achieve an environment conducive to price stability, as well as to promote competitiveness and employment growth.
Following the recent amendments to the Central Bank of Malta Act, the Central Bank of Malta's statutes are compatible with Treaty and Statute requirements for stage three of Economic and Monetary Union.
• The ECB's Convergence Report can be obtained from the ECB's website http://www.ecb.int