Central Bank revises GDP growth forecast to between 0.5% and 1.1%

The Central Bank of Malta's Annual Report 2008, released on Thursday, has revised Malta's GDP growth forecast for this year to range between 0.5 per cent and 1.1 per cent driven by domestic demand and then to recover to between one per cent and 1.6 per cent in 2010.

In an interview with Reuters last month Central Bank Governor Michael Bonello had said that the bank was revising its economic projections downwards. "Our latest figure had been 1.6 to 1.7 per cent growth for this year, but that was a long time ago before the end of 2008," Mr Bonello had said.

The revised forecast contrasts even more sharply with the government's economic growth prediction for this year - announced during last November's budget for 2009 - which Finance Minister Tonio Fenech had stated would be 2.5 per cent.

In his statement in the bank's report Mr Bonello pointed out that although the danger posed by the global financial crisis to the Maltese economy was mitigated by the existence of a sound financial system, risks to the banking system are likely to develop, "emanating from an expected weaker performance of key economic sectors, particularly the property market and those which are highly dependent on foreign demand such as tourism and manufacturing".

Mr Bonello referred to the adoption of the euro as a major milestone in Malta's economic integration with the European Union and a turning point in the history of the Central Bank of Malta. He said that Malta's membership of the eurozone meant that the economy has not been exposed to the risks inherent in managing a small, vulnerable currency, such as the Maltese lira, at a time of severe financial market turbulence.

He noted that while the sharp deceleration in international economic activity was accompanied by a reversal in global inflation trends, price movements in Malta did not fully mirror this pattern. This was due to the delayed pass-through of higher international energy costs to consumer charges and also because food prices failed to decline in response to trends abroad. This, the Governor said, is a source of concern as it could reflect market imperfections.

The Governor said that several EU governments announced large financial packages designed to bolster ailing financial institutions and to stimulate consumption and investment, but added that room for similar manoeuvres in Malta was limited by the relatively high budget deficit and debt levels.

"Subject to this caveat, an increased stimulus in the form of lower taxation or higher social benefits is not as cost effective as a rise in public investment expenditure. The only instance where a case could be made for higher discretionary public outlays is in those sectors, such as manufacturing and tourism, which are being negatively impacted by the sharp contraction in foreign demand. Any measures should, however, be targeted and be of a temporary nature," Mr Bonello said.

The Governor stressed that sustainable economic expansion can only be based on a greater role of exports, thus allowing the economy to benefit from scale economies and keeping the current account deficit to reasonable proportions. This requires a process of continuous investment, particularly FDI in view of the associated technology transfer and access to markets.

The Governor emphasised that it was essential for economic operators to prepare themselves with the products of tomorrow and at prices that the market will bear, so that when the economic recovery arrives they will be in a stronger position to compete in overseas markets.

"The current period of economic dislocation, therefore, may well be the right time to re-examine certain features of the domestic market with a view to removing remaining rigidities and increasing competition, as well as the working of certain labour market institutions and cost structures generally. An investment strategy more focused on products and markets where demand promises to grow faster in the years ahead should also prove beneficial," he said.

The Central Bank's report observed that the pace of economic activity moderated as the year progressed, as both investment and exports contracted substantially. As a result, the annual growth rate fell to 1.6 per cent in 2008 from 3.6 per cent in 2007, as growth turned negative in the final quarter. Employment continued to rise in the first three quarters of the year, but in last quarter labour market conditions, too, started to weaken. Thus, after falling to a low of 5.9 per cent, according to the Labour Force Survey, there were general indications of a rising trend in unemployment in the final quarter.

Reflecting a weaker exportc sector, the current account deficit of the balance of payments rose to 6.5 per cent of GDP in the 12-month period to September 2008. At the same time net inflows on the capital and financial account fell by nearly two percentage points to 4.7 per cent. This was mainly attributable to developments on the capital account, which posted a smaller surplus, as official transfers declined. At the same time, net inflows on the financial account also fell.

Turning to fiscal developments the report noted that on the basis of official estimates the general government deficit was expected to rise to 3.3 per cent of GDP in 2008 from 1.8 per cent in 2007, mainly because of one-off expenditure items related to early retirement schemes for shipyard workers and increased subsidies to the energy utility. As a result, government debt is estimated to have edged up to 63 per cent of GDP.

The report points out that HICP inflation is forecast to ease significantly during 2009, largely reflecting the base effect of past increases in commodity prices, but also lower locally-generated inflation. In 2010 inflation is projected to be slightly higher, mainly as a result of an expected rebound in commodity prices.

In January the Bank transferred a portion of its US dollar and gold reserves to the ECB in line with Eurosystem requirements.

Moreover, together with the Central Bank and Financial Services Authority of Ireland, the bank took responsibility for managing a part of the ECB's reserves.

In 2008 the bank's operating profit amounted to €48.6 million, as against €28.7 million in 2007.

The Annual Report 2008 is available on the Central Bank of Malta's website at http://www.centralbankmalta.org .