Central Bank likely to further revise growth projections downwards

The Central Bank of Malta is likely to further revise downwards Malta’s economic growth projections for 2009, a spokesman for the Bank told The Times Business.

Last month the Central Bank revised its GDP growth forecast for this year to range between 0.5 per cent and 1.1 per cent, down from the “just under two per cent” it had projected in December 2008 for 2009. When the European Commission launched its spring economic forecast earlier this month it had forecast that Malta’s GDP will contract by 0.9 per cent in 2009. Asked whether the Central Bank agreed with the Commission’s projection and whether it would revise its forecast, a spokesman said:

“The Bank is currently engaged, together with the other national central banks of the eurosystem in the preparation of a round of projections for euro area countries and for the euro area as a whole. Given that these projections are based on more negative assumptions than in the previous round, it is probable that growth for Malta will be revised downwards too.”

Questioned why the Central Bank took so long to revise its GDP growth forecast for 2009 even though the global economic crisis had long been well underway, the spokesman said that the global crisis is unprecedented, and as a result projecting its repercussions has been a very difficult and uncertain exercise.

“In fact forecasters have made repeated downward revisions as new information became available. The Bank’s forecasts have been scaled down as well. Projections had to be progressively revised downwards as each forecast exercise took on board increasingly deteriorating economic conditions in trading partners,” the spokesman said.

He added: “It should be emphasised that the Bank follows a set calendar of economic projections, with a fixed schedule that remains unchanged, as is also the case of the European Central Bank. Macro-economic projections are carried out by the national central banks in April/May and in October/November of each year and are subsequently aggregated by the European Central Bank into euro area projections. In addition, the Bank undertakes a further projection exercise in February/March for publication in its Annual Report in April. That has been the Bank’s consistent timetable.”

Edward Scicluna, a leading economist who is contesting the European Parliament elections on the Labour ticket recently criticised the Bank’s forecasts and blamed the Bank’s optimism on the “fact that the economic forecasting model used by the Bank is an annual one, which ignores quarterly variations unlike the economic model used by the European Commission.” In a separate interview, he remarked: “There are enough smart and qualified officials within the CBM who could handle an econometric model with ease and make reasonable estimates for the next two or three quarters.”

Asked to respond to this criticism, the spokesman said: “The first assertion suggests that the Bank’s model should use higher-frequency inputs. The second has to do with the frequency of the model’s output; in other words that the Bank should be compiling and issuing quarterly rather than annual forecasts.

“The first assertion is incorrect. For many years the Bank has used quarterly data to generate its annual forecasts. In fact, the Bank switched from an annual data base to a quarterly one at the start of the decade.

“Concerning his second criticism the Bank is unaware of any local or foreign institutions which make quarterly forecasts for the Maltese economy. Certainly not the European Commission. Prof. Scicluna is probably aware of these developments as he was a member of the Bank’s Board of Directors and Monetary Policy Council for a number of years.”

The spokesman added that more information would normally help in economic policy formulation and is therefore desirable. However, he pointed out, making quarterly, rather than yearly, forecasts, particularly in the case of Malta, is not an easy task. Quarterly numbers tend to be more volatile, especially where a very small and open economy is involved.

As for the quality of its forecasts, the Bank said it remains open to informed and constructive criticism.

Regarding whether the Central Bank agreed with the European Commission’s

prediction that Malta’s budget deficit will decline to 3.6 per cent in 2009, the spokesman said: “Downward revisions to projected domestic economic activity is likely to affect expected tax revenues negatively and social payments, such as unemployment benefits, positively. On the assumption of no changes in government policy, such conditions are likely to give rise to a more expansionary fiscal stance relative to that previously forecasted.”

The spokesman said that the Bank follows standard practice in the preparation of its forecasts.

“In simple terms its economists explore stable relationships between economic variables based on past trends and then use the estimated relationships to project values into the future. They take a current situation as the starting-off point, incorporating so-called external assumptions (mainly oil and commodity prices and likely growth in Malta’s export markets) and presuming no new policy measures.

“The ECB provides national central banks of the Eurosystem with common external assumptions. As Malta has a very open economy, these assumptions on economic developments in trading partner countries are an important input.

“The limitations of statistical forecasting have been especially evident in the current economic environment. When one is in uncharted territory, as we are today, past relationships may be a poor guide to the future. There is less in the past that will reliably guide you in projecting the future. Moreover, the collapse in financial markets and the breakdown in the credit channels, which of course affects the monetary transmission mechanism, are poorly incorporated into econometric models. In addition, the assumptions about the prospects for foreign economies are highly tentative and subject to repeated revisions.”

The spokesman quoted a former head of the ECB’s research department who had remarked: “This is a recession that the forecasters have not understood. We’ve been quite surprised and I was among those who though there would be a mild slowdown.”