The cost-of-living adjustment system used by Malta needs to be revised, Central Bank Governor Michael Bonello said yesterday as he warned that labour costs were far above the European average.
Mr Bonello said this mechanism was affecting the country's competiveness, since production costs increased but the rate remained unchanged.
The COLA mechanism raises wages based on the rate of inflation of the previous year. It was hotly discussed before the Budget was presented last year, with employers saying they could not afford to pay the adjustment and trade unions saying it was the workers' right to be compensated for the cost of living.
Presenting the bank's 2009 annual report, Mr Bonello said Malta's wages were linked to inflation, and as a result, local wages were rising faster than those of competing countries, undermining competitiveness. He therefore called for inflation to be brought down to eurozone levels.
The inflation rate in Malta stood at 1.8 per cent compared to 4.7 per cent in 2008. This brought about an increase in labour costs of 2.6 per cent, compared to the 4.2 per cent the previous year.
Furthermore, Mr Bonello said, in a situation where the eurozone had a common interest rate that applied to all countries, having an inflation rate that was widely different from that of most of eurozone countries was harmful to the country.
Delving into the outlook for this year, Mr Bonello said the Central Bank was predicting a positive growth for 2010 of 1.2 per cent, driven mainly by domestic demand, with inflation at 1.6 per cent. For 2011, the forecast gross domestic product growth is 1.8 per cent.
It was also forecasting a deficit of four per cent of the country's GDP next year. By 2011, the government is committed to reducing the deficit to below the three per cent mark of the GDP.
He said the bank was forecasting that domestic demand would grow by 1.7 per cent in 2010 and by two per cent in 2011.
"The bank's predictions for Malta are surrounded by an unusually high degree of uncertainty," he said, as he explained the volatility of such predictions.
In a presentation on the state of the Maltese economy last year, in the context of the financial crisis and adverse economic scenario, Mr Bonello said the recession in Malta tended to be shorter and less severe than in most euro area countries. This was mainly due to the resilience of the banking system in Malta, among other reasons.
He insisted the focus of the next Budget should not be on the distribution of wealth but on the creation of value.
"We cannot go about distributing wealth we do not have," he said.
The government's focus, therefore, should be on investment in productive activities, structural reforms to give it better control over its spending, a better business environment and further diversification of the export sector.
In 2009, the bank's operating profit amounted to €58.6 million, up from the €48.6 million in 2008.