The onset of the economic and sovereign debt crisis and financial instability in the EU have underlined more clearly than ever the interdependence of Europe’s economies, in particular inside the euro area. Although the pre-crisis instruments and methods of budgetary coordination enabled the EU to pull together its recovery efforts and to weather a storm that no member state could have survived on its own, the intensity of the crisis also uncovered gaps and weaknesses in the EU surveillance system.
Malta’s important challenges make it essential to stay the reform course
It soon became apparent that stronger and earlier policy coordination and additional prevention and correction mechan-isms for euro-area member states were needed for the EU to sail out of the crisis and attain the ambitious targets it set in the Europe 2020 strategy for jobs and growth.
In response to the need for stronger economic governance, the so-called six-pack legislation was introduced at end-2011, consisting of two regulations and a directive which further enhance fiscal surveillance.
Two other new regulations deal with macroeconomic surveillance and form the backbone of the so-called macroeconomic imbalance procedure (MIP).
The macroeconomic surveillance aims to identify potential risks as early as possible, prevent the emergence of harmful imbalances and correct those already in place. The MIP forms part of the European Semester, which ensures integrated and forward-looking EU economic policy coordination.
The annual MIP cycle kicks off with the publication by the Europ-ean Commission of a scoreboard of 11 indicators covering the major sources of macroeconomic imbalances – including competitiveness, indebtedness and adjustment and inter-linkages with the financial sector – as well as corresponding alert thresholds. The scoreboard and thresholds filter countries and issues for which an in-depth review (IDR) is deemed necessary.
In the 2013 scoreboard, the Commission found that 13 member states, including for the first time Malta, face different macroeconomic challenges and potential risks that warrant a closer look.
For Malta, the scoreboard signalled that the current account balance, public and private sector indebtedness, the growth rate of financial sector liabilities and banks’ exposure to the property market required an in-depth investigation. The Commission published the IDRs on April 10. In its assessment of these macroeconomic risks, the Commission found that Malta’s current account, which historically recorded a deficit, has declined gradually in recent years and turned into a surplus in 2011. Importantly, the improvement in the current account appears to be of a structural nature as it was mainly driven by higher services exports and lower goods imports.
The IDR concludes that despite the high level of private debt in Malta, significant liquid financial assets held by households seem to mitigate this imbalance. High corporate debt is more of a concern, even if the long-term maturity of the liabilities appears to reduce the risk somewhat.
The IDR concurs with previous recommendations addressed to Malta that a high public debt ratio, rising pension and healthcare expenditure due to an ageing population and sizeable guarantees to state-owned companies represent an important risk to the long-term sustainability of public finances.
Following a correction in recent years from overvalued levels, the price of property appears to have broadly stabilised. While property prices remain above their long-term trend, an abrupt adjustment appears unlikely as demand for construction remains moderate, underpinned by economic growth and a supportive taxation regime.
The IDR underlines the import-ance of a functioning property market also in light of the core banks’ large exposure to real estate. Although financially sound, non-core banks pose some risk in view of their asset portfolio and their closer links to the domestic market.
On the other hand, the limited interaction of the large inter-nationally-oriented banks with the domestic economy reduces the risk to financial stability.
Apart from identifying potential imbalances in the financial sector, the IDR for Malta discusses different options for addressing these challenges. In particular, action would be warranted in terms of closely monitoring the property market in view of its linkage with the banking system.
The real estate market would benefit from reviewing the property tax system, ensuring that the right incentives are given to market participants. Financial stability would be enhanced if banks regularly monitor property price developments and collateral valuation.
Despite the limited risks to domestic financial stability, continued monitoring appears warranted. With stricter super-vision and adequate provisioning, this is especially relevant for non-core banks in riskier activities.
In the case of core domestic banks, policy responses could include strengthened provisions for loan losses to contain risks associated with exposure to the property sector.
Lastly, the relatively-high public and private debt merit policy action.
Specifically, ensuring long-term sustainability of public finances by, among others, reforming pensions and healthcare would enhance stability and support financial intermediation. Measures to contain unsustainable growth in private indebtedness may also be warranted.
The economy has weathered the financial and sovereign debt crisis relatively well. The Commission’s 2013 in-depth review reveals a number of weaknesses which call for a timely response to avoid that they accumulate to unmanageable proportions.
Already, the 2012 country-specific recommendations addressed to Malta pointed to the need to strengthen the banking sector. As the crisis has shown, no country whatever its size is immune from the vagaries caused by economic shocks. Success breeds complacency, which breeds failure.
As with other member states, Malta’s important challenges make it essential to stay the reform course. Not reform for its own sake, but for sustainable growth and job creation.
The full review text is available at http://ec.europa.eu/economy_finance/publications/occasional_paper/2013/pdf/ocp139_en.pdf .
Ivan Ebejer is European Semester Officer, European Commission Representation in Malta.