Malta has shown remarkable resilience in the face of a major crisis in Europe, and its main challenge is to preserve this macroeconomic stability, the International Monetary Fund has said.

In its concluding statement of preliminary findings by a mission in Malta, the IMF noted the average growth of the Maltese economy was the best in the euro area since the beginning of the crisis, and the unemployment rate remained one of the lowest.

This resilience was underpinned by robust export growth and a sound banking system. The current account balance improved gradually in recent years, turning into surplus in 2012.

However, economic growth slowed to about 0.75 per cent in 2012 and remained below potential, reflecting a weak external environment and subdued domestic demand.

In addition, the fiscal position deteriorated and the level of public debt was uncomfortably high, constraining the fiscal space for manoeuvre in the event of further shocks.

The IMF said that going forward, domestic demand was expected to become a larger contributor to economic growth.

The mission projected a moderate acceleration in real GDP growth in 2013-15, which meant that Malta would continue to outperform the euro area average.

"The pick-up in activity is predicated on the recovery of private consumption and improved confidence, as policy uncertainty decreases. While this would lead to some increase in imports, the current account balance is projected to remain slightly positive."

Short-term risks to this scenario were largely related to the external environment, it said.

In the longer term, regulatory and tax reform at the European or global level could erode Malta’s competitiveness.

The IMF said policies should aim at maintaining macroeconomic and financial stability, safeguarding fiscal sustainability, and enhancing the growth potential. It recommended the following:

* In the banking sector, Malta should continue to impropve coverage of bank nonperforming loans through higher provisioning requirements;

* Stand ready to take action if the international banks’ business model changed or spillovers from abroad became imminent;

* Increase the resources of the deposit compensation scheme at least to the level implied by the draft EU proposal on the harmonisation of the deposit insurance;

* Pursue a credible adjustment of fiscal policy until the budget was balanced and debt was put on a sustainable path;

* Continue restructuring large public corporations with a view to restore their viability, enhance their efficiency, and reduce contingent liabilities of the government

* Persevere with the structural reform agenda to boost potential growth and competitiveness.

The IMF referred to recent events in Europe which heightened perceptions about risks of hosting a large banking sector in a small country.

“In the case of Malta, these risks are contained because the large international banking segment has limited balance sheet exposures to the Maltese economy and negligible contingent claims on the deposit compensation scheme,” it said.

It added that near-term risks related to the core domestic banks appeared to be contained. However, it noted that the banks were heavily exposed to the local property market and non-performing loans were on the rise, reflecting subdued conditions in the construction and real estate sectors.

“A significant decline in house prices, although not likely in the short term, could have a sizeable impact on the domestic banking sector,” it warned.

The IMF said that further efforts in several specific areas were still needed to shore up the resilience of Maltese banks and ensure financial stability.

The government’s objective to balance the budget over the medium term remained essential, but required credible and sustainable consolidation efforts. It said that restoring the profitability and viability of large public corporations was crucial to alleviate fiscal pressures.

“The high level of government-guaranteed debt and delicate financial position of Enemalta and Air Malta heighten concerns about fiscal sustainability.”

Further progress, it said, was needed to strengthen the fiscal governance framework. Moreover, it was critical that structural reforms were implemented steadily to boost potential growth and ensure sustainability of public finances.

The IMF said that with Malta’s growth model increasingly dependent on financial and niche services, measures to broaden competitiveness would help diversify the economy.