Menu for diversification
Economist Mario Vella was appointed governor of the Central Bank of Malta after three years as chairman of Malta Enterprise. He tells Vanessa Macdonald that the Central Bank of Malta’s main concern is to ensure financial stability without slowing down economic growth.
How do you see economic diversification? Are we heading in the right direction or are we leaning too far on services, or particular services?
Diversification is an absolute must. Past assertions about the post-industrial society, whereby vaguely defined ‘knowledge-driven services’ would completely replace industry have thankfully not materialised. That would have been the opposite of diversification.
Luckily for Malta, industrial production and industrial services have not become extinct. They evolved and, although they were overtaken by other economic activities, including financial services in terms of contribution to GDP, they continue to constitute a fundamental element of our economy. Also, and very importantly, they continue to attract export-oriented foreign direct investment.
Had this not been the case, would Malta have withstood the consequences of the 2007-2009 financial crisis as well as it did?
No, hence, at the European level, the importance of being earnest about the re-industrialisation of the EU economies with emphasis on innovation, modernisation and sustainability with industry accounting for as close as possible to 20 per cent of GDP by 2020. This does not mean that we should discourage other economic activities. Diversification itself requires the broadest possible menu. It means that, if it comes to choices, substance and less volatile economic activities should be prioritised. We appear to be having some success in this area.
The impact of the financial crisis on the banking sector in Malta, unlike in some other euro area member states beginning in late 2009, was very limited because domestic banks, especially the systemically important ones, were prudent in their asset management, preferring to use depositor funds to purchase securities of highly-rated countries, keeping to a minimum their exposure to sovereign paper of high-risk EU peripheral countries while also applying conservative lending policies to domestic borrowers, limiting the increase in non-performing loans.
We are creating a substantial amount of jobs in many sectors. As you very well know from your time at Malta Enterprise, labour is in short supply across the board in all sectors for both low- and highly-skilled jobs. Is it important from an economic point of view whether jobs are taken up by Maltese or expatriates?
First of all, we need to match supply and demand. Demography is not in our favour. If we are to sustain the current rate of economic growth, we need to ensure that there are enough people capable and willing to go for the jobs coming up on the market. Moreover, they have to be appropriately educated and trained and must have the skills required for available openings. It is becoming increasingly tight and there is no significant slack left.
We are investing heavily in education and training and we have taken effective measures to boost participation in the labour market and, specifically, to encourage female participation.
It is working but we cannot do without foreign employees. From a purely economic point of view, it does not matter whether you are Maltese or otherwise. What matters is that employers find suitable employees, that those employees pay taxes and social security contributions in Malta, and that they spend at least some of their wages and salaries here.
A recent Central Bank study by Aaron Grech shows that direct taxes collected from foreign workers increased ninefold over the last 15 years and today stand at one-tenth of the total direct tax revenue. But economies do not exist in a social, cultural and political vacuum. And that is another story.
Unit labour costs have been discussed at length with regard to whether productivity is keeping up with them. Others are not so worried as they say that the higher costs merely reflect the higher salaries associated with higher value-added services. What is your stand?
Growth in unit labour costs has been declining steadily over recent years, after peaking in 2012. In the last three quarters, it has been either below or close to zero. That said, competitiveness cannot be measured by a single indicator, especially in a small and fast-changing economy. We need to look at a suite of indicators and refine those trends affecting our economy.
In most sectors, labour costs remain much lower than those in the rest of the EU. The latest Eurostat data indicate that hourly wages in Malta stand at €12.20 as against €21.80 in the euro area.
Since 2004, Malta’s hourly wages have risen from 53 per cent of the euro area average to 56 per cent, hardly justifying the more significant rise in relative unit labour costs. In last June’s Central Bank Quarterly Review, we published a paper by Noel Rapa that partly explains this paradox.
We are now at a crossroads. The rapid pace of growth of services makes us increasingly dependent on increasingly scarcely trained labour. Against the backdrop of an ageing population, we will increasingly depend on improving labour supply quality. Investment in education and training, together with labour market flexibility, will be key. The attraction of more investment and a faster uptake of new technologies is increasingly vital for us to remain competitive.
We should also keep our eyes on the prices of whatever impacts the supply of labour. Rents have been on the increase and this will inevitably stimulate higher wage and salary expectations. The increase in the number of foreigners working in Malta raises the expectations of those investing in premises for rental. Steep increases in the cost of renting will make it less interesting for foreigners to seek and keep jobs in Malta and this will exacerbate the labour supply situation.
Is the solution to increase the supply of premises? Are you advocating the development of high-risers? Your predecessor was concerned about property being an ‘asset bubble’?
I do not think I should express myself on the specific issue of the desirability or otherwise of high-risers. Generally speaking, however, demand needs to be matched by supply. This supply needs to be matched in line with what the various market segments can afford.
As regards the possibility of a bubble, the Central Bank is adding more focus in its research functions to monitor developments in our property market. The latest research we have published shows that property prices are not fundamentally misaligned from their-long term averages and are nowhere near the peak of 2007.
It is not the bank’s function to advocate any particular type of development but we will continue to monitor property prices and rentals very closely and will take whatever action necessary within our competence to avoid overheating and unsustainable price bubbles.
Are you happy with the amount of asset buying through the European Central Bank’s asset purchase programme here? Is Malta unique in that a relatively high proportion of Malta Government Stocks (MGS) are held by local banks? How do you see this developing if they are expected to reduce their sovereign holding?
The European Central Bank’s asset purchase programme is necessary to support the euro area economy. It aims to create better financing conditions for businesses and to stimulate investment and aggregate demand.
“In Malta, we are at a different stage of the economic cycle. We experienced very high economic growth, driven mostly by booming aggregate demand as a result of rising disposable income. Last year, investment grew by €557 million, or 43 per cent, due to strong capital investment in sectors such as aviation and manufacturing and higher absorption of EU funds.
The European Central Bank’s asset purchase programme in Malta is not as crucial in determining aggregate demand or financing conditions as in the rest of the euro area, therefore, we have not just focused on it. We contributed to set up the development bank and introduced the central credit register to facilitate the granting of credit.
Malta is not unique in having a proportion of government bonds held by local banks. In Luxembourg, for instance, nearly all bonds are held by banks while, in Sweden and the Netherlands, the proportion is similar to ours. What distinguishes us from many other countries is that most of our government debt is held by Maltese residents, unlike Portugal, Slovenia and Ireland that have close to 70 per cent of their debt held overseas. We all know what happened to them.
If our banks decide to hold less government bonds, the capital markets are poised to absorb any such developments. Recent government debt issues were fully subscribed and oversubscribed by the private non-bank retail sector.
Former Central Bank governor Josef Bonnici had campaigned for banks to reduce their costs and margins and they were investigated by both the Malta Financial Services Authority and the Malta Competition and Consumer Affairs Authority. Are you content with the outcome?
I must emphasise that bank profitability is important for financial stability. In Europe, one of the main financial stability risks identified by the European Systemic Risk Board is the absence of bank profitability. So we must protect the profitability of the banking sector through efficiency gains rather than through dominant positions.
In a market economy, competition is the domain of competition authorities. The Central Bank of Malta’s role in this sense is through moral suasion. My predecessor successfully used moral suasion to achieve better pass through of interest rate cuts by the Central Bank to retail bank rates to borrowers. Further progress was complicated by interest rates nearing zero, whereby banks refrain from passing negative rates on to depositors and, consequently, protect their margins by resisting reductions in lending rates.
The transmission of policy rates to borrowers in the real economy is a complex process and I would recommend readers to go through an excellent analysis of the Maltese case by Brian Micallef, Noel Rapa and Tiziana Gauci in this year’s Central Bank research publication Understanding the Maltese Economy, available online.
Bank charges are best addressed through more competition and we are encouraged to see non-bank actors providing services that, until now, are dominated by banks. This will deliver efficiency gains which should benefit consumers.