Worried about growing imbalances, particularly related to the large financial sector and banks’ exposure to private debt on property, the European Commission has ordered an “in-depth review” of the Maltese economy.

Launching the second Alert Mechanism Report, Economic and Monetary Affairs Commissioner Olli Rehn said that, on a first analysis, Malta had been identified as a country that could be facing problems due to imbalances in its financial sector.

In its preliminary review, the Commission identifies three indicators – the state of the island’s public sector debt, the current account balance and government debt – which it fears might prove to be problematic if not tackled.

“Private sector indebtedness exceeds 200 per cent of GDP, mainly reflecting high credit growth to non-financial corporations during the boom years,” the Commission notes.

Reiterating its position, expressed earlier this year, that Maltese banks could be overexposed, the Commission said that “close monitoring of the domestic banking system is warranted due to its high exposure to the property market, which has seen very dynamic price growth followed by a relatively limited correction in the past decade, and the low level of provisions for loan impairment losses”.

According to information given to The Times earlier this year, Malta’s private debt by the end of 2010 exceeded €13 billion, most of it owed by businesses, while €4 billion is related to loans on mortgages.

Malta’s financial sector – a booming industry that drives the economy – is also on the Commission’s radar.

The EU Executive said that Malta’s financial sector was very large in proportion to the domestic economy, with total liabilities close to 900 per cent of GDP by the end of 2011.

“The growth rate of total financial liabilities has exceeded the indicative threshold (set by the EU) several times in the past decade and, as a result, the accumulated growth in 2011 significantly exceeds the average in the euro area.”

The Commission acknowledged that the investment comes from internationally oriented banks that had very little exposure to the domestic economy, thus reducing the risks to the islands, but said it wanted to study the issue in more depth.

With regard to the current account balance, which reflects the country’s international trade, the Commission said that although it posted sizeable deficits over the past decade, recent developments in the current account suggested a correction, also reflected in gains of export market shares.

“In the coming years, the current account is expected to remain in a small surplus and unit labour costs are expected to flow at a rate close to the euro area average.”

On government debt, the Commission said that, at 71 per cent of GDP, it exceeded its threshold of 60 per cent. However, when compared to the rest of the euro area, Malta’s government debt is significantly lower.

Overall, the Commission concluded that it would be useful to examine further the risks involved with a view to assessing whether an imbalance existed.

The Commission is initiating the same in-depth procedure in another 13 member states, including France, Spain, Italy and the UK.

What happens next?

The conclusions about Malta will now be discussed in different Council formations of the EU while the Commission starts its in-depth analysis of the problematic areas.

This will include teams of experts coming to the island to prepare their report.

When this is done, around March, the Commission will analyse the results and decide whether to include any specific recommendations for Malta in May.

The country will then have to incorporate the recommendations into its annual Budget to be presented in 2013.