Malta's commitment to bring the budget deficit ratio to below the three per cent limit by 2011 should continue to be a priority if the economy is to consolidate the substantial benefits derived from the adoption of a stable international currency, according to Central Bank Governor Michael Bonello.
In his statement in the Central Bank's Annual Report 2009 Mr Bonello said that achieving the required fiscal consolidation at a time of slow economic growth "represents a major challenge".
"The room for manoeuvre is already limited by the fact that more than two thirds of government revenue is cyclically sensitive, while a slightly larger proportion of expenditure consists of fixed commitments, which are furthermore being increasingly burdened by age-related costs. Particularly pensions and healthcare," Mr Bonello said.
Mr Bonello said the latest update of Malta's stability programme sets out a broad strategy for reducing the deficit and this should now be complemented by specific measures designed in particular to cut recurrent spending, as well as by further structural reforms.
"Experience shows that expenditure-based fiscal consolidation has the most beneficial effects on long-run economic growth. The final objective should be to release sufficient resources to finance the investments necessary for the modernisation of the economy and for income convergence with the euro area," the Governor said.
Mr Bonello said one of the main lessons to emerge from the recent crisis is that there must be a more responsible, forward-looking debate about the allocation of scarce natural resources in the context of a social market economy.
"This is particularly relevant to Malta. The time is long overdue to rebalance the discussion: it must be focused less on subsidies, benefits and other transfer payments and more on who is to pay for them and how; less on the distribution of wealth and more on creating value," he said.
Mr Bonello said the size of public resources and the efficiency with which they are used can also have an impact on the economy's external balance.
"Though the current account deficit has tended to decline in recent years, its persistence remains a source of concern as it may be symptomatic of a progressive loss of international competitiveness in some important economic sectors. Moreover, the recent combination of current account deficits and relatively low investment rates could be an indication that part of Malta's external borrowing is being used to finance consumption rather than to expand productive capacity."
The Governor said that the economy's strong growth performance in the years preceding the recession indeed owed more to domestic consumption than to exports. He said since the start of the new century Malta's export record has tended to lag behind that of the euro area, with a consequent loss of market share.
"As exports are a vital source of sustainable growth for a small, open economy, this failure to increase market share partly explains why Malta's income gap with the euro area has not narrowed in recent years," Mr Bonello said.
Mr Bonello said it was always important that production costs, particularly their predominant wage component, do not grow faster than productivity, especially at the current juncture "when export markets are subdued and nominal wages are being frozen or cut in a number of competitor countries".
The Governor said: "Addressing this challenge requires a cooperative effort. It should include the replacement of the national wage indexation mechanism with a productivity-linked wage adjustment system at the enterprise level".
He said that Malta's recent productivity performance has not been encouraging and between 2000 and 2008 compensation growth has outpaced productivity growth by a ratio of about seven to one.
"The resultant erosion in the economy's cost competitiveness shows up as a loss of around 15 per cent when measured by the harmonised competitiveness indicator, of which two thirds reflects exchange rate appreciation and the other higher unit labour costs relative to Malta's trading partners. This lost ground needs to be recovered," he warned.
Mr Bonello said in 2009 the Maltese economy followed the eurozone into recession and is now slowly returning to growth. He said the evidence suggests that the road ahead is fraught with challenges in the context of what promises to be a "gradual and uneven recovery".
He said Malta's ability to compete, and thus secure better living standards for its people, will depend increasingly on a more cost effective use of human and physical resources, higher rates of investment and sustained efficiency gains in both private and public sectors.
"The achievement of these objectives entails difficult policy choices that can no longer be postponed," he said.