Finance Minister Tonio Fenech, who is expected to present the government's budget in about two months time, was interviewed by Anthony Manduca on the state of the economy, privatisation, aid to industry, the global recession, combating inflation and the fiscal deficit.

You said recently that Malta's economy could witness negative growth throughout this year. Does this mean that the recession in Malta could drag on until next year?

Malta is feeling the impact of the international recession. The indications have shown that this year will be a slightly negative year and next year we will start seeing signs of growth. Germany and France are now showing signs of recovery and they started from a far more negative position than us, so obviously if from minus four you become minus three, that is a recovery, but it is still a minus.

In our case we are talking of minus one to slightly above the zero mark. So we will have slight signs of recovery. Our economy - and I say this with a sense of relief - has managed to remain quite resilient in the recession. We have had no major losses in the manufacturing sector, unlike what has happened in other countries, although unfortunately our unemployment rate has increased by 1,500 over a 12-month cycle, but compared to other countries this has been a very low unemployment increase.

The European Commission has said that Malta tackled the recession quite well, and this was also recently stated by credit rating agency Fitch. I think that through the excellent work we did in the task force - with people from Malta Enterprise, ETC and other stakeholders - we managed to identify those companies in need and come up with arrangements which will give us growth. We are now seeing growth in these companies and a good recovery, and this puts us in a better position to catch up more quickly when it comes to growth.

This does not mean we are completely out of the woods because the situation in the tourism sector, for example, is still very uncertain - while the numbers are still at the level of 2007, there are still a lot of late bookings which creates a lot of uncertainty in the industry. The industry is not creating the same level of jobs as it did in previous years and this is posing quite a number of challenges.

The recessions in France and Germany have both ended and growth in the eurozone declined by only 0.1 per cent in the Q2. Is this good news for the Maltese economy?

Clearly this is good news. Our main manufacturing trading partners are Germany, France and Italy and what happens in these three countries is very important for us especially for those companies affected by the recession which were mainly linked to the automotive and electronics sector. Companies like Trelleborg and Methode, for example, are showing positive results and new orders are coming in.

The UK economy is of critical importance for us especially from the tourism point of view and we are not yet witnessing that same level of recovery. However, I am hopeful that next year we will start seeing the European economy, not just the eurozone economy, faring better, and that will also help our economy. I think we have reached the bottom so now we are on the way up, hopefully not too slowly.

The government has so far given almost €4.9 million to industry since February. What feedback have you received from these companies?

Overall the feedback is very positive. The training schemes worked, jobs were saved and these companies have been able to invest. All this will bring new work and therefore our expectation is that we will actually see growth in these companies in terms of jobs. Our estimate is that they will together create about 250 new jobs in 2010 which is a good sign, and that means we have not only saved over 2,000 jobs but we've actually created new jobs through these packages. In contrast to the way other countries tackled the recession we tried to be a bit more specific instead of adopting a blanket approach and this paid off. We had to adopt such an approach because our resources are limited and we had to get the best impact possible.

Requests from industry for government aid have sharply declined. Does this mean that the worst is over for the manufacturing sector?

Yes, I think the worst is over. In fact we have received positive inquiries about new investments and we will soon be in a position to announce significant new investments into Malta which will create a number of jobs. Therefore, yes, we are attracting the right investments in this area. There are other areas which we can explore to create more jobs particularly in the services industry. We can come up with some attractive incentives for this.

Some observers have commented that it is wrong for the government not to disclose the individual packages given to manufacturing companies. After all, we are talking about taxpayers' money. Why have you chosen not to reveal the aid given on a company by company basis?

There is an issue of business confidentiality which we have to respect. I can assure everyone that every penny of aid that the government has spent has gone either to train employees or to secure investment. This has been done within the EU's state aid rules. I think at the end of the day what people want to hear is that the government is acting to secure jobs for our families.

To be quite frank the opposition has criticised us for giving very little. We have been very diligent with money - it is taxpayers' money - so we didn't take the "splash splash" approach" - we want to solve the problem with a limited impact on public finances. We are already very strained because of the recession - in the first six months of this year public revenue from income tax and VAT declined by over €60 million. That creates a huge budgetary constraint, but we've managed to work within those constraints, and this shows we have been very diligent in the way we have used public money.

The European Commission has given Malta until the end of next year to regularise its deficit which last year stood at 4.7 per cent of GDP. Do you think the Commission was being unreasonable with Malta?

We need to understand the logic by which the Commission makes an assessment. The Commission's objective is always to see that every member state abides by the stability and growth pact which requires every member state's deficit to be under three per cent. The Commission has accepted that we have passed through extraordinary times and therefore that governments have had to take active measures to address the economy which has meant that some countries saw their deficit widen considerably, such as Ireland by 12 per cent, the UK by close to 10 per cent and other countries by close to five or six per cent.

Our deficit last year was 4.7 per cent, this year we will still exceed the threshold and we are forecasting a deficit of 3.8 per cent. Our assessment is that in 2010 our deficit will be close to the three per cent limit, but still above, at around 3.3 per cent. The Commission's attitude was that since we are so close to the three per cent target we should make the effort to reach this figure which will not require extraordinary efforts. It therefore saw no reason to extend reaching three per cent by another year.

I have gone on record by saying that I appreciate the Commission's assessment and the government will try and reach the three per cent target by 2010, but this will not be done at the expense of creating more problems for the economy. The next budget, for example, will be one of investment. We need to invest further in our economy, we will create incentives for job creation and this will require public money so it's not a zero sum game. The economy is something which is very complex and in these difficult times economic growth and job creation exceed strict disciplinary deficit rules. We do not discard these rules, but we take them with a bit of caution.

Although inflation eased in July to 0.8 per cent Malta still had the highest 12-month moving average rate of inflation in the eurozone, at 3.9 per cent. Do you think the government has the necessary tools to combat inflation?

There are economic deficiencies in terms of the size of our economy, the number of players that dictate prices, our distribution chain, certain practices, both in the food sectors and other sectors. There are things we need to address. That is why the government is amending the competition laws to better enable our agencies to do their best to combat inflation. The new legislation will be discussed in Parliament before the budget is presented.

We will have two entities, a distinct Office of Fair Competition, which will take the role of an authority, and an agency which will look more at consumer protection. The latter will be along the lines of the NECC during the transition to the euro. It will inform consumers, take initiatives to give consumers a fair deal and indentify those shops which give the best prices to consumers.

Clearly there are sectors of the economy which need to be addressed in terms of market imperfections, such as the fresh fruit and vegetables segment where prices are high compared to European prices. In this sector we need to have stronger tools to be able to take action. We are not talking about price orders - those are things of the past - even within the European framework these are limited - they can only be applied on a temporary basis in extraordinary situations, or they can be applied in the pharmaceutical sector, but not much else.

I don't agree with many of the Labour Party's proposals in combating inflation like having to buy things from the government - we remember the bulk buying arrangement which meant a system of licences and a poor choice for consumers - these are things of the past and I was quite amazed to hear Labour come up with such proposals.

What specifically are you proposing for the fresh fruit and vegetable sector?

We have to have a serious look at the way the market is organised such as the pitkalija and other structures. We cannot allow prices to be controlled in the way that they are as this has been detrimental to the consumer. This is the area we really need to focus on. Statistics show that the two main elements that have pushed up prices over the last few months are yes, energy, but also the fruit and vegetable sector.

You recently ruled out changing the COLA adjustment mechanism unless there is an agreement between employers, unions and the government. Don't you find it odd that we are probably the only market economy in the world where employers are forced to give pay rises by the government irrespective of productivity levels? Surely the COLA system must end one day?

We are not the only country in the EU where this mechanism is in place. There are four or five other countries which have a similar set-up, including Cyprus. It is true that the European Central Bank have constantly criticised such arrangements, because they say they are not conducive to productivity.

I beg to differ. I think the way COLA has worked along the years has actually made Malta more competitive, so much so that the opposition has criticised the government over the fact that our wages have not grown as fast as other EU member states. This is due to the COLA mechanism which measures inflation and awards compensation through a formula agreed to by employers and unions.

When unions negotiate on a company by company basis, they will go back to their members and inform them that they can't expect cost of living pay increases because they have already been given that. Whatever increase given will have to be linked to productivity. One has to examine the alternative: Do we leave the negotiations purely between unions and employers? I don't think that would give us the industrial stability that we have enjoyed for quite some time which is so good for investment.

Investors find our labour skills attractive and they also like our industrial stability which COLA plays a part in. Do we want to see strikes talking place in every factory over wage demands? This discussion has to be seen in the wider context which is what we have tried to do in the pre-budget document. We have tried to move the discussion on competitiveness away from only COLA, which is not the only element which makes the country competitive.

We should move away from the mentality that to become competitive we must have the lowest wages in the world. We need to address other issues such as labour market flexibility and inflation. I am indeed hopeful that we will come to an agreement at the MCESD as to what areas need focusing on.

One assumes that the budget will focus on cutting the fiscal deficit. Will this be done by raising taxes or by cutting expenditure?

I do not want to increase revenue through taxation but through enforcement. We have to face the challenges as our revenue has gone down and our expenditure is what it is. We need to have a budget with an investment programme and we obviously need the revenue to do this. I have always tried to avoid using taxation as a means of raising revenue.

We need to review certain areas of expenditure such as subsidies. We tend to be a bit dependent on the government, even in a business sense. Many people believe that if they invest in something then the government has to give a part of it, as though there is an obligation. There is no such obligation and it is wrong for businesses to base their investment decisions on the level of support given by the government. It would be very dangerous for an economy if it had to become dependent on government subsidies. Government funds should be there for investing in the country in order to create the best environment for business to operate.

Let's continue cutting subsidies because these come from taxpayers' money and they can be made to better use. If we don't need the money - we will give the money back to the people through reduced taxation - as we have done in the past three budgets.

Also, as a country we cannot lose focus of our social responsibility where we have to show a sense of solidarity. We need to cut abuse, yes, but we need a society that cares. When presenting a budget a government needs to invest, to care and to meet its other obligations.

Specifically, what subsidies will be cut?

There are a number of areas which we constantly subsidise. I'd rather not list them as one will consider that these are to be cut, but we need to continue with this debate. We've already taken important decisions in this sense, such as with the water and electricity rates and for a long time we were subsidising the provision of LPG gas. Today we subsidise transport, the agricultural sector and tourism. We need to make sure we are getting the value of these subsidies and to consider whether the government should continue with these high levels of subsidies, or how we are to recoup some of them.

Last year we took a decision to introduce a per bed €0.50 charge in the tourism sector which didn't go down too well within the industry. However we subsidise tourism by €33 million a year. Low cost airlines are costing the country about €5 to €6 million a year. This is taxpayers' money. We need to get the tourists here but at the end of the day there has to be a value. The government has to recoup back in order to re-invest. No industry can expect the public to subsidise it indefinitely. Our social responsibility is towards the needy - and not everyone is the needy.

You have ruled out increasing taxation but some observers think you might widen taxation - for example by putting VAT on services which are so far exempt.

I cannot say that we are conducting such a review. We are looking at areas where we can widen principles such as the polluter pays principle; in other words taxing sectors which are damaging the environment.

Will pension reform feature prominently in the next budget?

A review is being carried out on the way forward for pension reform by the Social Policy Ministry. Changes have already been made to the first pillar pension. Discussions are now taking place on the second and third pillars. The question is whether the second pillar should be made mandatory which implies a higher contribution. This has raised questions about the impact on the economy of an increased tax burden.

I think this argument is still valid today considering the economic climate, although there is also a debate about the second pillar pension that should be introduced on a voluntary basis. Hopefully we will be taking some decisions shortly; whether these are taken during the budget will depend on the state of the review.

A local think-tank recently calculated that the Maltese welfare system could be running a deficit of €192 million by 2015. Does this concern you and what is the government doing to address this situation?

It's an interesting report but our projections do not show that the welfare system deficit will be at that level by 2015. Clearly, however, the debate created by this report is valid. The report has tried to highlight the sustainability of the system and we certainly have to be attentive towards our social welfare system.

I believe we have to cut down on abuse, both in our social welfare system and also in healthcare.

We believe in free healthcare but we need, for example, to examine certain aspects of the yellow and pink card systems which is being abused and is costing the country a lot of money.

When can we expect some developments regarding the privatisation of the shipyards?

We are at an advanced stage with the Manoel Island Yachts Facility and the Marsa facility. We had two further interesting bids on the ship repair side which are being evaluated. There is a legal hitch with regards to one of the bidders for the super yachts facility which needs to be resolved before we can go to the next stage. I hope to see more progress in the coming weeks and to conclude by the end of the year. However, very detailed discussions are taking place and we are talking about assets of strategic value to the country.

Does the government intend to sell its remaining shares in Bank of Valletta or find a strategic partner for the bank - or both?

At some point a decision will have to be taken to fully privatise Bank of Valletta. However, we have to be very attentive in the market. At the moment the banks that are being sold are not those which are perceived to be the strong banks but those which have some bad assets. We have no intention of selling the bank at a point in time when the market does not give us the right returns. I think it is important for Bank of Valletta to be part of an international network. This will also benefit Malta. Like HSBC it will bring business into Malta.

Last January the Cabinet was meant to take a decision on the future strategy of the Malta Stock Exchange such as privatisation or a strategic partnership. This was postponed due to the global economic crisis. What is the situation today?

The strategic review is still taking place and I am awaiting a final report. We are looking at the best possible options. As a long-term strategy, however, there is no reason why the Malta Stock Exchange should be government-owned. It is after all, a financial operator like any other, and not a regulator.