IMF Executive Board Concludes 2015 Article IV Consultation with Malta
Malta’s economy is growing strongly. Real GDP growth has been one of the highest in the euro area since the beginning of the crisis, supported by vibrant domestic demand, large infrastructure projects, and a stable banking sector. Unemployment is at historical lows and labor participation is increasing. The current account remains in surplus and the external position is broadly in line with fundamentals.
The outlook is strong. Growth is expected to remain solid in 2016–17, driven initially by domestic demand and later by a gradual recovery of external demand. Inflation is projected to pick up gradually due to the positive output gap and higher imported inflation on account of the weaker the exchange rate. The current account surplus will likely persist.
The authorities have taken action on multiple fronts. Regarding fiscal policy, an independent fiscal advisory council is now operational. The authorities have been reducing the fiscal deficit and debt, and are making progress on the restructuring of state owned enterprises. As regards the financial sector, regulatory and supervisory frameworks have been strengthened in several areas. On structural policies, they took steps to increase labor participation, improve the judicial system and reform the energy sector.
Executive Board Assessment
Malta has remained resilient in the face of global shocks and the economy is growing strongly, helped by policy initiatives. The reliance on domestic funding and the relatively well diversified economy have helped preserve stability. Growth accelerated to 5.1 percent in the first half of 2015 and unemployment is at historic lows.
The outlook is strong and risks are balanced. Growth is expected to remain solid in 2016–17, driven initially by domestic demand and later by a gradual recovery in external demand. Inflation is projected to gradually pick up with the positive output gap and the exchange rate pass-through. The external position remains broadly in line with fundamentals despite high uncertainty driven by volatile components of the current account. While, downside risks include slower global growth, delays in implementation of structural reforms, fiscal slippages, and regulatory and tax changes elsewhere, upside risks stem from increased energy efficiency and further increases in labor participation. The future of migration flows, the majority of which coming from other EU countries, remains uncertain.
Strong migration inflows boost potential output. Large inflows since the early 2000, mostly originating from other EU countries, have offset Malta’s declining working age population and raised potential growth. Refugee inflows have also been significant, but have declined since 2013. The planned agency for refugees should help enhance coordination between institutions to ensure their smooth integration into the labor market and society.
The challenge is to preserve high and stable growth. Given uncertainty regarding the global recovery, volatile migration flows, and ongoing efforts to enhance competitiveness by euro area neighbors, raising potential output in a sustainable manner will depend on i) building fiscal buffers to cope with adverse shocks; ii) maintaining financial sector stability and providing financing for growth; and iii) sustaining structural reforms.
The authorities’ proposed pace of fiscal consolidation for 2016–18 is appropriate. The deficit reduction is continuing, despite rapidly growing current expenditures, supported by revenue measures and stronger-than-expected revenues. The authorities aim to reduce the overall deficit to -0.2 percent of GDP in 2018, but measures beyond 2016 are not well specified at this stage.
Fast growth in current expenditures makes targeted debt reduction challenging, particularly beyond 2016. With the expected growth moderation towards its long-term trend, the fast growth of sticky current expenditures makes the planned consolidation difficult. To ensure meeting the fiscal targets, additional expenditure measures should be considered. In this context, the authorities should ensure that public sector wage negotiations will not result in increases higher than inflation and complete the ongoing and planned spending reviews. With the output gap closed, revenues in excess of targets should primarily be used to build fiscal buffers. Fiscal risks from SoEs should also be disclosed and managed in a consolidated manner.
Pension measures introduced in the 2016 budget are steps in the right direction. These measures aim to address both adequacy and sustainability of the pension system. Given that Malta ranks second worst in the euro area in its age related spending increases, the authorities should ensure that these measures lead to an increase in the effective retirement age and to higher participation in the voluntary third pillar to support disposable income at old age. Efforts to increase the efficiency of health care spending should help support pension reforms.
Ongoing efforts to strengthen fiscal governance and institutions should continue. Continued efforts to strengthen fiscal institutions and the budgetary framework are encouraged to increase efficiency, transparency, and ultimately avoid fiscal slippages. Efforts to link sectoral budget allocations and any new public spending to medium-term plans and outcomes are welcome and will help track the impact of reforms and their medium-term fiscal implications.
The banking system remains resilient. Banks are well capitalized, profitable, and liquid. Solvency and liquidity of core domestic banks and other peer banks remain above the minimum regulatory requirements, and their profitability is above the euro area average.
But nonperforming loans (NPLs) and the cost of credit remain high. The increase in the coverage ratio and the national authorities’ consideration of using further Pillar II measures to reduce NPLs are welcome, and further increases in coverage ratios as envisaged is appropriate. The completion of the ongoing work on insolvency legislation, aiming to reduce court proceedings time and enhance contract enforcement, should help improve NPL resolution.
Given the large size of the financial sector and ongoing regulatory and supervisory changes, continued policy actions are needed to boost resilience of the banks. Policies should focus on: (i) a swift implementation of bank action plans to ensure a level playing field and sound supervision; (ii) following the transposition of BRRD into national law and the establishment of a separate resolution unit in the MFSA, developing bank recovery plans and collecting of contributions for the resolution fund; (iii) strengthening the contingency framework, including by reducing the share of special contributions to DCS fund, (iv) introducing additional precautionary macroprudential measures, given the rapid increases in mortgages and pick up in real estate prices, and (iv) continuing to coordinate closely and ensure robust implementation of the AML/CFT framework in line with the 2012 FATF standard.
The authorities’ request for a Financial Sector Assessment Program Update is very timely, as the last FSAP was conducted in 2003.
The structural reform priorities, as outlined in the national strategy program, are appropriate, but momentum would need to continue. Raising potential growth requires that measures translate into outcomes. In particular: (i) measures to enhance female participation have been paying off and support the potential growth; (ii) linking measures to achieve the national education strategy goals to budget allocations is welcome; (iii) judicial reforms, including the focus on insolvency regime are welcome but need to be complemented by efforts to track and demonstrate the results, such as conducting an impact assessment, and (iv) ongoing efforts to improve access to credit, such as NPL resolution, judicial reforms, planned credit registry, and multi trading facility by the stock exchange will improve growth financing. The planned development bank (to facilitate SME and infrastructure financing) should be effectively supervised and have strong governance.
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