The improving competitiveness of stressed economies may pose a challenge for the Maltese economy, the governor of the Central Bank of Malta says in the bank’s annual report for 2013.
The report reviews the bank’s policies and operations during the year and includes detailed financial statements. It starts with a statement by the governor, which is then followed by an analysis of economic and financial developments in Malta and abroad. The report also carries a box on the bank’s estimate of household disposable income.
In his statement governor Josef Bonnici notes that even though inflation in the euro area stands below the European Central Bank’s objective of less than but close to two per cent, there is no sign of deflation. Recent price changes have been positive in all but three countries, meaning that price falls are not widespread. Moreover, price declines were only registered in a small proportion of the components of the HICP basket. Furthermore, there are no signs that low inflation is self-fulfilling, as long-term inflation expectations remain well anchored.
In order to address economic imbalances and to implement structural reforms, various euro area countries have seen lower nominal wages. Unit labour costs in these countries have decelerated and have now moved closer to those in the better performing countries.
The improving competitiveness of stressed economies may pose a challenge for the Maltese economy. The governor stresses that it is essential for higher wages in Malta to be sustained by gains in productivity. Malta needs to remain flexible in carving out new niche markets. The quality of human capital needs to meet the changing requirements of domestic and export markets, implying that the education system has to provide the required skills. The authorities also need to extend programmes that attract foreign investment to Malta and improve the business environment. Concrete measures to bring down the debt ratio to the 60% benchmark are essential, the governor argues, as room for fiscal manoeuvre is severely constrained.
Turning to the Maltese banking sector, the governor notes that this has contributed significantly to the resilience of the local economy to external shocks and to its alignment with the stronger group of economies in the euro area. In terms of the soundness of its banks, Malta ranked 14th place worldwide according to the World Economic Forum. The Capital Adequacy Ratio of Maltese banks remains well above the 8% regulatory minimum, while the solvency ratios are, on average, considerably higher than the EU average. Banking sector liquidity is ample. The Maltese banking sector is profitable, with the core domestic banks reporting returns on equity and assets that are better than the EU average. On the funding side, Maltese banks remain reliant on stable sources.
On the assets side, while credit to households grew on a year earlier, aggregate credit to the private sector fell in 2013, in part reflecting the orderly deleveraging of the corporate sector. At the same time, interest rates on loans to business remain high compared with other euro area countries. There appears to be scope for further lowering rates, particularly in relation to SMEs, to be more aligned with core country rates. In this regard, the governor points out that the eventual establishment of a development bank would provide further access to finance and may also complement the banks’ funding of larger projects.
Economic and financial developments
On the global economy the report observes that the recovery remained subdued and differentiated across countries and regions, though it is gradually strengthening in advanced economies. In the euro area there were some signs of an improvement as the year progressed, with the decline in real GDP, at 0.5% in 2013, being less pronounced than in 2012, when it contracted by 0.7%. Inflation in the euro area was also lower, at 0.8% at the end of 2013 compared with 2.2% a year before.
During 2013, the ECB lowered key interest rates on two occasions, in May and in November. In each case, the interest rate on the main refinancing operations (MROs) was cut by 25 basis points to end the year at a historical low of 0.25%. Rates were cut against a backdrop of economic weakness and subdued monetary and loan dynamics, as well as low underlying price pressures over the medium term. In July the ECB introduced forward guidance, announcing that it expected key interest rates to remain at existing or lower levels for an extended period of time. The Eurosystem also continued to implement non-standard monetary policy measures.
The Maltese economy continued to outperform the euro area average, with real GDP growth accelerating to 2.4% in 2013, from 0.6% a year earlier. Domestic demand recovered, but a fall in net exports dampened economic growth. For 2014, the bank projects the pace of economic expansion to remain sustained, driven by a further recovery in domestic demand and a much less negative contribution of net exports.
During 2013, employment in Malta was on average 3.1% higher than a year earlier. However, since the labour supply rose at a faster pace, the unemployment rate increased marginally. In seasonally-adjusted terms, the unemployment rate averaged 6.5% in 2013, slightly higher than that recorded in 2012.
Turning to price developments, the report notes that the rate of inflation in Malta based on the Harmonised Index of Consumer Prices decelerated to an average of 1.0% over the year under review, as against 3.2% in 2012. The drop in inflation was mainly due to developments in services prices.
Turning to fiscal developments, the Bank estimates that the general government deficit for the whole of 2013 declined to 2.9% of GDP, and is projected to stabilise at that level in 2014. Government debt is estimated to have increased to 71.3% of GDP in 2013 and is then expected to rise further to 71.8% in 2014.
The bank’s operations
In reviewing the bank’s operations during 2013, the governor highlights the fact that as a member of the Eurosystem and through the governor’s participation in the governing council of the ECB, the bank contributed effectively to the formulation of monetary policy in the euro area.
The bank remains responsible for the implementation of the single monetary policy in Malta. In this context, it conducted market operations with eligible banks worth an aggregate of €23.7 billion, more than double the amount conducted in 2012.
During the year, the Joint Financial Stability Board (JFSB), set up between the bank and the Malta Financial Services Authority (MFSA), addressed a number of issues of a macro and micro-prudential nature. One outcome was the amendment to the rules on credit risk measures arising from the assessment of the quality of asset portfolios of credit institutions. Banks are now required to allocate an amount of capital to a reserve, equal to 2.5% of their non-performing loans (NPL), less impairments and interest in suspense as defined in International Financial Reporting Standards. For certain overdue NPLs, the requirement rises to 5% and can be raised further by the MFSA. With these amendments, the definition of NPLs and forbearance is aligned with newly established draft standards of the European Banking Authority.
With the increased responsibilities for the bank, particularly in the area of financial stability, the governance structure at the bank has been modified. In 2013, the Central Bank of Malta Act was amended to add a deputy governor position with particular focus on financial stability. The act now also provides the legal framework for the establishment of the JFSB.
The bank’s operations in TARGET2, the euro area’s real-time gross settlement system, increased further in 2013, but the value of payment flows fell significantly, as lower interest rates reduced the incentive for counterparties to hold overnight deposits with the bank.
With yields across financial markets declining during 2013 and maturing securities in the bank’s portfolio being reinvested in lower yielding assets, the bank’s annual profits, though well above the average for the past 10 years, were lower compared with the level recorded in 2012. The profit level for 2013 (including provisions) amounted to €66.7 million compared with €78.2 million in the previous year.
The annual report 2013 is available on the Central Bank of Malta’s website at http://www.centralbankmalta.org.