The International Monetary Fund called on Malta to apply ongoing vigilance to contain risks to the integrity of the country’s financial system on account of the Individual Investor Programme and the rapid growth of the remote gaming and financial services.

Along such lines, the IMF, in its annual report on Malta published on Friday, warned: “It is important to continue with close coordination between the involved regulatory institutions, provision of adequate resources for inspections and training, and a robust implementation of the Anti-Money Laundering/Combating the Financing of Terrorism framework in line with the 2012 Financial Action Task Force’s standards.”

On Saturday, the government issued three press statements, one by the OPM, one by the Finance Ministry and one by the Justice Ministry, saying that the IMF spoke about Malta’s situation in glowing terms. But the press statements failed to point out other matters about which the IMF did not have positive things to say.

For example, in its report the IMF also called on Malta to improve the financial health of state-owned enterprises – namely Air Malta and Enemalta – to reduce fiscal risks.

“The recovery of Air Malta is lagging behind and, although financial performance has improved recently, the company continues to generate losses,” the IMF noted, adding, “A faster restructuring of Air Malta is needed to contain fiscal risks.”

As far as Enemalta is concerned, the IMF found that “The restructuring of Enemalta, the main provider of electricity, has led to efficiency gains and supported the company’s return to profitability.”

But it also noted that: “At the same time, Enemalta’s elevated government-guaranteed debt calls for continued close monitoring of its operations.”

The country’s banking system, according to the IMF, “appears sound and resilient, but faces a number of challenges.

“Domestic banks report adequate capitalisation and liquidity, and profitability above levels seen in peers. However, headwinds from protracted low interest rates, weak credit growth and legacy non-performing loans (NPLs) in the corporate segment pose challenges.”

Brexit also continues to pose challenges to the banking system, with the IMF having found that “Future regulatory changes and uncertain external environment, including from the Brexit decision, may affect banks’ profitability prospects and their capacity to support growth.”

Moreover, the IMF found that, “High and increasing exposure of banks to the property market may increase financial stability risks.”

 

External downside risks: Brexit and the EU’s corporate tax reform

The IMF observes that Malta’s high degree of openness makes it vulnerable to a weaker external environment and rising anti-globalisation sentiment in large economies.

It explains: “Uncertainties surrounding the Brexit negotiations could weigh on economic activity through both direct and indirect exposures while EU-wide corporate tax reform may impact unfavourably Malta’s economy.

“Domestically, recent structural reforms could have a stronger-than-expected positive effect on growth. While data do not point to a misalignment of house prices at the current juncture, persistence of upward trends in mortgage lending and the housing market may lead to imbalances, amplifying risks to financial system and the broader economy.”

 

Recommendations

Increase female labour force participation

According to the IMF’s findings: “Recent measures supporting female labour force participation continue to bear fruit. Further actions are needed to integrate the remaining inactive population, particularly women, into the labour market. Expanding labour activation policies, and enhancing education quality in line with the recently completed in-depth review, would reduce skill mismatch in the face of the changing labour demand. Further incentivising delayed retirement would boost labour force participation among the elderly.”

Enhance SMEs’ innovation

Higher research and development activity would boost productivity growth and competitiveness, the IMF reported. “Strengthening firms’ balance sheets and broadening SMEs’ non-bank and equity financing would alleviate financing constraints, including for innovative projects. Increased public R&D spending as a share of GDP towards the EU average, close partnerships with education institutions and improved access to foreign markets would complement these efforts.”

Streamline the legal process

Recent measures to speed up the settlement of civil and commercial cases will strengthen the business environment, the IMF said in its report. “Completion of ongoing work to address the shortcomings of insolvency and bankruptcy frameworks would improve contract enforcement and allow a faster resolution of balance sheets problems.”

Economic growth exceptionally strong

Overall, the IMF found that Malta’s economic growth has been exceptionally strong. It explained: “Sound policies and favourable external and domestic conditions have led to robust employment growth and an improvement in public finances. Looking ahead, the key policy challenge is to sustain the high growth and make it more inclusive in an increasingly uncertain external environment.

“Efforts should therefore focus on further enhancing the economy’s resilience to shocks, and addressing the remaining structural impediments.”

Robust economic activity projected to slow

Domestic demand-led GDP growth is projected to reach about four per cent in 2016 and stabilise at a potential rate of three per cent over the medium term, the IMF found. “Strong job creation is expected to continue in the coming years, keeping unemployment low. Inflation is set to increase modestly, as import prices recover, while sizable services balances will continue to support current account surpluses.”

Building buffers and managing fiscal risks

Further fiscal consolidation is expected in the near term

The IMF observed that robust growth and adjustment measures are expected to bring the 2016 fiscal deficit down to 0.7 per cent of GDP, well below the budget target. The 2017 deficit is projected to decline modestly to 0.6 per cent of GDP on the back of higher excise taxes and lower public spending, resulting in a structural adjustment of 0.4 percentage point of GDP. This adjustment, along with favourable economic conditions, will support a reduction of public debt to below 60 per cent of GDP.

Well-specified measures should underpin the medium-term consolidation plan

Achieving the medium-term objective of a structural fiscal balance will put public debt on a firmly downward path while sustaining the positive economic momentum, the IMF reported.

“However, policy measures should be better specified. Priority should be given to containing the fast-growing wage bill and intermediate consumption, including by building on the recommendations of the recent in-depth spending reviews and conducting similar reviews for the broader public sector. Ongoing efforts to enhance tax collection efficiency would support the fiscal adjustment while creating space for growth-enhancing policies.”

Long-term spending pressures should be contained

The IMF said recent steps to reform the pension system are commendable, given long-term demographic pressures. It adds: “Additional measures to align the effective retirement age with life expectancy, better link pensionable income to life-time earnings, and lengthen the contributory period would further mitigate the associated long-term fiscal risks. Continued efforts to incentivise voluntary long-term savings would help ensure socially sustainable pensions.”

Resilience of the private sector needs to be bolstered further

According to the IMF, the deployment of targeted macro-prudential tools linked to mortgage lending would enhance banks’ and households’ resilience to possible property market swings. “Closing data gaps is critical to calibrate such measures. A careful review of the fiscal incentives related to the property market, together with measures to address housing supply bottlenecks, would help avoid imbalances in this market. Furthermore, a faster resolution of legacy NPLs would strengthen private sector balance sheets and unlock resources for growth. In this regard, the recent regulatory changes which require banks to submit time-bound plans to reduce their NPL ratios, and efforts to streamline legal proceedings, would foster the resolution of distressed loans. While supervision is effective, it is important to ensure the availability of adequate resources in the light of the growing size of the financial sector.”

Malta Development Bank (MDB) could support the economy but fiscal risks should be contained

The strategy for the future bank aims at increasing banks’ lending to credit-constrained SMEs and providing co-financing for large development and social projects, the IMF reported.

“Nevertheless, it is critical –as intended by the authorities – to ensure that MDB’s operations will lead to new credit origination by banks to viable firms rather than ‘evergreening’ existing exposure to distressed borrowers. Robust governance structure, prudent risk assessment, adequate supervision and well-designed origination rules are critical to mitigate contingent liability risk to public finances.”