The bank’s annual report for 2003 was yesterday tabled in parliament.

In his annual statement, the bank’s Governor Michael Bonello stressed the country fiscal deficit which “could threaten the country’s past achievements”.

He added that the combination of slow economic growth and persistent macroeconomic imbalances suggests the need for policies aimed at improving competitiveness and at focusing more on the economy’s supply capabilities. Enhanced competitiveness would make it easier to cope with fluctuations in external demand, he said.

The governor also suggested that, given the Maltese economy’s heavy dependence on foreign trade, efforts at improving competitiveness must be accompanied by a more forceful export-oriented approach.

This implies, for example, that increases in wages must be matched by improvements in productivity and that waste and inefficiencies need to be eliminated. At the same time, the available resources must be used more effectively, while structured efforts should be made to promote innovation and the upgrading of skills.

Referring to Malta’s European Union membership in a few days’ time, Mr Bonello said that a crucial factor will be the ability of the government to create a congenial policy and operating environment, and of entrepreneurs to exploit it.

Focusing on the public sector, the governor said this sector has a crucial role to play in facilitating the development of export-oriented activities by fulfilling its functions in a more cost-effective and timely fashion. He added that a higher proportion of budgetary resources needs to be devoted to wealth-creating activities.

Welfare schemes should be reviewed to eliminate disincentives to work and introduce more flexibility in the labour market while the continued subsidisation of activities and practices that are not economically self-sustaining must be phased out, he said.

In his statement, the governor stated that in Malta’s case, the transition towards the euro should be characterised by continuity and stability. He notes that the Maastricht criteria on inflation and long-term interest rates have been met on a sustainable basis and that there are no indications of major misalignment in the value of the Maltese lira.

He said that the major challenge on the way to a rapid and orderly adoption of the euro is the structural nature of the fiscal deficit. Persistent fiscal deficits imply a relatively high risk premium on Maltese lira interest rates, which, among other things, inflates government expenditure through the increased cost of debt servicing.

Against this background, the governor welcomed the government’s intention to bring the fiscal deficit down to three per cent of gross domestic product by 2006. Given the structural nature of the deficit some social components of budgetary spending, such as the pension system and the provision of health and other social services, will need to be critically reviewed.

Since this is likely to imply short-run sacrifices, the governor called for a consensual approach to fiscal consolidation in an attempt to reconcile what is socially desirable with what is financially affordable.

Putting government finances on a sounder footing would bring about a reduction of the public debt, interest on which amounts to 3.5 per cent of GDP and is equivalent to more than two-thirds of the cost of retirement pensions.

Financial and economic developments in 2003

The report notes that the bank’s easing of monetary policy during 2003 was mainly prompted by cuts in official interest rates abroad and the expansion of the bank’s external reserves. Over the year, the central intervention rate was cut on three occasions, by a total of 75 basis points, to three per cent

Looking ahead, the report sees a modest pick-up in activity during 2004, underpinned by higher public sector investment as well as a recovery in exports. The latter is based on the assumption that external demand will strengthen as economic growth in Malta’s trading partners becomes more robust.

It says that inflation is projected to rise due to the upward adjustment in the standard VAT rate to 18 per cent while unemployment is expected to increase slightly as the restructuring process gathers further momentum.