The Maltese economy probably still has structural impediments to growth which need to be removed, Michael Bonello, Governor of the Central Bank, said in a statement accompanying the bank’s annual report.

These impediments hindered the economy from benefiting as much as other economies from the favourable global environment of the past three years, he reasoned.

Welcoming the progress achieved in 2006 towards the satisfaction of the Maastricht convergence criteria and the sustained output growth for the year, Mr Bonello emphasised that, given the policy constraints of membership of a monetary union, an economy could only adjust successfully to asymmetric shocks to the extent that it is flexible and uses its resources efficiently.

“This is particularly relevant for Malta’s open economy since its capacity to generate wealth on a sustainable basis depends on its ability to respond rapidly to changing demand patterns overseas and to offer competitive prices,” he said.

Success in such an endeavour depended crucially on how fast labour costs in Malta went up in relation to those of competitor countries.

While wage moderation was essential in today’s competitive global environment, he said, higher productivity levels were indispensable to sustain economic growth and living standards.

In Malta, he noted, pay growth has been moderate and this helps explain the stability in unemployment levels in recent years. However, it cannot fully account for the slippage in international competitiveness. “The latter is partly due to the failure of productivity gains to compensate even for subdued wage growth,” he said.

The Governor said that a key factor in raising productivity is the quality of human capital and its ability to adapt to the challenge of rapid technological change. This should be addressed through an improvement in the quality of education and the provision of more life-long learning and training; and through increased investment in R&D and innovation.

“Investment in human capital must also be accompanied by an effort to strengthen the economy’s physical capital base, particularly in the form of new foreign direct investment. Moreover, the government has a central role to play in the upgrading of both human and fixed capital. Given the current fiscal situation, the only way forward is through a rationalisation of recurrent budgetary expenditures and a reallocation of budgetary funds. This requires broad-based support, particularly that of the social partners, whose cooperation should also be enlisted to achieve greater labour flexibility and more efficient work practices.”

Mr Bonello observed that the sustained economic recovery in 2006 suggests that the restructuring process has begun to manifest itself in the macroeconomic indicators. He pointed out that 2007 could be marked by the expected qualification for membership of the euro area. He stressed, however, that while the adoption of the euro will enhance the economy’s capacity to grow faster, the full benefits can only be achieved if further structural reforms are implemented. This will enable the economy to react flexibly and competitively to the new opportunities opening up to it.

In its analysis of economic and financial developments, the Report noted that the economy continued to recover in 2006, with real GDP growing by 2.9 per cent. The expansion was mainly driven by external demand, even though private consumption increased considerably.

Inflation picked up during the year. It peaked at 3.2 per cent in September before easing in the last three months, to end the year at 2.6 per cent. This acceleration and the subsequent slowdown primarily reflected developments in fuel and electricity costs, which in turn tended to move in line with international oil prices.

Looking ahead, the bank sees the economy growing slightly faster in 2007 than it did in 2006, mainly on account of stronger private consumption and gross fixed capital formation. The external sector is also projected to contribute positively as export growth is expected to be stronger. However, this may be partly offset by faster import growth. The bank expects inflation to ease further.

Commenting on the bank’s policies, operations and activities, the Report noted that the bank’s independence in the conduct of monetary policy was complemented in 2006 by a greater degree of transparency. In May, the bank was invited to report for the first time to a parliamentary committee on the conduct of its monetary policy. A second report was presented in November.

Preparations for the adoption of the euro intensified in 2006. The bank participated in the work of the Steering Committee for Euro Adoption and the National Euro Changeover Committee (NECC). Moreover, the bank helped the NECC in drafting the legal framework necessary for the adoption of the euro and contributed to the Euro Changeover Master Plan.

The bank’s net operating profits rose to Lm11.2 million in 2006 from Lm10.8 million in the previous year.

The annual report 2006 is available on the website of the Central Bank of Malta at www.centralbankmalta.com.