In a press release issued yesterday evening, the Central Bank of Malta said the IMF Report for the 2007 IMF Article IV Consultation with Malta, which was approved by the executive board of the International Monetary Fund (IMF) on 24 August, was placed on the IMF website yesterday.

The report was prepared by an IMF Consultation Mission following its visit to Malta between 15 and 30 May. As has been the practice since 1999, the Maltese authorities have given their consent for the report to be published together with a Press Information Notice, which focuses on the executive board’s assessment of the IMF Staff Report.

The Staff Report

In its introduction, the Staff Report notes the decision by the Council of the European Union to accept Malta as a member of the Economic and Monetary Union (EMU) from January 2008. It states that in recent years, preparations for EU membership spurred broad-based economic reform that helped mitigate structural impediments, especially by initiating the restructuring of the public-enterprise sector and liberalising the trade regime. The report then reviews recent economic developments, which were characterised by an economic recovery that is gaining traction, with a forecast GDP growth rate of three per cent for this year, a steady decline in inflation, a substantial narrowing of the fiscal deficit and a stable exchange rate within ERM II. Despite these positive indicators, the Report highlights the fact that the current account remains in a protracted deficit and that while the economic recovery has bolstered banking sector earnings, the concentration of loan portfolios in real estate continued to rise. This notwithstanding, the outlook for the economy is overall positive as economic growth continues to be boosted by domestic demand. The report also sees the possibility of stronger economic growth being generated by the new export-oriented service activities that are gaining in momentum and private consumption, possibly driven by the dehoarding of cash holdings. However, there are also downside risks to this benign scenario notably in the form of higher interest rates and oil prices, a downturn in the domestic real estate market and weak export competitiveness.

The report then refers in more detail to the policy discussions with the Maltese authorities on bolstering competitiveness, advancing fiscal adjustment and enhancing financial sector stability. Detecting signs of a loss in export markets in recent years, the report stresses the need to restore competitiveness in order to enable the economy to avoid the dangers of weak growth in the monetary union and thus reap the benefits of economic integration. In this regard, the report recommends a determined implementation of further structural reforms, particularly in the public enterprise sector. The latter should include the maintenance of wage restraints to help lower unit labour costs, a shifting of resources from the public sector to the private sector and measures to address inefficiencies in the energy sector. On the fiscal side, the report emphasises the need to achieve further consolidation through expenditure-based adjustment, particularly in view of rising expenditure pressures caused by aging-related factors such as pension and health care costs. On the financial sector, the report highlights the improvement in the sector’s stability, but notes with concern the concentration risks as demonstrated by the increased exposure of the banks to the real estate market. The report therefore recommends the introduction of incentives to the banks to bolster provisioning.

The executive board

assessment

In their assessment of the Staff Report, the IMF executive directors commended the Maltese authorities for achieving a substantial degree of fiscal consolidation and other broad-based structural reforms, which are supporting the cyclical upswing. They also noted that despite the recovery that began in 2005, growth has lagged behind most other EU members. They recommended decisive measures that would allow Malta to reap the full benefits of EU membership. The presence of competitive pressures was indicated by the reduced market share of the major export sectors and the protracted current account deficit, although the emergence of new export sectors was a sign of risk-reducing diversification. Directors agreed that the determined implementation of productivity-enhancing reforms and a commitment to rein in labour costs will be essential to strengthen Malta’s competitiveness, export base and growth within the monetary union. They noted the improvement in the operations of the ports.

On the fiscal front, the directors welcomed the continued deficit reduction in 2007-08 and the planned reduction in the dependence on one-off revenue measures in 2008. They also called for restraint in expenditures on pension and health care. Further fiscal adjustment should thus focus on the expenditure side, with an emphasis on cuts in subsidies and public consumption. They also recommended the pursuit of a fiscal surplus in the medium term, given demographic pressures and output volatility.

The directors also welcomed the continued improvement in financial sector stability, particularly the banking sector’s strengthened performance, the comfortable levels of regulatory capital and the decline in non-performing loans.

At the same time, they urged that consideration be given to an increase in the risk weighting of new residential mortgages, allowing tax deductibility of specific provisions and the introduction of collateral discounting as a regulatory requirement.