The European Commission has warned it is essential that Malta takes measures to prevent competitiveness strains, as income levels begin to catch up with eurozone levels following Malta’s euro adoption at the beginning of the year.

As such, the Commission, in its Quarterly Report on the Euro Area, stated it was “essential” that Malta’s economic policies continue to be geared toward preserving macroeconomic stability and competitiveness.

This, it added, must be done in such a way as to further improve the functioning of product and labour markets to foster productivity growth and facilitate restructuring toward more innovation-driven activities.

“This,” the Commission observed, “would prevent competitiveness strains as income further catches up with EU average levels, and help maintain a sustainable current account balance.”

Malta, the Commission urged, needs to develop a prudent fiscal stance, aimed at avoiding a build-up of excessive demand pressures and wage developments in line with productivity gains.

The country, the Commission stressed in its report, will also have to continue its fiscal consolidation efforts to reduce its still high fiscal deficit levels.

While Malta’s impending eurozone membership is to bring its citizens and businesses additional opportunities, the Commission observed that Malta faces an “acute” challenge, in that its labour productivity and employment rates stand well below the eurozone average, and that the country’s unemployment rate is still high.

On 1 January Malta will become the smallest member of the euro area, contributing 0.06 per cent to the eurozone’s gross domestic product and 0.13 per cent to its population.

GDP per capita in Purchasing Power Standards in Malta reached 77.3 per cent of the eurozone last year, while consumer price levels stood at 70.9 per cent of eurozone average prices.

Labour productivity, however, remains a problematic area and the Commission urged Malta to ensure increases in the area to bring labour productivity levels closer toward eurozone averages.

While noting that labour market averages in fellow euro adopter Cyprus stand in line with those of the euro area, the Commission observes that “the picture is less rosy in Malta”.

The Maltese employment rate is relatively low at 54.8 per cent, notably in terms of women and older persons, and the Commission describes Malta’s unemployment rate as “relatively high” at 7.3 per cent, although the figure is still below the eurozone average.

In both Malta and Cyprus, the current account has been in deficit for the last decade, with a trade deficit only being partially compensated for by a sizeable surplus in the services trade – reflecting the island states’ competitive advantages in the fields of tourism and financial and business services.

Malta’s euro convergence process has, the Commission observes, been accompanied by a sustained increase in trade and financial integration with the euro area – being a small, open economy “highly integrated” in terms of trade and foreign direct investment with the eurozone.

In Malta, trade with the euro area represents 48 per cent of Malta’s total trade levels, while 55 per cent of FDI coming into Malta in 2005 had been derived from eurozone countries.

The Commission also noted how both Malta’s and Cyprus’ financial systems are substantially interlinked with those of the euro area. Both countries’ financial sectors are well developed in relation to their stage of economic development, with predominant banking sectors but with other financial intermediaries also developing.

Malta’s entry into the eurozone, the Commission observed, is the result of a successful process of convergence toward the euro area, accompanied by stability-orientated policies and structural reforms.

Real GDP growth in Malta had stood around zero between 2001 and 2004, the Commission observed, while adding how real GDP growth had “picked up strongly” between 2005 and 2006. According to Commission forecasts, the rate is due to continue at close to three per cent in both 2007 and 2008.

Although at times volatile, inflation has been traditionally moderate and has been very close to the euro area average in recent years, especially last year when the rate had stood at 2.6 per cent. Interest rate convergence, meanwhile, has been largely achieved, while the short term interest rates differential had declined sharply after its exchange rate mechanism accession. Since August 2006, the Commission pointed out, it has almost vanished in Cyprus while the rate has been below 50 basis points in Malta. Long term interest rates, meanwhile, have also narrowed substantially over the last two years and since January 2007 have stood at close to 40 basis points in Malta and below 30 basis points in Cyprus.

The Commission also notes how general government deficits have declined over recent years in both countries and now stand at 2.5 per cent of GDP in Malta and 1.32 per cent of GDP in Cyprus. Public debt has also been slimmed significantly and amounted to 64.7 per cent of GDP in Malta and 65.2 per cent of GDP in Cyprus.