Directors endorsed the government’s ambitious fiscal consolidation plans in response to the increase of public debt and guarantees and implicit liabilities to relatively high levels. They noted that although fiscal deficits have remained contained, a more rigorous approach that spells out specific measures underpinning priorities for the next budget will raise the credibility of adjustment plans. Directors commended the authorities for the recent efforts to improve expenditure control. Strengthening fiscal institutions, particularly by introducing a strong fiscal rule will improve the long term sustainability of public finances. Further pension reform will help avoid a surge of age-related public spending.

Directors noted that Malta’s financial sector showed resilience during the global crisis. However, high credit risk following a long real estate boom and the large exposure of a few banks to foreign securities, including to euro-area peripherals currently under stress, warrant heightened vigilance and determined supervisory action. This includes encouraging banks to strengthen their capital buffers, preferably through equity injections and retained earnings. Directors also called for enhancing supervisory and regulatory arrangements to better link macro and micro prudential regulation, in line with developments at the European level.

Directors agreed that further structural reforms will be critical for increasing Malta’s competitiveness, productivity and attractiveness to foreign direct investments. Measures to enhance the education system and encourage women and older workers to participate in the labor market will be important to raise employment. Further liberalization of the regulated sectors will boost economic efficiency.

Background

Malta weathered the global recession relatively well. Output fell less than the euro area average and unemployment rose only modestly, partly reflecting government support. Driven by external demand, a cyclical upswing is now underway and manufacturing and tourism activity, hit hard by the global recession, have recovered with the latter near pre-crisis record levels. However, the recovery is not yet broad based and some sectors, including construction and retail, are lagging. On the back of softer real estate prices, elevated unemployment, and higher uncertainty about job prospects, consumption growth slowed but has been supported by very low interest rates. Investment, especially in construction, decelerated sharply and remains sluggish. Inflation has picked up as the ongoing rebound allows firms to rebuild profit margins and pass on higher energy prices, but underlying inflation is expected to remain contained.

Fiscal performance weakened in 2008‒09, but deficits and debt remained relatively contained. After several years of fiscal consolidation, the fiscal deficit rose to over 4 percent of GDP in 2008 from about 2 percent in 2007, reflecting substantial one-offs as well as slippages in current expenditure. Despite the 2009 recession, however, and helped by the proceeds from a tax amnesty and relatively strong income tax performance by international companies registered in Malta, the overall deficit narrowed somewhat in 2009. Nevertheless, in July 2009 the European Commission concluded that Malta had an excessive deficit and recommended to bring it below 3 percent of GDP by 2011. In 2010, revenue performance was boosted by another tax amnesty and relatively strong corporate profits, which contributed to higher income taxes, also reflecting the economic recovery. Only few and targeted stimulus measures were executed, including some measures to support investment and the tourism sector, some support to households compensating for the sharp rise in utility tariffs, and some increase in childcare benefits.

The Maltese banking sector has weathered the global financial crisis relatively well, but vulnerabilities are rising. Relatively conservative funding models and little exposure to U.S. toxic assets have kept spillovers from the global financial crisis to banks in Malta at bay. However, a long real estate boom contributed to a significant increase in private sector debt and as a result domestic credit risk. Real estate prices and collateral values experienced some correction and appear to have stabilized more recently, but excess supply likely remains in segments of the market. Household debt has grown rapidly but still remains somewhat below the euro area average. Non-financial corporate sector debt has risen to elevated levels, with a significant share of debt incurred by the construction and real estate sectors. Banks have tightened lending policies and bank credit growth has decelerated but remains strong compared to the euro area average. In parts of the banking sector the growing exposure to debt securities, including to euro-area peripherals currently under stress, poses additional risk.