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In his annual statement accompanying the Report, the Governor focuses primarily on the future thrust of economic policy in the light of Malta’s recent growth experience and the approaching prospect of full membership of the Economic and Monetary Union (EMU).
The Governor welcomed the progress achieved in 2006 towards the satisfaction of the Maastricht convergence criteria and the sustained output growth for that year. He notes, however, that the Maltese economy has not benefited to the same extent as other economies from the favourable global environment of the past three years. This suggests that structural impediments to growth continue to exist.
In this regard the Governor emphasised that, given the policy constraints of membership of a monetary union, an economy can 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.
Success in such an endeavour depends crucially on how fast labour costs in Malta increase in relation to those of competitor countries. The Governor observed that while wage moderation is essential in today’s competitive global environment, higher productivity levels are 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.
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.
The Governor further emphasised that the efficient delivery of support services is also essential to achieve faster growth. In addition, efforts to boost output growth should include measures to raise the labour participation rate. In this context, there needs to be a better balance between ensuring adequate support for the unemployed and making work pay.
Concluding his message on the state of the economy, the Governor 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 observes that the world economy expanded at a faster pace in 2006, against a background of high oil prices and persistent structural imbalances. While the US economy grew by 3.4%, the euro area surpassed expectations growing by 2.7%. Meanwhile inflation in the major industrial countries stood at 2.6% unchanged from the previous year’s level.
Turning to the Maltese economy, the report notes that the economy continued to recover in 2006, with real GDP growing by 2.9%. The expansion was mainly driven by external demand, even though private consumption increased considerably. The labour market remained buoyant in 2006, with growth in both employment levels and the labour force. The number of registered unemployed fell.
Inflation picked up during the year. It peaked at 3.2% in September before easing in the last three months, to end the year at 2.6%. 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.
On the balance of payments, the report says that the current account deficit widened over the twelve months to September 2006. This reflected a larger merchandise trade gap and a contraction in net receipts from services. Meanwhile, after excluding movements in reserves, net inflows on the capital and financial account declined. Reserve assets extended the upward trend that began in 2005.
As for the fiscal position, the report notes that, according to the latest Update of Malta’s Convergence Programme, the general government deficit declined to 2.6% of GDP in 2006 and general government debt as a proportion of GDP was estimated to have fallen below 70%.
Monetary developments in 2006 were characterised by an acceleration in the growth rate of broad money (M2) as domestic credit grew at a faster pace. Credit growth was mainly driven by increased lending to the non-bank private sector, especially to households. In the domestic financial markets, money market rates rose during the year, while long-term government bond yields declined. Meanwhile, corporate bond yields and equity prices both dropped.
Taking into account developments in the international and domestic financial markets as well as economic trends the bank tightened its monetary policy stance during the year, raising the central intervention rate by 25 basis points on two occasions, in May and October. At the end of the year the rate stood at 3.75%, compared with 3.25% a year earlier.
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.
An article in the report focuses on the stability of the financial system. This analysis observes that during 2006 the financial sector experienced further expansion over the year and its capital base remained adequate. Profits registered by the domestically oriented banks increased, driven by higher interest and non-interest income, lower allocations for loan losses and reduced write offs of bad debts. The Bank’s overall assessment of the stability of the domestic financial sector remains favourable. This notwithstanding, the analysis identifies a number of downside risks, such as a possible slowdown in the construction sector and growing competitive pressures in the external market.
Commenting on the bank’s policies, operations and activities, the report notes 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.
As far as the implementation of monetary policy was concerned, the Bank continued to use weekly market operations to absorb excess liquidity from the banking system in line with its policy stance. Also during the year a directive on minimum reserve requirements was amended to allow the Bank to review exemptions granted to credit institutions more frequently.
In exercising its statutory responsibility for maintaining financial stability, the Bank continued to monitor the domestic financial system to detect any potential risks to stability, while maintaining close contact with the Malta Financial Services Authority (MFSA), the single regulator.
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. Preparations for the physical cash changeover also gathered pace with the selection process by the general public of the designs for the national side of Malta’s euro coins being completed by mid-year.
The Bank continued to strengthen its relations with the European Central Bank (ECB) and other national central banks which, together, make up the European System of Central Banks (ESCB). The Bank ensured that Maltese legislation was compatible with the Treaty establishing the European Community and with the Statute of the ESCB and of the ECB. It also took steps to ensure that the domestic payments system will be fully integrated with payment systems in the euro area.
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. |
