POINT OF VIEW| Wednesday, 01 August 2007

The restructuring of Malta’s economy (part 2)

Adopting the Euro as a means to improve competitiveness

Euro Adoption
With a GDP of around €4.9 billion and a population of some 400,000, Malta is the smallest and most densely populated EU Member State. In 2006 it had the fourth most open economy in the EU, and its average trade-to-GDP ratio hovered around 82% in recent years. These characteristics constitute a challenge for both policymakers and analysts in those key economic variables are prone to volatility, being highly sensitive to external events and to shocks in specific sectors or individual enterprises which, though small in absolute terms, can have a disproportionately large impact in a small country context.
It was always Government’s stated policy to join the euro area sooner rather than later following EU membership and this because of the obvious benefits euro membership could give us. It was clear that our economy stood to benefit from closer economic and monetary integration with the euro area, particularly in terms of lower transaction costs, exchange risks, greater economic stability and policy credibility.
The Maltese economy is well suited to participate in the EU single currency area as it is already closely integrated with the EU through trade and finance, has close similarities with the euro area in the sectoral composition of output and employment, as well as in terms of business cycle synchronization, enjoys a relatively high level of development and the Maltese currency has a long history of stability, with a strong peg to the euro in recent years.
While Malta has a good track record when it comes to interest rate policy and exchange rate stability, the two main criterion that were considered difficult to satisfy were the deficit and debt levels, that is reducing them to internationally accepted sustainable levels. More recently inflation was also a concern, although this had more to do external global developments than anything we had control over.
I would like to take you back a few years and remind you about the deficit situation and just how far from the benchmark we were. At the beginning of this decade our general deficit was relatively high and in 2003 reached a peak of 10% of GDP. However one must emphasise that the 10% in 2003 included the one-time impact of the absorption of the accumulated debts of the Malta Drydocks; however a 7.6% deficit to GDP ratio net of the Malta Drydocks debt, was still more then twice as much the 3% criterion established by the treaty which in nominal terms implied reducing a deficit of some Lm110 million to Lm50 million.
To achieve these targets, structural changes were needed in the economy and we had to implement a tight fiscal consolidation programme to get our public finances under control. We removed inefficiencies within the public sector and where beneficial, divested Government assets and encouraged public private partnerships. Initiatives were also undertaken to upgrade our infrastructure, improve our productivity, increase our competitiveness and attract investment to our shores. These left the desired results as it brought the budget deficit down considerably with a deficit-to-GDP ratio of 2.6% in 2006. The first quarter of 2007 has also been very positive, with the government deficit being Lm1 million less than the comparative figure of last year.

Results
The results speak for themselves. After four years of low or negative growth, real GDP recovered in 2005 and 2006, expanding by 3.3% in both years. For the first quarter of this year GDP growth was registered at 3.5%.
Over recent years, a considerable part of the domestic demand in Malta was underpinned by investment expenditure. The ratio of investment to GDP was practically constant amounting to around 20 per cent of GDP.
During 2006 exports of goods recovered and increased by Lm108.1 million from 2005. Imports also increased by Lm128.6 million.
The unemployment figures of April 2007 show a decrease of 789 in the number of registered unemployed over the month of April 2006. The total unemployed in April 2007 stood at 6,748 persons.
Private sector employment (exclusive of temporary employment) increased by 3,017 persons underpinned by an increase in employment in private market services, mainly rises in employment in post and telecommunications, other business activities, and the recreational, cultural and sporting services.
Public sector employment (exclusive of temporary employment) declined by 2,143 during the period under review, reflecting the sale of shares of government held in Maltacom plc., as well as a significant decrease in employment in government department.
During this same period the number of gainfully occupied persons increased by 766 persons, or 0.6 per cent to 138,666 employed persons. The increase in the labor supply reflects an increase in the gainfully occupied population as well as a decrease of 218 in the number of persons registering in unemployment. In fact, during the year to December 2006 the number of unemployed under part I and part II of the register declined by 3 per cent to 7,161.
We can never stop improving our competitiveness. Losing focus from making Malta a more competitive country means regressing. This entails a clear value-for-cost policy mix balancing out efforts for better quality outputs, investment in process-efficient technology, and an improved human resource base. Within this context, structural reforms to instil greater efficiency and to enhance the supply side of the economy are important. We must also improve the business environment by making it more efficient, supporting SMEs as the backbone of our economy, promoting entrepreneurship and encouraging creativity and innovation.
As an EU member, Malta has already gained more credibility and this in itself renders the country more attractive for foreign direct investment. Joining the euro area will further this outlook as Malta will have a more stable macroeconomic environment, lower cost of capital for investments, and no foreign exchange risk on euro-related transactions.
Government has always believed that our country has the potential to attract high quality investment. In 2006 alone, Malta attracted €1.3 billion in foreign direct investment. This year has continued on the same track with a number of major projects already announced and others in the pipeline. Such sectors as financial services, aviation, pharmaceuticals, electronics and Information and Communication Technology (ICT) have continued to grow and flourish in our economy thanks to wise policy decisions.

ADDRESS BY THE HON TONIO FENECH, PARLIAMENTARY SECRETARY IN THE MINISTRY OF FINANCE, DELIVERED AT THE VODAFONE ECONOMIC FORUM HELD AT THE RADISSON SAS BAY POINT HOTEL, ST JULIAN’S ON TUESDAY 17TH JULY 2007