IMF Concludes Article IV Consultation With Malta

by Lorys Charalambous, Tax-News.com, Cyprus

15 September 2009

On September 14, the International Monetary Fund (IMF) published the findings of its Article IV consultation with Malta.

After a period of sustained expansion following successful EU entry, the IMF notes that Malta started feeling the effects of the global downturn in the fall of 2008, with declining trade flows and investment. More recently, private consumption also weakened, as the labor market prospects deteriorated, and growth slowed substantially early-2009. Although inflation has begun moderating recently, it has remained the highest in the eurozone since October 2008, and reached 3.4% in the second quarter of 2009. The IMF observed that this is mostly as a result of a lagged impact of energy price increases and imperfect pass-through in food prices.

Fiscal consolidation came to a halt in 2008, with the deficit widening to over 4.5% of GDP, both as the result of restructuring measures in the state-owned shipyards and of spending slippages, most notably in energy subsidies and the health care sector. With the economy deteriorating, the authorities are letting the automatic stabilizers play and are implementing a stimulus package, focused on infrastructure projects and support to the manufacturing and tourism sector. The IMF notes that while the authorities have managed to finance the fiscal deficit without difficulties, it has come at a higher cost, with the debt ratio starting to inch up again.

Banks have so far withstood the global financial turmoil relatively well, as they were protected by their limited exposure to structured products, a traditional retail funding model, and conservative lending policies. Credit has proved resilient, and no government intervention to shore up capital or liquidity has been necessary. Nonetheless, some institutions suffered large valuation losses on their security portfolio, and credit concentration in the construction and real estate sectors remains a concern to the IMF, especially as property prices have fallen noticeably recently.

The external current account deficit narrowed to 5.5% of GDP in 2008, reflecting continuous efforts at export diversification and value-added upgrading. Competitiveness has therefore remained broadly stable, notwithstanding moderate appreciation of the real effective exchange rate driven by accelerating wage costs, weakening labor productivity gains, and the strengthening of the euro. Nonetheless, labor market participation remains low, particularly for women, and education attainment trails peers. Furthermore, wage flexibility is limited by an automatic indexation to inflation.

The Executive Directors noted that past efforts at fiscal consolidation and export diversification toward high-value-added services activities in the run-up to euro adoption had increased the resilience of the Maltese economy. Nevertheless, the IMF noted that the global crisis had started to affect the manufacturing and tourism sectors, weakening growth prospects and jeopardizing the hard-won gains. The main challenges facing policymakers in the current environment are remaining supportive in the short run without compromising the fragile fiscal position, and preserving competitiveness as a foundation for medium-term growth, the Board observed.

The Executive Board considers that the fiscal stance for 2009 has been appropriately accommodative. The IMF believes that the full play of automatic stabilizers, combined with a limited stimulus package focusing on infrastructure investment, should provide an adequate counter-cyclical response to the slowdown. The Executive Directors encouraged the authorities to improve the composition of the fiscal stimulus by winding down measures to support enterprises as the implementation of planned investment projects gathers pace. While recognizing the need to avoid premature withdrawal of fiscal support, the Executive Directors considered it important that consolidation efforts start as soon as feasible, with a number suggesting frontloaded measures in order to reach the Maastricht deficit target by 2010. The Executive Directors called for a well-articulated medium-term consolidated strategy, supported by a strengthened institutional framework and budget execution discipline. The IMF believes that this would require targeted action on the expenditure side, particularly with regard to the wage bill, social transfers, and pension and health care spending.

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