Maltese economy faces contagion threat as global crisis worsens – IMF

The Maltese economy faces a worsening external environment that has heightened risks of contagion from the global financial crisis, the International Monetary Fund said today following a routine visit to Malta.

The IMF highlighted threats to Malta's growth in exports, and said that deteriorating confidence and a soft real estate market will make it harder to offset the drop in external demand.

"At the same time, uncertainty in economic policy could adversely affect growth if investment decisions and structural reforms are put on hold. With the euro area expected to go into a mild recession in 2012, we project Malta's real GDP growth in 2012 to be relatively modest at 1 percent.

"Risks and uncertainty around this scenario are significant, reflecting the potential for large negative spillovers from the euro area crisis," the IMF said.

The international body said increasing productivity and growth had to be achieved by diversifying the economy into high value-added activities, reducing the economy's dependence on energy imports, strengthening female labour force participation, and aligning better wage and productivity developments.

The IMF warned that Malta's resilience to date could not be taken for granted.

"Continued vigilance is required. The authorities need to balance concerns over a slowing economy, which calls for accommodative policies, against increased risks that require more prudent fiscal management."

The IMF warned that bank profits could suffer if loan quality - which is highly concentrated in housing and construction - deteriorates further due to further declines in real estate prices or a fall in growth.

The IMF said that Malta had to ensure fiscal sustainability after the European Commission called Malta to take effective action to correct its effective deficit.

The deficit is estimated to have narrowed to 3% of GDP but the adjustment measures to cut down the deficit "remains suboptimal, relying excessively on one-off and revenue measures."

It also called for further fiscal consolidation, with structural annual adjustment of 0.5 percentage points of GDP. "Proposed EU directives on budgetary frameworks and governance should help the government achieve its fiscal balance objective, by adding credibility to the consolidation effort and enforcing stronger and more effective fiscal discipline and transparency."

The IMF said the restructuring of Air Malta, which will benefit from €200 million in government recapitalisation over the next five years, and Enemalta - which is exposed to some €500 million in debt guarantees - will need "sound governance requirements, specified benchmarks, and performance targets."

Pension reform also remained crucial to improve fiscal imbalances. The IMF said Malta's projected increase in ageing-related expenditure was twice the EU average, and that this rendered the current pay-as-you-go system "unsustainable".

The IMF said it supported the main recommendations of the Pensions Working Group, which include indexing the retirement age to longevity, and introducing a mandatory, privately-funded second pillar and voluntary third pillar.

On the positive side, the IMF found healthy and sound capital and liquidity rations in Malta's banking and insurance sector. But the size of the financial sector - eight times the Maltese GDP - and its large foreign ownership, presented a number of risks to financial stability and fiscal sustainability.

"These include concerns about too-big-to-save and the adequacy of backstopping resources in case of default or deposit run, the capacity to deal with a banking shock and its impact on the economy, as well as supervisory challenges."

The IMF commended the Central Bank and the Malta Financial Services Authority for extending the EU-wide stress testing exercise to all domestic banks, and for participating in EU-wide insurance sector stress tests.

The IMF however pointed out that Malta's Deposit Compensation Scheme (DCS) was unsatisfactory.

"A shortfall could have knock-on effects on the entire banking system through confidence and reputation effects and on the government's budget in case the DCS needs emergency funding. As a small economy with a large financial sector and idiosyncratic features, the authorities should give due recognition to the potentially high risks to financial stability, by erring on the conservative side and imposing buffers above the suggested minima."