Central Bank governor calls for welfare reform to address 'persistent' imbalance

Central Bank governor Michael C. Bonello has called for the set-up of an independent monitoring agency on the same lines of Sweden and most recently Portugal, in a bid to keep government spending in check.

He has warned that Malta’s per capita income level is being “artificially supported by government deficit spending" and that it was crucial to introduce a mandatory and privately-funded second pillar pension without delay.

“In order to reduce the deficit and to achieve a higher level of investment without raising taxes, recurrent spending must be cut,” Bonello stressed in the Central Bank’s annual report published today.

He said the recently set-up President's forum should take the opportunity to discuss the urgent concerns on sustainability of free health to all. He said it was an urgent issue that should not be discussed by political parties, and instead taken up by the forum to prepare the country for fiscal sustainability.

“Since most of this spending is on welfare, a reassessment of the role of state must be undertaken. Providing a safety net only for those who need it most should be a guiding principle for reforms in this regard.

“Additionally, for an open economy to close the income gap in the context of uncertain global prospects, policies at the sectoral level should be designed to enhance international competitiveness.”

The governor also announced that following an average annual inflation rate of 2.0% in 2010, the Bank forecasts prices to increase by 2.5% in 2011 and 2.4% in 2012. Both rates are higher than the corresponding euro area inflation forecasts.

Inflation will be a major policy challenge in 2011 after energy prices during 2010 pushed up the average inflation rate.

Bonello said that inside the Eurozone, Malta had to regain competitiveness through adjustments in the real economy. “To this end, prices and wages have to increase at a slower rate over time than the average in the euro area.

“The adoption of productivity-enhancing measures, increased competition in domestic markets and a wage-setting process that reflects efficiency gains rather than past inflation are important conditions for achieving this objective.”
He warned that prospects for Maltese exports, despite a recent rise, “remain uncertain: and have been further clouded by events in Libya with which Malta has substantial economic relations.

“While the economy has proved to be quite resilient to external shocks, with GDP growth recovering to 3.7% in 2010, its openness is nevertheless a source of vulnerability,” Bonello said.

“The recovery in fact reflected a sharp rebound in exports, particularly in the electronic components and tourism industries, activities which were hard hit by the recession.”

He said further efforts are needed to ensure that the upswing in economic activity can be maintained.

The Bank’s latest macroeconomic projections point to a smaller contribution of net exports to growth in 2011 and 2012, with real GDP slowing to a growth rate of 2.5% this year and then accelerating slightly to 2.9% in 2012.

Bonello emphasised that the risks to these forecasts are on the downside, referring to a number of factors that could dampen external demand. These include regional political tensions, the natural disaster in Japan, the winding down of monetary stimulus in a number of emerging economies and the aggressive fiscal tightening and structural reforms underway in many euro area countries.

“Such considerations and Malta’s still substantial income gap with the EU add to the urgency of addressing the structural weaknesses that act as a drag on the economy’s international competitiveness, including its positive inflation differential with the euro area."