IMF issues stark warning to Malta ‘momentum is expected to fade’

In its annual report on Malta the IMF has made a clear warning to those who harp about how well the island did in the wake of the global recession, and is “enjoying a cyclical upswing, momentum is expected to fade.”

"Uncertainty remains high and the risks tilted to the downside," the IMF said, adding that “economic growth and financial activity may slow more than currently expected by the government and future tax revenue may turn out lower than the latest targets.”

The report analysed the different sectors of the Maltese economy, and was cautious in its approach to forecasts on the economic performance.

The IMF spoke out on “vulnerabilities” that are rising in Malta’s financial sector.

"Conservative funding models and a focus on domestic assets kept spillovers from the global financial crisis to banks in Malta at bay. However, the past real estate boom led private debt to increase significantly.

“The household debt-to-GDP ratio remains below euro area average but the non-financial corporate sector appears highly leveraged.

“Banks have tightened lending policies and bank credit growth has decelerated, although it remains relatively strong on the basis of continued household mortgage lending.

“Capital market activity has picked up markedly reflecting issuance of bank and other corporate bonds, also by large companies active in the commercial real estate market.

“After an extended period of high growth, real estate prices experienced some correction and appear to have stabilized more recently, but excess supply remains in segments of the market. Experience from other countries in the euro area underscores the importance of treating such potential imbalances proactively," the IMF said, adding that that “high credit risk and growing exposure to securities in parts of the Maltese banking sector call for heightened vigilance and determined supervisory action.”

Domestic credit

"Domestic credit risk is rising on the back of softer real estate prices and other sectors with still sluggish activity. Concentration risk is quite significant and many banks remain highly exposed to the real estate sector where variable mortgage rates prevail.

"Low coverage ratios and high uncertainty associated with real estate collateral valuation require a more conservative supervisory approach to ensure appropriate provisioning. At the same time, capital buffers need to strengthened, preferably through equity injections and retained earnings. Some banks are highly invested in foreign debt securities making full use of ECB enhanced credit support and low refinancing rates. The authorities should discourage bank business models that are overly reliant on ECB facilities for financing large investment portfolios. Supervisors should employ all available tools, including the issuance of directives, to aggressively reduce leverage in these cases," the IMF warned.

The Fund also called for higher productivity, skills and employment rates and said that wages should follow productivity developments.

Economic performance

"Manufacturing and tourism activity, hit hard by the global recession, have recovered with the latter near pre-crisis record levels. However, the recovery is not yet broad based and some sectors are lagging behind.

“On the back of softer real estate prices and somewhat higher unemployment, consumption growth slowed but is supported by very low interest rates. Investment, especially in construction, decelerated sharply and remains sluggish. Inflation has picked up as the ongoing rebound allows firms to rebuild profit margins and pass on higher energy prices but underlying inflation is expected to remain contained.

“Over the medium term, economic growth may exceed the euro area average if reform momentum and diversification into high value export activities is sustained."

Real estate

The IMF said that real estate market weakness "could turn out deeper and more protracted than expected as excess supply in segments of the real estate market and some debt overhang need to be worked off.

“If the fragile economic and financial situation in parts of the euro area worsened, negative spillovers might occur."

It added that “Malta’s attractiveness as a business location and some of its new high-growth export activities (e.g. some business and financial services, pharmaceuticals, etc.) could be adversely affected should EU or member state regulations or taxation change.

“On the upside, low interest rates and stronger demand for Malta’s exports could sustain growth momentum longer than anticipated.”

“Fiscal consolidation should be growth friendly, supported by increased public sector efficiency and accompanied by the necessary reforms to raise productivity and employment rates.

"Recent international experience underlines that prudent financial regulation and supervision is indispensable, especially in view of rising vulnerabilities associated with high domestic credit risk and the growing linkages of Malta’s financial sector with the rest of the world in the context of volatile international financial markets."

Public debt

The IMF welcomed government’s goal of reducing the fiscal deficit to 1.4 per cent by 2013.

"Consolidation should be expenditure based and not impede further progress in attracting high value added export activities. Setting expenditure priorities and containing entitlements are crucial for lasting fiscal consolidation."

It warned that economic growth and financial activity may slow more than currently expected by the government and future tax revenue may turn out lower than the latest targets.

"On the expenditure side, the intention to contain government wages and spending on goods and services over the next years is welcome but slippages are likely. A more strategic approach that protects spending priorities, identifies areas to cut, is fully backed up with concrete measures and accounts for contingencies would raise the credibility of adjustment plans. This would limit the chance of last minute cuts, often at the expense of investment, or missing deficit targets."

"The implementation of a legally anchored, strong fiscal rule to better control public expenditure growth should be considered. Further tax amnesties may harm tax collection over the medium term."