Call for pro­duc­tiv­ity and sta­bil­ity for sus­tain­able growth

In his first speech as Gov­er­nor of the Cen­tral Bank to the an­nual din­ner of the IFS, held last night, Gov­er­nor Mario Vella called for pro­duc­tiv­ity and sta­bil­ity for Malta’s sus­tain­able growth

Malta Independent - - CALL FOR PRODUCTIVITY AND STABILITY FOR SUSTAINABL - The gov­er­nor said:

Malta’s re­cent eco­nomic per­for­mance

Against a back­drop of weak growth in Europe as a whole, eco­nomic ac­tiv­ity in Malta re­mains ro­bust. Fol­low­ing an ex­cep­tional in­crease of 6.2% last year, real GDP ex­panded at a more than re­spectable av­er­age an­nual rate of just over 4% dur­ing the first half of 2016.

The ex­pan­sion in out­put is be­ing driven by do­mes­tic de­mand, es­pe­cially by strong growth in pri­vate con­sump­tion and in­vest­ment. Ex­ports of ser­vices are also per­form­ing well, in­deed sig­nif­i­cantly bet­ter than the ex­port of goods.

Growth is be­ing driven by pri­vate mar­ket ser­vices, en­com­pass­ing a mix of tra­di­tional and new sec­tors, in­clud­ing tourism and dis­tri­bu­tion, avi­a­tion and pro­fes­sional ser­vices. The util­i­ties, which were for­merly loss-mak­ing, have now re­turned to profit, re­flect­ing the use of cheaper en­ergy sources and ef­fi­ciency gains.

Man­u­fac­tur­ing is hold­ing its own, with pock­ets of suc­cess and oth­ers that con­tinue to face strong com­pet­i­tive pres­sures. At the same time, fol­low­ing vig­or­ous growth last year, growth in value-added in con­struc­tion has eased.

Growth in out­put de­pends upon and feeds into a dy­namic labour mar­ket. Ac­cord­ing to ad­min­is­tra­tive records, which are avail­able up to April 2016, an­nual em­ploy­ment growth con­sis­tently ex­ceeded 4% in re­cent quar­ters. The Labour Force Sur­vey paints a sim­i­lar pic­ture, with em­ploy­ment gains av­er­ag­ing around 3% dur­ing the first half of the year. More re­cently, reg­is­tered un­em­ploy­ment has con­tin­ued to fall to record low lev­els over the sum­mer.

Notwith­stand­ing such a dy­namic eco­nomic per­for­mance, price pres­sures re­main con­tained, with in­fla­tion fluc­tu­at­ing in a nar­row range around 1% since the be­gin­ning of the year.

The ex­ter­nal bal­ance, tra­di­tion­ally in deficit, has now been in sur­plus for a num­ber of years, re­flect­ing growth in ser­vices ex­ports. The fis­cal deficit nar­rowed to 1.4% of GDP in 2015 and should con­tinue to de­crease fur­ther this year. In­deed, in the fore­see­able fu­ture the bud­get deficit is planned to fall to zero, while the gov­ern­ment debt to GDP ra­tio should de­crease to less than 60% of GDP.

This healthy eco­nomic per­for­mance and fis­cal con­sol­i­da­tion ef­forts have been well noted by the credit rat­ing agen­cies. In­deed, last month, Stan­dard & Poor’s raised Malta’s long-term sov­er­eign rat­ing to ‘A-‘ with sta­ble out­look. Ear­lier, Fitch had raised their out­look from neu­tral to pos­i­tive.

In sum, the Mal­tese econ­omy is go­ing through an un­prece­dented pe­riod of strong growth, low un­em­ploy­ment, re­strained in­fla­tion, a pos­i­tive ex­ter­nal bal­ance and di­min­ish­ing bud­get deficit and debt ra­tios.

Over the medium term, this per­for­mance has re­sulted in the con­ver­gence of Malta’s real per capita in­come with the EU av­er­age. Real GDP per head went up from 81% of the EU av­er­age in 2004 to 89% in 2015.

The con­di­tions that de­ter­mine per­for­mance

It is worth ex­am­in­ing the con­di­tions that have made this per­for­mance pos­si­ble to as­cer­tain the ex­tent to which it is sus­tain­able or oth­er­wise.

Some of the growth can be at­trib­uted to cycli­cal fac­tors. For ex­am­ple, Malta is ben­e­fit­ing from the Euro­pean Cen­tral Bank’s ac­com­moda­tive mone­tary pol­icy stance. For rea­sons un­re­lated to the do­mes­tic sit­u­a­tion, but re­flect­ing a pro­longed pe­riod of low in­fla­tion in the euro area, the ECB is us­ing both con­ven­tional and unconventional mea­sures to stim­u­late ag­gre­gate de­mand.

Hence in­ter­est rates are ex­tremely low: con­sider that the do­mes­tic 10-year bond yield is now be­low 1%. Such low rates stim­u­late ag­gre­gate de­mand. One could also ar­gue that, in the ab­sence of the ECB’s mone­tary pol­icy mea­sures, the euro would also be much stronger than it is to­day. This would have had ad­verse im­pli­ca­tions for ex­ter­nal com­pet­i­tive­ness and, hence, Mal­tese ex­ports.

Over the last two years, the econ­omy also ben­e­fited from ex­cep­tion­ally strong gov­ern­ment in­vest­ment - with a key role played by EU funds - as the ad­min­is­tra­tion made sure that avail­able en­ti­tle­ments were ab­sorbed to the fullest ex­tent pos­si­ble. This cap­i­tal spend­ing has both a tem­po­rary and a per­ma­nent ef­fect. While the projects them­selves are un­der way, in­vest­ment boosts ag­gre­gate de­mand as seen in the lev­els of ac­tiv­ity in the con­struc­tion sec­tor. Once the projects are com­pleted, the ad­di­tional cap­i­tal stock that has been put in place en­hances ef­fi­ciency and al­lows the econ­omy to con­tinue grow­ing into the fu­ture.

This brings me to a cru­cial con­cept in the anal­y­sis of Malta’s un­der­ly­ing eco­nomic per­for­mance: po­ten­tial out­put. Po­ten­tial out­put can be un­der­stood in many ways. In­tu­itively it can be seen as the max­i­mum out­put an econ­omy can pro­duce with­out gen­er­at­ing im­bal­ances that show up in in­fla­tion. Po­ten­tial out­put is a con­cep­tual mea­sure. It can be es­ti­mated, but not ob­served.

The Cen­tral Bank de­votes much ef­fort to es­ti­mat­ing Malta’s po­ten­tial out­put growth and its un­der­ly­ing de­ter­mi­nants. Growth in po­ten­tial out­put can be largely ascribed to struc­tural re­form mea­sures that bring about changes in the fac­tors of pro­duc­tion, namely labour and cap­i­tal, and the way they are com­bined, or pro­duc­tiv­ity. We es­ti­mate that the po­ten­tial growth rate of the Mal­tese econ­omy has more than dou­bled from be­low 2% at the time of the global fi­nan­cial cri­sis to over 4% to­day.

This partly re­flects a steady in­crease in the labour sup­ply, com­ing from higher fe­male par­tic­i­pa­tion in the work force, mea­sures to in­crease the ef­fec­tive re­tire­ment age and the in­flux of for­eign work­ers, mainly from EU coun­tries. Apart from the in­crease in labour sup­ply, the qual­ity of hu­man cap­i­tal has also im­proved. At the same time, a pick-up in in­vest­ment, partly driven by de­vel­op­ments in the en­ergy sec­tor, has boosted the cap­i­tal stock. How­ever, there is am­ple scope for im­prove­ment of labour pro­duc­tiv­ity in the com­ing years. In­deed it is crit­i­cal that it must im­prove.

A sound and sta­ble fi­nan­cial sys­tem is an es­sen­tial pre-con­di­tion for strong and sus­tain­able eco­nomic per­for­mance. The per­for­mance of the do­mes­tic fi­nan­cial sys­tem, es­pe­cially the core do­mes­tic banks, which have the strong­est link­ages to the do­mes­tic econ­omy, re­mained sound with strong cap­i­tal ra­tios, high liq­uid­ity and re­mained very prof­itable de­spite the chal­lenges of a pro­longed low in­ter­est rate en­vi­ron­ment.

As­set qual­ity con­tin­ued to im­prove, as non-per­form­ing loans, es­pe­cially to the non-fi­nan­cial cor­po­rate sec­tor de­clined by al­most 12%, mostly re­flect­ing im­proved cred­it­wor­thi­ness and an in­creased com­mit­ment by bor­row­ers to hon­our their loan com­mit­ments. As a re­sult the Non-per­form­ing Loan ra­tio de­clined to 6.5% by mid-year and is ex­pected to de­cline fur­ther to be­low 6% later on this year. While banks have con­tin­ued to adopt a pru­dent stance by in­creas­ing pro­vi­sions, and while such loans are gen­er­ally cov­ered to a sig­nif­i­cant ex­tent by col­lat­eral, nev­er­the­less they need to build fur­ther cov­er­age and ex­er­cise re­straint in div­i­dend dis­tri­bu­tion to share­hold­ers to pre­serve fur­ther the sound­ness of the bank­ing sys­tem.

In this re­gard, the au­thor­i­ties, namely the Cen­tral Bank and the Malta Fi­nan­cial Ser­vices Author­ity through the Joint Fi­nan­cial Sta­bil­ity Board, have taken pol­icy mea­sures to en­sure that by pre­serv­ing its sound­ness, the over­all bank­ing sys­tem re­mains sup­port­ive of eco­nomic growth. Dur­ing 2016, the au­thor­i­ties in­tro­duced the Other Sys­tem­i­cally Im­por­tant In­sti­tu­tions cap­i­tal buf­fer, to pre­serve cap­i­tal in those banks that are the most sys­tem­i­cally im­por­tant for the do­mes­tic econ­omy. We have also launched the Coun­ter­cycli­cal Cap­i­tal Buf­fer, although this has been cur­rently set at 0% as credit growth has not been ex­ces­sive rel­a­tive to eco­nomic growth or con­tribut­ing to as­set price in­fla­tion.

Other de­ci­sions to main­tain the sound­ness of the bank­ing sys­tem re­late to ad­dress­ing the stock of NPLs, which is in­ci­den­tally also high on the agenda of the Sin­gle Su­per­vi­sory Mech­a­nism. In this re­gard the au­thor­i­ties launched a con­sul­ta­tion process with the stake­hold­ers in­volved, to amend Bank­ing Rule 9 which in­volves mea­sures ad­dress­ing credit risks arising from the as­sess­ment of the qual­ity of as­set port­fo­lios of credit in­sti­tu­tions.

In a nut­shell, the pro­posal aims to es­tab­lish a con­crete plan with those banks with NPLs higher than 6% to re­duce such NPLs be­low that level over a pe­riod of 5 years, where fail­ure to ad­here to this plan will re­quire the in­sti­tu­tion to shore up its re­silience through the ac­cu­mu­la­tion of an ad­di­tional cap­i­tal re­serve.

Mean­while, on a Euro­pean level, the Euro­pean au­thor­i­ties are push­ing for the es­tab­lish­ment of a Euro­pean De­posit In­surance Scheme, which is a nec­es­sary in­gre­di­ent to com­plete the ar­chi­tec­ture of the Bank­ing Union project. This is be­cause a com­mon de­posit in­surance fund in­spires the same level of con­fi­dence to de­pos­i­tors through­out the en­tire Bank­ing Union, cre­at­ing a con­sis­tent and com­mon frame­work for su­per­vi­sion, res­o­lu­tion and de­pos­i­tor pro­tec­tion.

More­over, this joint safety net within the Bank­ing Union is ex­pected to pre­vent the cre­ation of com­pet­i­tive dis­tor­tions, thus fa­cil­i­tat­ing cross-bor­der bank­ing and hence strengthen fi­nan­cial in­te­gra­tion. How­ever, in this re­gard, there is still some way to go for agree­ment among all Mem­ber States, as risk re­duc­tion mea­sures, par­tic­u­larly through as­set qual­ity re­views of the less sig­nif­i­cant in­sti­tu­tions and ad­dress­ing the bank­ing-sov­er­eign debt loop, need to be also im­ple­mented. Malta is com­mit­ted to tak­ing the EDIS file for­ward dur­ing its pres­i­dency.


Go­ing for­ward, we ex­pect eco­nomic growth to mod­er­ate, while re­main­ing ro­bust and well above the euro area av­er­age. We con­sider that risks around this sce­nario are bal­anced. On the up­side, there is the po­ten­tial for pri­vate con­sump­tion to grow even more rapidly in a low in­ter­est rate en­vi­ron­ment es­pe­cially if labour pro­duc­tiv­ity in­creases to

per­mit higher wage set­tle­ments.

The down­side risks re­late mostly to the ex­ter­nal sit­u­a­tion. Malta is one of the most open economies in Europe, heav­ily de­pen­dent on in­ter­na­tional trade for its long-term pros­per­ity. Slower than ex­pected growth in key trad­ing part­ners, geopo­lit­i­cal ten­sions in our im­me­di­ate neigh­bour­hood and a resur­gence of pro­tec­tion­ism threaten this pros­per­ity.

An­other di­men­sion of risk re­lates to in­fla­tion. I have al­ready ex­plained that the Bank be­lieves that Malta’s po­ten­tial eco­nomic growth rate has risen in re­cent years, im­ply­ing that the econ­omy can grow more rapidly than it used to with­out fu­elling in­fla­tion. Nev­er­the­less, out­put cur­rently ex­ceeds po­ten­tial.

Should such a sit­u­a­tion per­sist, we would nor­mally ex­pect to see up­ward pres­sures on prices and costs. We have not ob­served them yet, as wage growth has re­mained largely con­tained and for­eign in­fla­tion is sub­dued.

The labour mar­ket sit­u­a­tion, how­ever, is tight­en­ing, which could lead to an in­ten­si­fi­ca­tion of wage pres­sures. This un­der­lines the need to achieve bet­ter re­sults in labour pro­duc­tiv­ity growth to sup­port wage de­mands with­out loss of com­pet­i­tive­ness. In ad­di­tion, global oil prices are now ris­ing af­ter hav­ing reached a trough to­wards the be­gin­ning of this year.

Chal­lenges ahead

The Cen­tral Bank of Malta’s prime re­spon­si­bil­ity is to en­sure price sta­bil­ity. From this per­spec­tive the chal­lenge is to en­sure that the Mal­tese econ­omy con­tin­ues to ex­pand at a sus­tain­able pace, with­out over­heat­ing.

It is vi­tal that we avoid the for­ma­tion of as­set price bub­bles. The re­cent global fi­nan­cial cri­sis has shown the huge costs that can arise when as­set prices de­part from their fun­da­men­tal val­ues, even­tu­ally jeop­ar­dis­ing the fi­nan­cial sys­tem and the econ­omy as a whole.

At the Cen­tral Bank we are keep­ing a very watch­ful eye on the price de­vel­op­ments in the prop­erty mar­ket. Ear­lier this year we have pub­lished work by our Eco­nomic Re­search Depart­ment ex­plor­ing prop­erty price mis­align­ment with fun­da­men­tals based on an in­dex of 5 sep­a­rate in­di­ca­tors. It shows that at the end of 2015 house prices were still be­low their equi­lib­rium fun­da­men­tal value but nev­er­the­less price trends in this re­gard will con­tinue to be closely mon­i­tored.

There are, how­ever, other as­set classes which need close ob­ser­va­tion to avoid for­ma­tion of as­set bub­bles. In the cur­rent low in­ter­est rate en­vi­ron­ment in­vestors’ search for yield may stim­u­late ex­ces­sive risk-tak­ing be­hav­iour. More in­vestors’ ed­u­ca­tion is needed to en­sure that there is bet­ter ap­pre­ci­a­tion of the risks of un­rated cor­po­rate debt, es­pe­cially where mar­kets are some­what thin.

At the same time, we have to recog­nise that, as mem­bers of the euro area, the mone­tary pol­icy tool is no longer avail­able at the na­tional level. This means that ac­tion needs to be taken in those pol­icy do­mains where we do en­joy some free­dom of ma­noeu­vre, that is, fis­cal pol­icy, macro­pru­den­tial pol­icy and struc­tural re­forms.

Pol­icy rec­om­men­da­tions

On the fis­cal front, the re­cent de­vel­op­ments I have just high­lighted are en­cour­ag­ing. I would stress the im­por­tance of meet­ing our fis­cal tar­gets in terms of struc­tural ad­just­ment and re­duc­tion in the debt ra­tio.

Apart from com­pli­ance with do­mes­tic and Euro­pean fis­cal rules, it is im­por­tant for Malta to build up suf­fi­cient fis­cal buf­fers to al­low us to counter even­tual ad­verse eco­nomic shocks with fis­cal pol­icy if needed. In this re­gard, ju­di­cious con­trol of gov­ern­ment ex­pen­di­ture is es­sen­tial, bear­ing in mind that some im­por­tant gov­ern­ment rev­enue streams may be past their peak and need to be re­placed through new ini­tia­tives.

En­hanc­ing labour pro­duc­tiv­ity is crit­i­cal - for­give me for pos­si­bly bor­ing you by re­peat­ing my­self but I am sure you will agree with me that bet­ter bored than sorry. This re­quires on­go­ing in­vest­ment in our labour force, in our peo­ple.

In terms of the gen­eral busi­ness en­vi­ron­ment, it is im­por­tant to en­sure that Malta re­mains an at­trac­tive lo­ca­tion for in­vest­ment, es­pe­cially for­eign di­rect in­vest­ment. We need to keep costs com­pet­i­tive, not only labour costs but also the costs of an­cil­lary ser­vices in­clud­ing en­ergy, trans­port and fi­nance, as well as trans­ac­tion costs gen­er­ally.

Per­mit me, at this point, to stress the im­por­tance of con­tain­ing the asym­me­tries of knowl­edge fac­ing in­vestors, es­pe­cially for­eign di­rect in­vestors. The Cen­tral Bank is do­ing its ut­most and in­tends to boost its ef­forts and the qual­ity of these ef­forts by pro­vid­ing top qual­ity and highly re­li­able pub­lic do­main quan­ti­ta­tive and qual­i­ta­tive in­for­ma­tion. Our re­search ca­pa­bil­ity is one of our top pri­or­i­ties. This enhancement of our ca­pa­bil­ity to pro­duce re­li­able knowl­edge will ben­e­fit all dis­cern­ing stake­hold­ers in­clud­ing the pol­icy maker (who we are statu­to­rily com­mit­ted to ad­vise) and the po­ten­tial in­vestor (who ab­hors any vac­uum of knowl­edge con­cern­ing the tar­get lo­ca­tion).

Pro­mot­ing a healthy busi­ness en­vi­ron­ment also re­quires ac­tion to re­duce ex­ces­sive bu­reau­cracy, to in­crease the ef­fi­ciency of our ju­di­cial sys­tem and to en­sure that our le­gal and reg­u­la­tory frame­works re­main ap­pro­pri­ately flex­i­ble.

At the Cen­tral Bank of Malta we have taken ini­tia­tives to help the busi­ness en­vi­ron­ment by launch­ing the Credit Reg­is­ter and by pro­mot­ing the set­ting up of the De­vel­op­ment Bank to give bet­ter ac­cess to credit for SME’s and to in­fra­struc­ture in­vest­ments on the Pub­lic Pri­vate Part­ner­ship model.

We are also pi­lot­ing changes to pre-in­sol­vency pro­ce­dures in an ef­fort to curb un­nec­es­sary liq­ui­da­tions and save busi­nesses that de­serve a sec­ond chance through fi­nan­cial re­struc­tur­ing. We are also lead­ing ef­forts to amend leg­is­la­tion to achieve more ef­fi­cient con­tract en­force­ment pro­ce­dures to ad­dress the long du­ra­tion of NPL’s on bank bal­ance sheets. These ini­tia­tives will help us climb the ad­mit­tedly steep ladder of in­ter­na­tional rank­ings mea­sur­ing busi­ness ef­fi­ciency.

The great ef­forts of other pub­lic sec­tor or­gan­i­sa­tions, led by the Of­fice of the Prin­ci­pal Per­ma­nent Sec­re­tary and Malta En­ter­prise, to rad­i­cally stream­line busi­ness en­abling pro­ce­dures across the board, are crit­i­cal if we are to suc­ceed to rad­i­cally up­grade the busi­ness en­vi­ron­ment. I in­sist on the word “radical” be­cause only a radical up­grade (an up­grade from the very roots of the sys­tem) will make a dif­fer­ence.

We need to en­hance com­pe­ti­tion. It is es­sen­tial to en­sure that con­sumers and busi­nesses can ac­quire the goods and ser­vices they need at fair prices. Within the bank­ing sys­tem, we be­lieve that there re­mains scope for pay­ment ser­vices charges to re­spond to more com­pe­ti­tion and for fur­ther pass-through of the cur­rent low in­ter­est rates to cus­tomers, although it is en­cour­ag­ing that we have seen re­duc­tions in re­cent months.

Fast eco­nomic growth does not come with­out some pain and costs. In­fra­struc­ture de­vel­op­ment has not kept up the pace and trans­lates into prac­ti­cal prob­lems. There are no easy so­lu­tions to such prob­lems. Build­ing in­fra­struc­ture takes time and adopt­ing ur­ban de­vel­op­ment poli­cies is inevitably com­plex, es­pe­cially in a very small is­land where ev­ery space is some­body’s back yard.

At an in­ter­na­tional level, as an ex­tremely open econ­omy, we need to take a res­o­lute stand against poli­cies that close bor­ders to trade and to in­ter­na­tional flows. As a small open econ­omy we need to de­fend open bor­ders and glob­al­i­sa­tion.

How­ever we need to ac­knowl­edge that the ben­e­fits of glob­al­i­sa­tion have been very un­evenly dis­trib­uted, even in the most de­vel­oped economies where many wage earn­ers have not seen a real in­crease in wages for decades and have lost their jobs and se­cu­rity. This is what pop­ulism feeds on whilst cer­tainly not of­fer­ing so­lu­tions in­tended to en­sure so­cial jus­tice.

Eco­nomic growth is only a means to the ul­ti­mate end of pro­vid­ing a higher stan­dard of liv­ing and con­fi­dence about the fu­ture for all cit­i­zens. But it is an ab­so­lutely nec­es­sary means.

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