AND STABILITY FOR SUSTAINABLE GROWTH
PRODUCTIVITY
BY
ADDRESS DR MARIO VELLA
OF
GOVERNOR, CENTRAL BANK MALTA
DELIVERED DURING THE IFS DINNER
ANNUAL
18 NOVEMBER 2016
Dear President and Members of the Committee of Institute of Financial Services (IFS) Malta,
personally and on behalf of the Board of Directors of the Central Bank of Malta and of its
Senior Management, I thank you for the opportunity to address this distinguished audience.
Dear Minister. Ladies and gentlemen.
This annual event brings together key stakeholders in this country's economic development
and growth, and in the development of the social, educational and cultural conditions without
which economic development and growth are not possible. It is now an established tradition
that the Governor of the Central Bank seizes the opportunity of the Annual Dinner of IFS
Malta to make a number of factually grounded remarks about some matters in the remit of
the Central Bank.
The traditional presence of the Minister of Finance at this event is of vital importance
because it provides the stakeholders present with a more dynamic view of the whole, in the
light of the statutorily distinct roles of the Ministry of Finance and the Central Bank.
Before sharing some thoughts with you, I would like to commend IFS for its ongoing
commitment to responding to the changing needs of the marketplace and its pursuit of
excellence in the provision of financial services education.
It is encouraging to hear that the Institute has had a successful year and that you are
working on new initiatives to promote even higher professional standards. This is most
welcome, as education and professional development are fundamental to the sustainability
of our financial sector and its continued success.
Your strategic partnerships with the University of Malta and overseas professional bodies
such as the European Banking & Financial Services Training Association (EBTN), the
London Institute of Banking and Finance, and the Global Association of Risk Professionals
reflects the Institute's excellent
(GARP) - whose representatives are with us tonight -
reputation. That a Committee member of IFS-Malta has been elected to the highest decision
association for a third consecutive term confirms the Institute's
making body of a European
integrity and professionalism.
The Central Bank has always worked closely with IFS and will continue to support its
activities. This year, we also cooperated with the IFS during the European Money Week to
promote financial literacy to underprivileged youths and participated in the successful IFS
Malta Annual Seminar on pension reform. I look forward to even more cooperation in the
future.
Mr President, well done and thank you for taking a proactive stance towards raising the
standards of financial services education. I wish you and your Committee every success in
your future endeavours.
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 with stable outlook. Earlier, Fitch had raised their outlook from
'A-'
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.
of Malta's real per
Over the medium term, this performance has resulted in the convergence
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 (EDIS), 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.
Risks:
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
In the current low interest rate environment investors' search for yield may
asset bubbles.
behaviour. More investors' education is needed to ensure
stimulate excessive risk-taking
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, macro-prudential 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 (PPP) 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
on the word "radical" because only a radical upgrade (an
business environment. I insist
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.