josef bonnici : lessons from the recent past and the road ahead address by professor josef bonnici, governor of the central bank of malta, at kpmg ’ s biennial financial services conference “ maintaining the vision – driving value from change ”, st. julian ’ s, 1 november 2011. * * * the euro area is currently addressing the challenge of a number of interacting problems : the economic slowdown, the sovereign debt crisis and financial sector instability. the sovereign debt crisis has been aggravated by the impact on fiscal balances of slower economic growth and, in many countries, government support for distressed banks. in turn, sovereign debt problems have damaged the balance sheets of euro area banks and impaired the supply of credit to the economy. the fact that this monetary union is made up of sovereign and autonomous member states shows up at various levels. looking at national fiscal and structural policies in the recent past, one notices sharp differences in the extent to which different countries have exercised budgetary caution and preserved their international competitiveness. other national differences can also be observed. in the case of greece, for example, the country ’ s problems were compounded by the statistical understatement of the budget deficit and debt. in the case of ireland, as another example, it was imprudent bank lending policies, particularly to the real estate sector, which led to a massive rise in the debt burden of the state. of course, determined efforts are required on the part of eu governments to reach a consensus on improvements in governance – particularly on the rules governing budgetary policy in the monetary union – and on the provision of bail - out funds. while the discussion and decision process surrounding these matters are often regarded as a weakness in the governance structure, it must also be recognised that the changes involved represent significant levels of assistance to programme countries and also touch directly on issues related to sovereignty. it is perhaps ironic that current problems are in part a side effect of the success of the monetary union, and the benefits it brought about. more precisely the crisis has also been triggered by the misuse of the benefits of monetary integration. the new currency reduced the cost of borrowing in several countries, as credit spreads narrowed and exchange rate risk on intra - euro area borrowing was eliminated. 1 the reduced cost of financing public as well as private debt was reflected in higher government debt and private sector leverage. in the wake of risk repricing by the financial markets, there is now the strong tendency for market operators to unwind their holdings of

consolidation and eu membership are unlikely to exercise a marked impact on growth in the coming months. growth forecasts for 2006 vary between 1 % and 2 %. the current economic situation, therefore, requires decisive action designed to produce early results. i, therefore, feel obliged once again to make a strong appeal to all the social partners not to underestimate the threat which today ’ s realities represent for the wellbeing of their own members, and to cooperate in the search for real, long - term solutions in the national interest. the alternative is a slow, but depressing process of stagnation. the way forward towards faster growth lies in the first instance in striving to maintain the competitive advantage of traditional sectors – which typically rely heavily on cost advantage and where market share is being lost -, while promoting the development of new activities that exploit the potential offered by malta ’ s strategic assets. these include eu membership, a modern technological infrastructure and a skilled and flexible labour force. the current, encouraging expansion in new activities such as financial services, software development and pharmaceuticals attests to the competitive edge which our economy indeed enjoys in these areas. this advantage must, however, also be supported by a stable operating environment that is responsive to changing market conditions. elements of a coherent policy framework such an environment requires a coherent policy framework on three levels : the first is the macroeconomic level, where a sound financial system and prudent fiscal and monetary policies should combine to provide favourable conditions for the restructuring of the productive base. at the microeconomic level, resources must be more efficiently allocated and managed by enterprises so as to obtain the maximum possible degree of cost - effectiveness and market penetration. the third involves what may be termed as meso - level policies, involving specific sectors. policy at this level should primarily avoid distorting the mechanisms that facilitate economic activity. supportive macroeconomic policies are already in place … at the macroeconomic level, the recent track record has been largely positive. fiscal consolidation is progressing in line with the projections of the convergence programme. despite weak growth, the fiscal balance improved significantly in 2004 and again this year. this has not escaped the attention of international observers. the recent assessment of the maltese economy by the imf, for example, commends the progress achieved in strengthening macroeconomic management, including the substantial reduction in the fiscal deficit. looking ahead, i am pleased to note that the budget for 2006 bears the hallmark of continuity. operating within the constraints represented by the natural upward