to some at the time, but a combination of appropriate policies implemented within a clear strategic framework and an improvement in malta ’ s external environment led to the desired objective being achieved just three years after eu accession. in july 2007, in fact, the european commission recommended to the eu council that malta be allowed to adopt the euro on the grounds that it had achieved the high degree of sustainable convergence required by the treaty. achievements of the past five years the implementation of reforms began to pay dividends after 2004. also with the help of stronger external demand, growth accelerated to an average annual rate of 3. 4 % between 2005 - 2008, compared with 0. 5 % in the preceding four years. importantly, growth was driven by a pick up in labour productivity and by faster employment growth. closer economic integration with the eu led to increased business cycle synchronization, which meant that malta was better placed to benefit from the common monetary policy of the ecb. between 2005 and 2008, economic activity displayed an average bilateral correlation of over 82 % with the euro area, up from 45 % in the previous four years. 2 while eu funds also played an important role, economic expansion since 2005 has been largely driven by foreign direct investment ( fdi ), as the economy shifted towards higher value - added activities and exploited new niche markets opened up by eu membership. as a proportion of gross fixed capital formation, fdi inflows increased from an average of 56 % in the period 2001 - 2004 to 93 % during 2005 - 2007. meanwhile, the stock of fdi stood at around 100 % of gdp, an increase of more than half since 2003. business cycle synchronization is measured by the contemporaneous correlation of de - trended gdp levels in malta and the euro area. the data were obtained from eurostat and de - trended using the hodrick - prescott filter on quarterly statistics that were seasonally adjusted and adjusted by working days. at the same time, industry became increasingly oriented towards more capital intensive activities, such as generic pharmaceuticals, while the share of labour intensive operations such as textiles continued to decrease. in the services sector, the importance of tourism, which rebounded in 2007 following the introduction of low - cost airlines and growth in cruise ship business, has been complemented by growth in a broad range of new activities, including financial services, aircraft maintenance and repair, online gaming, ict, call centres and back office operations. the more diversified supply of services and the shift towards

. since eu membership, growth in unit labour costs practically matched the euro area average. thus, in terms of labour cost competitiveness, malta has kept pace with the euro area average. however, to maintain competitiveness a further focus on the wage setting process may be appropriate. in particular the basic principle must be to emphasise that productivity improvements are at the basis of sustained wage increases, and that these are best negotiated at firm level, where improvements in productivity can be best gauged. consequently, any cost of living adjustments should form part and parcel of the collective agreement and not be superimposed on collective agreements by legislation as happens today. indeed, already a number of collective agreements incorporate the cola increase, and i suggest that this should be the norm. another important message that has emerged from the sovereign debt crisis is the need for fiscal prudence, which provides the space for countercyclical fiscal policy during a downturn. in the euro area, fiscal policy is the major macroeconomic management tool at the national level. thus, in periods when economic activity is relatively strong, policy needs to be sufficiently prudent to build the necessary fiscal buffers that would be utilized during periods of weaker growth. bis central bankers ’ speeches in the aftermath of one - off expenditure during 2008, the deficit ratio in malta declined in 2009 despite the recession of that year and narrowed slightly further in 2010. the debt ratio generally declined until 2008, but then picked up in 2009, partly in response to the contraction in the economy. although the debt ratio has been considerably below that of the euro area as a whole, the government ’ s determination to achieve its fiscal targets is welcome. strong efforts need to be made in order to adhere to these targets, particularly during times of slow economic growth. recent experience has shown that with the adoption of targeted and limited spending measures, the economy has proved relatively resilient to external shocks. still, at this juncture, the continuing slowdown in external demand is likely to impact the economic growth rate, adding further pressure on the fiscal balance at a time of heightened institutional and market scrutiny. this will introduce a delicate balance between two considerations. first, cutting the deficit is important in order to reduce macroeconomic imbalances that in the longer run hinder economic growth. secondly the immediate effect is to reduce aggregate demand, whether via spending cuts or through higher taxation, which would slow the economy down. bis central bankers ’ speeches given the desirability of avoiding such dilemmas,