Michael Bonello

Q: Why was Malta in general, and its finance sector in particular, not as badly affected by the financial crisis and recession as other European countries?

A: In the first place, membership of the euro area has strengthened the capacity of Malta's economy to withstand external shocks, and we have not had to face the risks that are inherent in the management of a small national currency.

Moreover, the threat posed by the financial crisis was mitigated by the strength of the banking system. There were no toxic assets in the banks' portfolios; their lending policies were prudent and funding was based mainly on retail deposits. Capital and liquidity ratios remained well above the regulatory minimum throughout the crisis. This helped to retain investor confidence in the banking system.

Another factor which sheltered Malta from a more severe recession was the ongoing diversification of the economy towards high value-added services, which have proved resilient to the downturn.

However, certain sectors of the economy which are significantly exposed to the international economy, such as manufacturing and tourism, did sustain a notable decline in demand. To combat the negative effect of the recession on these sectors, the government provided financial assistance specifically targeted at particular firms which were willing to maintain and expand their operations in Malta. The government also embarked on a number of capital projects aimed at enhancing the infrastructure.

Q: What was the extent of Malta's recession?

A: Gross domestic product (GDP) fell by 1.9% in 2009, a smaller drop than that registered by the euro area. Furthermore, Malta's peak-to-trough decline in GDP was estimated at 3%, whereas that of the euro area amounted to 4.7%.

Manufacturing and tourism took the brunt of the recession, but several service activities, such as remote gaming and financial and other related activities, continued to register healthy growth. Their resilience contributed to a narrowing of the current account deficit, from 9.2% of GDP in 2006 to a projected 3.7% in 2009.

Even in the labour market Malta fared reasonably well. Its latest unemployment rate - 7% in January 2010 - is one of the lowest in the euro area. In terms of inflation on the other hand, price trends in Malta in the first half of the year diverged from those in the euro area, although they converged gradually over the second half as energy and food prices, which had risen strongly in the early part of 2009, decelerated substantially.

Even on the fiscal front, Malta's public finances performed relatively well, registering a smaller deficit than most other euro area countries. In fact, compared with the previous year, Malta's fiscal deficit/GDP ratio declined to an estimated 3.8% in 2009 from 4.7% in 2008. At the same time, general government debt as a percentage of GDP stood at 66.8% in 2009, compared with an estimated 78.2% for the euro area as a whole.

Q: What about the financial sector - how did it compare with the rest of the economy?

A: The financial sector's gross value added, in nominal terms, grew by an impressive 33% in 2009. Furthermore, net financial inflows have contributed substantially to the contraction in the current account deficit. This notable performance by the financial sector was also reflected in the fact that new licences were issued by the Malta Financial Services Authority in 2009, to a commercial bank and a number of investment funds. In addition, the domestic banking sector remained stable and its resilience was confirmed by stress tests conducted by the Central Bank of Malta over the past two years.

Meanwhile, liquidity and capital ratios remain well above their regulatory minimum. Let me give some examples. Liquid assets to short-term liabilities stood at 43.9% in January 2010, compared with a regulatory minimum of 30%. The ratio of customer deposits to customer loans stood at about 127%, which confirms that customers' deposits are large enough to finance the provision of loans by Malta's banks. In terms of capital adequacy, the regulatory capital to risk-weighted assets and the regulatory Tier 1 capital to risk-weighted assets ratio stood at a healthy 15.2% and 12.7%, respectively, at the end of 2009. Profitability indicators have also improved steadily throughout 2009, driven largely by a partial reversal of the valuation losses incurred in 2008.

In terms of the risk assessment, there are some weaknesses which warrant attention. For example, non-performing loans have been on the increase, rising to 5.6% at the end of 2009 from 4.9% a year earlier. In addition, the domestic banking sector is highly exposed to the property market, both directly and indirectly through collateral. In view of these vulnerabilities, the bank has repeatedly encouraged the banks to strengthen their capital buffers further beyond statutory ratios.

Q: What are your forecasts for Malta's economy in 2010?

A: The Central Bank of Malta's latest forecast points to GDP growth recovering to 1.2% this year, followed by 1.8% in 2011. The main engine of growth is expected to be domestic demand, with the contribution of net exports being negative in both years.

Labour market conditions are expected to remain slack. Even though employment growth is projected to become positive again, the unemployment rate is projected to increase slightly from 6.9% in 2009 to 7.2% in 2010, before declining marginally to 7.1% in 2011. Price pressures are expected to remain subdued. HICP (harmonised index of consumer prices) inflation is forecast to decline to 1.6% in 2010 from 1.8% in 2009.

Q: Has Malta's adoption of the euro caused inflation to rise more than it otherwise would have done, and if so, how damaging has that been?

A: The inflationary effects of the introduction of the euro tended to be overstated throughout the euro area. Interestingly, consumer surveys showed that inflation perceptions actually declined in Malta in the first two months after its introduction.

According to Eurostat's calculations, the total (one-off) impact of the euro changeover on headline inflation in Malta during, and immediately after, the changeover was estimated at about 0.2 and 0.3 percentage points. These estimates are in line with the experience of the first-wave countries in 2002 and of Slovenia in 2007.

Q: Has adopting the euro restricted your ability to manage the economy?

A: Not in any significant way because the two traditional adjustment policy instruments, the exchange rate and the interest rate, were not viable policy options in Malta's case, given its small size and openness and the fact that in the past it pursued a fixed exchange rate policy, characterised by a rigid link to a currency basket.

Q: What are the main shortcomings of the Maltese economy?

A: A main weakness is the slow growth in productivity. This has undermined economic performance in recent years and delayed progress in achieving higher levels of convergence with the major euro area countries. In spite of the recent downsizing efforts, the public sector remains relatively large and over-manned, which also contributes to the overall poor productivity performance.

Another shortcoming in the economic structure is the low employment rate, 55.3% in 2008 compared to 66.1% in the euro area, which is the result of a low female employment rate (37.4% in 2008 compared to 58.8% in the euro area), a declining male employment rate (from 75% in 2000 to 72.5% in 2008) and a low average exit age from the labour market (59.8 years in 2008 compared with 61.4 years in the EU).

Relatively low educational attainment levels are another source of concern. For instance, in 2008, only 27.5% of the population aged between 25 and 64 had completed at least an upper secondary education in Malta compared with 66.7% in the euro area. In 2008, Malta's expenditure on research and development is also low by international standards. It amounted to 0.5% of GDP compared with 1.9% in the euro area.

Q: What are the latest trends in foreign direct investment?

A: According to the World Investment Report 2009, FDI flows into Malta as a percentage of gross fixed capital formation averaged 92% per annum between 2006 and 2008.

These figures are significantly affected by the activities of the international banks operating in Malta. The FDI stock has reflected these steady inflows, rising from 18.9% of GDP in 1990 to 58.1% in 2000 and 108.4% in 2008.

Close co-operation between industry and academia has been an important factor behind the strong FDI inflows. Sectors where such co-operation has produced particularly good results include the insurance, pharmaceutical and aircraft maintenance industries.