Maintaining external competitiveness "crucial"

A report on macroeconomic and financial sector stability in the EU candidate countries, just released by the European Commission, says the Maltese economy is expected to continue growing at relatively high rates over the coming years.

It says that despite the small size of the economy, volatility of GDP growth had been relatively low over the last years.

GDP growth had oscillated between 3.4 per cent and 5.3 per cent in the period 1996-2000. Although average output growth was negative in the first nine months of 2001, the expected medium-term trend of growth was likely to be more in line with previous years at three to four per cent.

The leading forces of growth were likely to be higher private domestic demand coupled with an improvement in the trade and services accounts, the report said. Export and import growth in 2001 was negative, as imports of investment goods soared in 2000 because of a renewal of production capacity by the major electronics manufacturer and exports increased sharply due to the increase in exports of electronic equipment.

Household consumption was expected to remain relatively strong, enhanced by higher employment and income. The contribution of government consumption to GDP would decrease, while capital expenditure was likely to remain at levels somewhat above those in 1999.

"Due to Malta`s dependence on foreign trade, the main risks of an economic slowdown could stem from a weakening of export markets, which reveals the importance to keep the external competitiveness of the economy," the report said.

It added that enterprise restructuring and trade liberalisation in Malta were a potential risk for temporary increases in unemployment. However, some labour shortages were arising in strategic sectors and policies towards encouraging a shift from low to high productive sectors should be enhanced.

The report said that Malta`s macroeconomic challenges stemmed primarily from the maintenance of its external competitiveness and the reduction of the government deficit to sustainable levels.

A potential decline in exports could lead to lower growth and persisting high current account imbalances. Although the high level of the current account deficit experienced in 2000 was seen as temporary, the savings investment balance could deteriorate in comparison with the recent trend, and might increase vulnerability if non-debt creating inflows were insufficient to largely finance the deficits.

The ongoing capital movements liberalisation increased the potential for higher volatility of capital flows and international reserves.

The report argued that maintaining external competitiveness would be crucial for the coming years to reduce potential risks. In this regard, it would be fundamental to maintain wage growth moderation and to continue with structural reforms to increase the competitiveness of the Maltese economy.

At the same time, fiscal policy needed to progress towards further consolidation. The new public deficit targets were seen as a positive step forward. This would be crucial to support the exchange rate peg, which had proved to be an appropriate nominal anchor.

The report said the financial sector was developing satisfactorily and the regulatory and supervisory framework was, in general, sound. The main challenge for the sector drew from the ongoing liberalisation of capital movements which increased the potential for capital flows volatility.

The maintenance of sustainable external balances, so that they could be largely matched by non debt-creating inflows, and further fiscal consolidation would substantially reduce the volatility risks. The continuation of the strengthening of the financial sector through the adoption and implementation of sound legislation is also crucial for increasing efficiency in the sector and guaranteeing the confidence of foreign investors.

Some specific weaknesses would need to be addressed more deeply to better identify potential risks within the Maltese financial sector: information about foreign exposure and other prudential indicators of the corporate sector was limited and the level of non-performing loans over total loans was rather high.

The report concludes that:

¤ Malta`s external vulnerability will be conditioned mainly by its external competitiveness and domestic demand on the one hand, and by the impact of the liberalisation of capital movements on the other hand;

¤ The capital movements` liberalisation increased the potential for higher foreign exchange exposure;

¤ Fiscal consolidation was likely to continue, in line with the government`s plans;

¤ Privatisation revenues were expected to moderate public debt growth;

¤ Continued fiscal consolidation was necessary;

¤ Monetary policy decisions were likely to have a higher impact on the economy;

¤ Monetary policy was likely to be more active in response to the effects of the capital movements liberalisation.

Overall, the report called on candidate countries to develop their own capacity for implementing permanent and continuous risk monitoring. The ability of most candidate countries to cope with potential future macroeconomic challenges and to safeguard macroeconomic stability in the medium term, had, however, considerably improved.

It warned that candidate countries` real convergence with current member states had so far been relatively modest and growth performance had been mixed. Average GDP per capita measured on the basis of purchasing power standards (PPS) for all candidate countries reached 35.2 per cent of the EU average in 2000 - basically the same level as in 1996. It ranged from below 30 percent in Bulgaria, Romania and Turkey, to 86.2 percent in Cyprus.

Candidate countries` average real GDP growth rates in the period from 1996 to 2000 stretched from minus 1.6 per cent in Romania to 5.2 per cent in Poland.

As a result of initial transition recessions and on-going restructuring in the enterprise sector, unemployment remained a major problem in most countries, with unemployment rates in 2000 varying from 4.9 percent in Cyprus to over 15 per cent in Bulgaria, Lithuania, Poland, and Slovakia.

The report urged the candidate countries to create an environment that facilitated faster growth and accelerated real convergence. It added that the catch-up process depended on continued high investment and rapid technological change. In 1996 to 2000, average annual FDI inflows to

the transition candidate countries ranged from 1.2 per cent of GDP in Slovenia to 7.4 per cent of GDP in Lithuania.

In the area of financial sector stability, the report says that almost all candidate countries have made great strides in reforming their financial sectors. Nevertheless, further development and expansion is clearly necessary, states the report.