Central Bank of Malta Governor Michael Bonello yesterday called for the establishment of an independent agency which would monitor government spending and stressed that a serious reappraisal of the role of the state was needed in Malta.

Such an agency already existed in Sweden and one was recently set up in Portugal, Mr Bonello said while presenting the Bank’s 2010 Annual Report.

“We need to go back to basics especially where welfare is concerned,” he said, adding that Malta’s per capita income level has been artificially supported by government deficit spending.

“The importance of fiscal consolidation is accentuated by the downside risks to growth projections, the pressing need to reduce the debt ratio and the expectation that age-related public spending will accelerate more than the EU average. Hence the need to introduce a mandatory and privately-funded second pillar pension without delay,” Mr Bonello said.

The Governor said that in order to reduce the deficit and to achieve a higher level of investment without raising taxes recurrent spending must be cut.

“Since most of this spending is on welfare, a reassessment of the role of state must be undertaken. Providing a safety net only for those who need it most should be a guiding principle for reforms in this regard. Additionally, for an open economy to close the income gap in the context of uncertain global prospects, policies at the sectoral level should be designed to enhance international competitiveness.”

Mr Bonello said that while Malta’s economy has proved to be quite resilient to external shocks, with GDP growth recovering to 3.7 per cent in 2010, its openness is nevertheless a source of vulnerability.

“The recovery in fact reflected a sharp rebound in exports, particularly in the electronic components and tourism industries, activities which were hard hit by the recession. The prospects for external demand, however, remain uncertain and have been further clouded by events in neighbouring countries with which Malta has substantial economic relations. Further efforts are therefore needed to ensure that the upswing in economic activity can be maintained.”

Mr Bonello said the Bank’s latest macroeconomic projections point to a smaller contribution of net exports to growth in 2011 and 2012, with real GDP slowing to a growth rate of 2.5 per cent this year and then accelerating slightly to 2.9 per cent in 2012.

The Governor said that there were risks to Malta’s economic growth such as higher oil prices, the turmoil in Libya and the Arab world, the situation in Japan and the possible further appreciation of the euro.

Following an average annual inflation rate of two per cent in 2010, the Bank forecasts prices to increase by 2.5 per cent in 2011 and 2.4 per cent in 2012, Mr Bonello said. Both rates are higher than the corresponding euro area inflation forecasts.

He emphasised that when part of a currency union, competitiveness has to be regained through adjustments in the real economy.

“To this end, prices and wages have to increase at a slower rate over time than the average in the euro area. The adoption of productivity-enhancing measures, increased competition in domestic markets and a wage-setting process that reflects efficiency gains rather than past inflation are important conditions for achieving this objective,” he said.

The Governor identified inflation as a policy challenge for the eurozone. “The strong increase in energy prices during 2010 pushed the average inflation rate to 1.6 per cent. Moreover, it is expected to rise further to two per cent to 2.6 per cent during 2011 before easing slightly thereafter,” he said.

Against this background the Governor said sustainable public finances, as well as the timely implementation of national reform plans are important preconditions for a return to more stable economic and financial conditions and higher growth rates. He also called for a more ambitious economic governance framework for the eurozone and the full utilisation of the lending potential of the European Financial Stability Facility.

In the eurozone the recovery has become more broad-based and increasingly self-sustained, Mr Bonello said. However, structural weaknesses remain and economic performance has been heterogeneous across the area’s constituent economies.

“Growth in the euro area is expected to remain moderate, in a range between 1.3 per cent and 2.1 per cent this year and between 0.8 per cent and 2.8 per cent in 2011, amid further balance sheet adjustments in the private sector and fiscal austerity measures,” he said.

Mr Bonello also highlighted the Bank’s responsibilities in relation to monetary policy in the eurozone and said it conducted market operations with eligible counterparties in Malta, injecting almost €20 billion.

During 2010 the Bank also continued to keep a close watch over the domestic financial system to assess potential risks to financial stability. The Central Bank of Malta began to participate in the work of the European Systemic Risk Board and its sub-structures.

Additionally, the Bank continued to upgrade its existing stress-test tools and participated in the EU-wide stress test exercise. The Bank is currently extending this test to the majority of banks operating in Malta, with the aggregate results to be published in its forthcoming Financial Stability Report.

In general, the banking system continued to maintain high levels of capital and liquidity during 2010. However, Mr Bonello said, any setbacks in the economic recovery could increase the implied credit risk carried by the banks. It therefore remains imperative for banks to strengthen their capital buffers.

The Bank’s operating profit for 2010 amounted to €57.6 million, as against €58.6 million in 2009.