Country Report Malta
Malta has a small and open economy. At 0.8%, growth was sluggish in 2012, amid weaker demand from the rest of the EU. It is expected that economic growth will remain subdued in the coming years, because of Malta’s reliance on EU demand. Malta is an offshore international banking center and has a financial sector with assets roughly eight times its economy. Despite the similarities with Cyprus, Malta is not likely to follow suit, because it has strong macroeconomic fundamentals and a much healthier and more segregated financial system. Early general elections in March 2013 led to a unique shift of power from the conservatives to the labor party. The decisive majority in parliament of the current cabinet bodes well for the adoption of reforms, in contrast to recent years. The increasing and large public debt is a matter of concern, especially due to the weak perspectives for fiscal consolidation. The fact that the public debt is mainly domestically financed and that there is high demand for it gives some comfort.
Economic structure and growth
Malta is a member of the Eurozone and has a small and open economy. Its main trade partners are Germany, Italy, France and the UK. As a result, economic developments in the rest of the EU tend to have a very strong impact on the Maltese economy. Malta has a service based economy, since the services sector accounts for roughly 74% of GDP (according to the last available data of 2007). The service sector consists mainly of the financial sector and tourism. Actually, the size of the banking sector is so large (financial assets represented 791% of GDP in January 2013 – see figure 1) that the country is often categorized as an offshore international banking center. Gross exports accounted for 59% of GDP in 2012 and Malta is a net exporter of services ( the service balance was 2.7% of GDP in 2012). The fact that roughly two thirds of the output in the services sector is exported, indicates that the sector relies heavily on foreign demand, which makes Malta highly susceptible to external demand shocks. However, the manufacturing sector is also significant and accounts for roughly 24% of economic output. Within this sector there has been a shift away from labor intensive industries towards high added value ones such as pharmaceuticals, information technology and automobiles. The main import and export good is fuel, as oil is being imported to be processed into oil export products. Other important export products are machinery and transport equipment, and manufactured goods, which together account for 42% of all exports of goods.
The Maltese economy has showed good resilience in the years following the financial crisis, despite its openness and trade vulnerabilities. In 2012 growth was sluggish at 0.8% amid weaker demand from the EU. The economy is expected to grow by more or less 1% in 2013 and 2014, as a pick-up in demand from other regions is likely to offset weak European demand, while domestic demand is likely to remain subdued. Renewed financial turbulence in the region could have a negative impact on the Maltese financial sector, and therefore poses significant downside risks to this forecast.
In recent years, the main growth driver of the Maltese economy was external demand. Exports of goods and services amounted to 106% of GDP and brought by far the largest contribution to growth in 2012 (figure 2). As pointed out earlier, this results in a relatively high susceptibility to external shocks. On the other hand, exports to regions outside the Eurozone have been increasing in recent years. These exports pulled the economy out of recession in the second half of 2012 and consisted mainly of high value added products such as electronics and online gambling for Asian customers, financial services exports to Turkey and relatively acyclical pharmaceuticals. Domestic private consumption accounted for 60% of GDP in 2012. However, the share of private consumption in output has been diminishing in recent years. Domestic demand is further expected to remain subdued due to the relatively high level of private sector indebtedness and possible increases in utility rates.
Poor productivity is a persistent issue in Malta. Together with Portugal, the country has the lowest level of productivity in the EU-15. Meanwhile, the pace of productivity growth is far below European Union levels. This limits the speed at which the economy can grow.
The attractive tax regime, the relatively low business set-up costs, the attractive labor laws, the location in the EU and the UK- based legal system have drawn many financial service companies to Malta, turning it into the banking center it is today. In the long run, the possible implementation of a Common Consolidated Corporate Tax Base (a EU-wide system for corporate tax) and of a financial tax at the EU level could have a negative impact on the sector and therefore pose downside risks to economic development. It is expected, though, that the national authorities will form a united front and strongly oppose such measures. However, it is questionable whether they have enough power within the EU to prevent the implementation of such measures.
Not the next Cyprus
After the bailout of Cyprus at the end of March, Malta was sometimes mentioned as a possible candidate for a similar crisis, given the size of its financial sector and the high leverage of the economy (foreign debt was 5 times GDP in 2012). However, the similarities with Cyprus pretty much end there.
To start with, the banking sector in Malta is in much better shape. The asset quality of the domestic Maltese banks is much better compared with that of the Cypriot banks, as they have little exposure to the troubled euro countries and there is less leverage in the private sector. They also have less bad loans, since non-performing loans represented 7% of total loans at the beginning of 2013, while in Cyprus they were already exceeding 15% in the third quarter of 2012. Moreover, the Maltese banks are well capitalized and have a healthy loan-to-deposits ratio of roughly 75%. Besides, the domestically oriented Maltese banks also run a low risk traditional, deposit- based model.
Furthermore, in Cyprus, major problems were caused by the fact that the domestic and foreign parts of the banking sector were closely interwoven. Foreign funding was used to provide excessive lending to Cypriot and Greek residents. In Malta, on the other hand, there is a clear distinction between banks which do business with foreigners and the ones which serve the domestic market and there is little interaction between the two. The domestically oriented part of the sector is estimated to account for roughly 1/3 of the total assets of the banking sector. It mainly consists of Bank of Valletta (40% state owned) and the local activities of HSBC. The part of the banking sector serving foreigners is mainly accounted for by the Turkish banks Garanti Bank and Akbank. These banks have little to no interaction with the local economy. They have almost no local deposits and loans, and do not own Maltese sovereign paper. According to a recent analysis by Fitch, these international banks with little links with the domestic economy of Malta have assets equal to 494% of GDP. According to Fitch, the Maltese government is unlikely to support these banks. Systemically important domestic banks have assets of 218% of GDP, but Fitch believes that the bulk of support for HSBC Bank Malta would come from its parent. As a result, the potential contingent liabilities resulting from the banking system are much smaller in Malta than in Cyprus. However, in May 2012 the IMF noted an increase in the interaction of the international banks with the local economy through increased deposit-taking, bond issuance and participation in ECB operations. Furthermore, the fact that the Maltese deposit compensation scheme is inadequately funded may make bank rescues more difficult.
Figure 3: Government bond yield
Source: Reuters EcoWin
In both Malta and Cyprus, the financial sector relies heavily on (foreign) deposits for funding. However, in Cyprus, the dependence on foreign deposits and, as a result, the domestic funding mismatch, was underestimated because a significant share of the deposits classified as resident belonged, in fact, to foreigners. This does not, or at least much less, seem to be the case in Malta.
Last but not least, unlike Cyprus, Malta has solid macroeconomic fundamentals: a stable growth path, a reasonable fiscal deficit, a good current account position, low inflation (2.4% yoy in 2012) and a low unemployment rate (6.4% in 2012).
All in all, Malta is not likely to need a bailout. Furthermore, while difficulties amongst the banks serving foreign markets may have a negative impact on the reputation of the banking sector, they are unlikely to materially affect the local economy. The markets seem to agree on this, as indicated by the long term Maltese government bond yields (figure 3) which kept decreasing in March 2013, unlike those of Cyprus and Slovenia.
Political and social situation
The EIU has classified Malta as one of the 25 “full” democracies of the world, holding the 15th place out of 167 countries in their democracy index ranking. Malta’s main strengths are the political culture, the electoral process and the civil liberties, while political participation constitutes a weakness, as in most “full” democracies.
As a democracy Malta has a president and a parliament, led by the prime minister. The current president is George Abela of the Nationalist Party and he was elected by the House of Representatives in 2009. The next appointment will be in 2014. The parliament is currently led by prime minister Joseph Muscat of the Labor Party (PL), after a landslide victory at the general elections on 9 March 2013, when the PL got 55% of the votes and the Nationalist Party (PN) lost after having been in power for 15 years. The PL thus obtained the largest majority in Malta’s history since independence from the UK.
The previous elections had burdened the NP government with a fragile majority of one seat. This led to internal frictions and a turbulent 2012 for the NP cabinet, which eventually lost its majority in the parliament in July 2012. Therefore, the failure to get parliamentary approval for the 2013 budget by former prime minister Lawrence Gonzi in December 2012 did not come as a surprise. After the opposition called a motion of no confidence, the president dissolved the parliament on 7 January 2013. The clear majority held by the new cabinet bodes well for political stability and reforms in the coming years.
The proximity of Malta to North Africa leads to a high influx of immigrants and puts a toll on the country’s resources. Malta has the highest refugee burden per capita in Europe. The political instability brought about by the Arab Spring has led to a further increase of immigration, leading to increasing social tensions. Malta has repeatedly appealed to the EU to develop an immigration burden sharing scheme which would entail the redistribution of immigrants across EU members. The failure of the EU to support Malta on this issue has amplified the anti-European sentiment.
Though the economic policy agenda of the incumbent PL cabinet does not differ much from that of its predecessor, its large majority in parliament allows for policy implementation without obstruction. Malta is in need of reforms of the health system and the pension system (currently a pillar I only system – a state-run system based on a pay-as-you-go approach), amid an ageing population and increasing costs. It is expected that the newly elected cabinet will book modest progress on these issues, though some aspects of the pension system reform, such as the introduction of a voluntary third pillar in the pension system, are regarded as problematic. Another structural problem which needs to be addressed is the large burden caused by loss-making state owned enterprises such as the energy supplier Enemalta and the aviation company Air Malta. The pace of restructuring and privatization of these companies has been slow in recent years due to the weakness of the previous government. Though some restructuring is expected to take place under the new cabinet, neither competitiveness enhancing reforms, nor privatization are expected to advance significantly in the upcoming year.
The track record of the Maltese government with respect to fiscal policy gives mixed signals. In December 2012, Malta was one of the first countries to leave the European Commission’s Excessive Deficit Procedure after the financial crisis. However, the fiscal deficit in 2012 came in at 3.2% of GDP and thus exceeded the Maastricht threshold once again. Meanwhile, public debt has increased to 71% of GDP in 2012 and is expected to keep growing. On top of that, contingent liabilities, consisting of guarantees the government provided to state owned enterprises, add up to 16% of GDP, driving the total public debt to 87% of GDP. Public debt is mainly financed domestically and is very popular amongst retail investors in the absence of a mandatory two-pillar pension scheme. The fact that most debt has been financed domestically gives some comfort, especially since the Maltese sovereign was downgraded by one notch to BBB+ by Standard & Poor’s in January 2013, due to the increasing debt burden and the political uncertainty caused by the dissolution of the Maltese parliament.
The weak perspectives for fiscal consolidation is what actually makes the large public debt a matter of concern. The government is planning to reduce the fiscal deficit to 2.6% of GDP in 2013 and 2.1% of GDP in 2014, indicating the issue is high on the agenda. But the attainability of the consolidation plans is questionable. Most of the reduction of the deficit is forecast to be realized by an increase in tax revenue thanks to economic growth. However, we think the growth assumptions of the government are too optimistic. Furthermore, the agenda of the newly elected cabinet, which might include tax cuts and lower energy prices and planned infrastructural investments are likely to put upward pressures on public spending.
Meanwhile, inflation has been relatively stable and fell to 2.4% in 2012 from 2.7% in the previous year.
Balance of Payments
The current account showed a slight improvement to a surplus equivalent to 0.3% of GDP in 2012, from a deficit of 0.5% of GDP in 2011. The Maltese current account has a history of deficits, as the large services surplus compensates for the significant trade deficit, but is not large enough to also offset the income deficit. However, in 2012, the services surplus was 22.7%, which was large enough to compensate for both the trade deficit of 18.5% of GDP and the income deficit of 4.7% of GDP. The significant income deficit mainly reflects the large repatriations of profits by foreign companies. Malta has further received relatively big net inflows of foreign direct investment (8.6% of GDP in 2012). In 2012 and 2011 Malta also recorded large net inflows of portfolio investment (36.9% of GDP in 2012). Both foreign direct investment flows and portfolio investment flows have been rather volatile in recent years. This applies to both inflows and outflows.
Malta’s total external debt was USD 43.5bn or 497% of GDP in 2012. Furthermore, 73% of foreign debt consisted of short term liabilities. However, as mentioned earlier, the external balance sheet of Malta is heavily inflated by the activities of foreign financial companies. Together, they accounted for 86% of foreign debt in September 2011. They fund their activities mainly with short-term debt and deposits, which accounted for roughly 67% of external debt in September 2011. The short term debt of these companies thus explains the high level of short term debt Malta has. Together, these companies also hold large assets abroad, and had, as a result, a net foreign asset position of EUR 8.5bn in September 2011. Actually, according to the IMF, Malta itself (excluding the foreign financial companies) had a net asset position of EUR 2bn or approximately 22.2% of GDP in September 2011.