The Central Bank of Malta has published the first issue of its Quarterly Review for 2010, which analyses economic and financial developments during the fourth quarter of 2009 and the initial months of 2010.

In its analysis of fiscal developments, the Review reports that the general government deficit narrowed to 3.8% of GDP during 2009, from 4.5% in 2008, as revenue increased and expenditure fell. The general government debt continued to rise, however, reaching 69.1% of GDP in December.

Commenting on the conduct of monetary policy, the Report notes that the ECB left the interest rate on the Main Refinancing Operations (MRO) unchanged at 1.00% during the final quarter of 2009 and the first four months of 2010, as price developments were expected to remain subdued over the policy-relevant horizon. In December, the ECB began to phase out some of the non-standard credit support measures designed to ease conditions in the financial system. More specifically, the Governing Council decided that the twelve-month long-term refinancing operation (LTRO) held on 16 December 2009 was to be the last, and that the rate charged on this operation would be fixed at the average minimum bid rate of the MROs over the life of the operation. Furthermore, in March the Governing Council decided to return to variable-rate tender procedures in the regular three-month LTRO and to fix the rate in the six-month LTRO allotted on 31 March 2010 at the average minimum bid rate of the MROs over the life of this operation. Both the regular MROs and the special-term refinancing operations with a maturity of one maintenance period, however, would continue to be held as fixed rate tender procedures with full allotment.

Subsequently, however, concerns over the fiscal situation in some euro area Member States led to renewed tensions in financial markets, as shown by widening sovereign bond yield spreads. In response, the ECOFIN Council, on 10 May 2010, adopted a package of measures to preserve financial stability, including the creation of a European stabilisation mechanism. In addition, on the same day, the Governing Council of the ECB decided to intervene in the euro area public and private debt securities markets to ensure their depth and liquidity. These interventions are being sterilised to avoid an additional injection of liquidity and neutralise their impact on money market rates. Moreover, the Governing Council decided to adopt a fixed rate tender procedure with full allotment in the three-month LTROs to be allotted on 26 May 2010 and 30 June 2010, and to conduct an additional six-month LTRO with full allotment on 12 May 2010. Finally, the Council decided to reactivate temporary swap lines with the US Federal Reserve and to resume US dollar liquidity-providing operations. The Governing Council considered these measures essential to address malfunctioning securities markets and ensure the effectiveness of the monetary policy transmission mechanism.

In its analysis of international economic conditions, the Review observes that in the last quarter of 2009, the incipient recovery in the global economy gained ground. Inflationary pressures increased, driven by rising global demand and higher commodity prices. The Review notes that in the euro area, real GDP contracted at a slower pace, falling by 2.2% on a year earlier as against a 4.1% decline in the previous quarter. This was driven by a less rapid fall in domestic demand and a positive contribution from net exports. The annual rate of inflation, as measured by the Harmonized Index of Consumer Prices (HICP), turned positive in November and ended the year at 0.9%. Inflation continued to pick up during the first quarter of 2010. Looking ahead, according to the March 2010 Eurosystem Staff Projections, annual real GDP growth in the euro area is set to range between 0.4% and 1.2% in 2010, with inflation expected to range between 0.8% and 1.6%.

Turning to the Maltese economy, the Review notes that output resumed growth in the final quarter of 2009, with real GDP rising by 0.5% on a year earlier. The recovery was driven by net exports, although the drop in domestic demand moderated too. Industrial confidence strengthened in the final quarter of 2009, but declined slightly in the following three months. On the other hand, confidence in the service industries continued to rise throughout both quarters.

With regard to price developments, the Review notes that annual HICP inflation continued its downward trend during the final quarter of the year, turning negative and reaching -0.4% in December. This fall was mainly driven by a sharp drop in the rate of increase in unprocessed food prices, as well as larger year-on-year falls in prices of energy and non-energy industrial goods. Annual inflation picked up in the following quarter, however, reaching 0.7% in February.

According to Labour Force Survey data, employment rose during the December quarter, while ETC statistics point to a more moderate year-on-year contraction in the gainfully occupied population until November. The seasonally-adjusted unemployment rate was stable during the same period, and began to fall in the first quarter of 2010.

Turning to developments in the balance of payments, the Review noted that while the current account deficit widened in the December quarter compared to the same period of 2008, during 2009 as a whole the deficit narrowed to 3.9% of GDP from 5.4% in 2008.

Towards the end of 2009, the Maltese economy’s international price competitiveness improved, as both nominal and real Harmonised Competitiveness Indicators fell. Additionally, the long-term rise in Unit Labour Costs was stemmed during the quarter, as employee compensation declined while productivity increased.

The Review’s analysis of monetary trends shows that during the December quarter of 2009 the contribution of Maltese MFIs to the euro area broad money stock increased as residents’ deposits rose. At the same time, credit to residents picked up slightly while net claims on non-residents of the euro area fell. Domestic money market yields extended their downward trend, while movements in government bond yields were mixed.

From a policy perspective the Review argues that as the economic recovery gathers pace, attention should turn towards fiscal consolidation. The Government still has an important role in supporting the economy through the provision of an adequate physical infrastructure and further measures to improve the quality of the labour force. The focus of consolidation should, therefore, be on reducing recurrent expenditure. The Review stresses that the pursuit of structural reforms also remains necessary to strengthen competitiveness.

The first issue of the Quarterly Review for 2010 is available on the website of the Central Bank of Malta at www.centralbankmalta.org

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