The Central Bank of Malta’s first issue of its Quarterly Review for 2012 analyses economic and financial developments in Malta and abroad during the last quarter of 2011 and the first months of 2012.

The Review begins by analysing the monetary policy stance of the Eurosystem. The European Central Bank’s (ECB) interest rate on the Main Refinancing Operation (MRO) was lowered by 25 basis points in November and again in December, to end the year at 1.00%.

These cuts were propelled by the expectation that financial market tensions would continue to dampen economic activity in the euro area, and that price pressures would remain moderate going forward. Interest rates were left unchanged during the first five months of 2012.

During the final quarter of 2011 and the first five months of 2012, the Eurosystem continued to implement non-standard monetary policy measures to support the functioning of the financial system in the euro area. It introduced long-term refinancing operations with a three-year term to maturity and also announced a new covered bond purchase programme. Moreover, the range of assets eligible as collateral was increased while the reserve ratio was lowered to 1% from 2%.

The Review notes that economic developments in the major industrial countries were mixed in the fourth quarter of 2011. While the annual pace of growth in the United States and the United Kingdom picked up compared to the previous quarter, the Japanese economy contracted further. The main emerging market economies grew at a slower pace in the last quarter of 2011 compared with the previous quarter.

In the euro area, economic activity weakened further, with real Gross Domestic Product (GDP) dropping on the previous quarter’s level. On an annual basis, real GDP expanded by 0.7%, down from 1.3% in the third quarter. Net exports were once again the main driver of economic growth. Meanwhile, the annual inflation rate based on the Harmonised Index of Consumer Prices (HICP) in the euro area remained unchanged from September through November, at 3.0%, before easing to 2.7% in December. Inflation remained at this level until February 2012, before falling slightly to an estimated 2.6% in March.

According to the March 2012 ECB staff macroeconomic projections, annual real GDP growth in the euro area is expected to be between -0.5% and 0.3% in 2012 and between 0.0% and 2.2% in 2013. The average annual headline inflation rate is expected to range between 2.1% and 2.7% in 2012 and between 0.9% and 2.3% in 2013.

Turning to the Maltese economy, the Review reports that economic activity also weakened in the last quarter of 2011, with the annual real GDP growth rate turning mildly negative, at -0.1%. This contraction was spurred by domestic demand, as negative developments in changes in inventories, private consumption and investment offset the favourable impact of higher government consumption. On the other hand, net exports boosted annual real GDP growth significantly.

Beyond the date when the Quarterly Review was finalised, information was made available on real GDP covering the first quarter of 2012, when a year-on-year drop of 1.0% was recorded. For the third consecutive quarter, the change in inventories, which includes the error term, was negative, at 5.9% of GDP. On the expenditure side, this item was the primary factor behind the drop in GDP. On the production side, the service-oriented sectors of the economy contributed positively to growth, while negative changes were limited mainly to developments in the energy and electronics sectors.

As regards price developments, the annual rate of HICP inflation dropped to 1.3% in December from 2.7% in September. The major factors behind this deceleration were price reductions for non-energy industrial goods and for services, along with slower increases in prices of energy and processed foods. Inflation subsequently rose to 2.4% in February.

Labour market data point to annual growth in employment during the quarter reviewed. Meanwhile, the unemployment rate derived from the Labour Force Survey rose by 0.4 percentage points compared with the September quarter to stand at 6.6% in the fourth quarter, but remained below its level a year earlier.

Fourth quarter competitiveness indicators were mixed. Unit labour costs were higher compared with the preceding quarter, as labour productivity fell while employee compensation increased. On the other hand, Harmonised Competitiveness Indicators improved between September and December 2011, driven by the depreciation of the euro against major currencies and a narrowing of Malta’s inflation differential against its main trading partners.

In the external sector, the current account of the balance of payments registered a surplus, after it had been in deficit a year earlier. The improvement mainly reflected a narrowing in the visible trade gap and a decline in net outflows on the income account. These offset lower net current transfers and a minor drop in the service surplus. As a result, the current account deficit for the year as a whole halved to 3.2% of GDP.

The contribution of Maltese monetary financial institutions to the euro area broad money stock continued to accelerate, driven by movements in overnight deposits. While deposits held by Maltese residents grew moderately, credit issued to them gained momentum. Turning to domestic financial markets, the Review notes that the yield on three-month Treasury bills declined from its end-September level, in both the primary and the secondary market. However, secondary market yields on ten-year government bonds increased slightly. Meanwhile, the Malta Stock Exchange share index decreased marginally over the quarter. During the first two months of 2012, domestic money market rates edged up, while in contrast, ten-year government bond yields fell.

In its analysis of fiscal developments, the Review observes that the general government deficit decreased on a year-on-year basis in the fourth quarter, as revenue expanded and expenditure declined. This contributed to a reduction in the deficit-to-GDP ratio for 2011, which went down to 2.7% from 3.7% in 2010. However, general government debt, as a ratio of GDP, increased to 72.0% by the end of the year.

From a policy perspective, the Review argues that even though the deficit ratio is expected to narrow further in 2012, additional measures need to be specified so that the official fiscal targets for later years are attained and faster progress is made on reducing the debt-to-GDP ratio.

Given the present uncertainty in the international economy and increased competitive pressures, it is also important to pursue further structural reforms to raise productivity and enhance economic growth. Improved productivity and restrained cost increases would also increase Malta’s attractiveness as an investment location. In this regard, therefore, wage awards should, as much as possible, mirror productivity gains. Stressing the importance of a healthy banking system as a vital element in supporting economic growth, the Review urges the sector to remain prudent, in terms of its capital adequacy and liquidity ratios, the mix of its funding sources and its provisioning policy.

The first issue of the Quarterly Review for 2012 is available on the website of the Central Bank of Malta at www.centralbankmalta.org

Permalink: Additional measures needed to achieve fiscal targets – CBM