Brief Overview: The current financial & economic situation in Malta
by the Central Bank of Malta

CENTRAL BANK QUARTERLY REVIEW – September 2002
Issue Date: 15th November 2002

The Central Bank of Malta’s latest Quarterly Review, which analyses economic and financial developments in Malta and abroad during the second quarter of 2002, also includes the results of the Bank’s latest Business Perceptions Survey, a box on the Bank’s revised forecasts of economic activity for 2002, and an article on the Maltese financial sector delivered by the Deputy Governor during a workshop on financial sector issues held at the European Central Bank.

Interest Rates

The Review notes that the Bank left the central intervention rate and the discount rate unchanged at 4% both during the second quarter and throughout the third quarter. This decision was based on an analysis of economic and financial developments in Malta and abroad and their impact on the Bank’s strategy of pegging the value of the Maltese lira to a basket of currencies. In this regard, the Review recalls that on August 23, 2002, the Monetary Authorities updated the weights of the component currencies of the basket to take into account current trends in Malta’s external trade and likely future developments. Following the review, the weights of the euro, the dollar and sterling were set at 70%, 10% and 20%, respectively.

Throughout the second and third quarters, considerable uncertainty as to the timing and the extent of the global economic recovery prompted major central banks around the world to leave official interest rates unchanged. Thus, the short-term Maltese lira interest rate premium remained relatively stable. Moreover, there were no underlying pressures on the external reserves as, after a drop in April, the Central Bank’s net foreign assets rose during the remainder of the June quarter and through July and August. These developments underpinned the Bank’s decision to maintain rates unchanged.

The Review notes that during the second quarter of 2002 the Maltese economy recovered further, with growth in real Gross Domestic Product accelerating to 2.2%, from 1.2% in the March quarter. According to the Central Bank’s latest forecasts, which are presented in the Review, real GDP is expected to grow by 2.9% this year.

Indicators

Gross fixed capital formation started to pick up again following the sharp drop recorded in 2001, as the slump in certain segments of manufacturing industry, such as electronics, seems to have bottomed out. The decline in overall exports, in fact, was more contained during the quarter, even though the performance of the tourism sector worsened. Consumption expenditure continued to expand, resulting in higher domestic sales by the manufacturing sector and an increase in imports. Labour market activity, nevertheless, remained subdued, with the gainfully occupied population dropping marginally during the two months to May. Meanwhile the unemployment rate fell slightly, to stand at 5.1% at the end of May 2002. Inflationary pressures also abated, with the headline inflation rate falling for the first time in nearly a year to stand at 3.5% in June. The Bank’s latest business perceptions survey, which was carried out between July and August, also indicated that activity levels continued to improve during the second quarter. Respondents did not expect any major change in the economic situation during the second half of the year, though the slowdown in tourism should moderate. However, against the general pattern observed in the past two years, the majority of respondents considered the present time as being appropriate to undertake new investment projects.

Government Finance

Turning to Government finance, the Review observes that during the June quarter the fiscal deficit reached almost Lm47 million, more than twice the shortfall registered in the corresponding quarter of 2001. This expansion in the deficit reflected sluggish revenue growth, whereas expenditure rose in line with projections. At the end of June, gross Government debt stood at Lm1.1 billion, up by Lm3.8 million from the end-March level.

Analysing developments in the external sector, the Review notes that after having improved through most of 2001 and the first quarter of 2002, the balance of payments position worsened slightly during the quarter under review. The current account deficit widened, following a deterioration in the services account, mainly related to weaker tourism activity and higher outlays on freight and professional services. Since net inflows on the capital and financial account did not cover the current account shortfall, official reserves (net of revaluation adjustments) declined slightly, after having risen continuously since the second quarter of 2001.

Foreign Exchange

With regard to exchange rate movements the Review says that during the quarter reviewed the Maltese lira gained ground against the US dollar and, to a lesser extent, the pound sterling, but weakened against the euro. The latter depreciation was reflected in a fall in the nominal and real effective exchange rate indices for the lira, implying a slight gain in Malta’s external competitiveness.

Monetary Sector

Commenting on the monetary sector, the Review notes that broad money expanded again during the second quarter of 2002 as bank deposits owned by households continued to increase. Monetary expansion was fuelled fairly equally by growth in the external assets of the banking system and domestic credit. The rise in domestic credit was entirely driven by net claims on Government, as outstanding credit to the private and parastatal sectors declined. Meanwhile, the persistence of excess liquidity in the banking system forced the Bank to continue absorbing funds through auctions of term deposits. Consequently, pressure on money market rates was minimal, though Treasury bill yields contracted slightly. In the capital market, Government bond yields also lost ground, while the downward trend in equity prices persisted.

During the June quarter, rapid growth in deposits underpinned the expansion registered in the aggregate balance sheet of the deposit money banks. Bank credit contracted, as a number of private sector firms issued bonds on the primary market and used part of the proceeds to reduce their outstanding bank advances. The deposit money banks’ profits before tax rose to Lm7.1 million during the three months to June as a rise in operating expenses was more than offset by higher net interest and non-interest income. Provisioning charges remained substantial, reflecting the adoption of more prudent risk assessment policies. Meanwhile, the aggregate balance sheet of the international banking sector expanded slightly, after having dropped in previous quarters. However, the sector’s profits fell significantly, due to lower net interest income.

(Lm1=US$2.4=EURO 2.4=GBP 1.5)