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

CENTRAL BANK QUARTERLY REVIEW (Sept. 2003)
Issue Date: 10th November 2003

The Central Bank of Malta has just published the September issue of its Quarterly Review. The Review analyses economic and financial developments in Malta and abroad during the second quarter of 2003 and presents a revised outlook for the Maltese economy during 2003 as a whole. It also includes the results of the Bank’s latest business perceptions survey and two articles, one analysing employment and labour input trends in the Maltese economy during the twelve years to 2002 and the other describing forthcoming changes in the compilation of monetary and banking statistics.

During the second quarter of 2003 the Central Bank lowered its central intervention rate by twenty-five basis points twice, in May and in June, bringing it down to 3.25%. In September the Bank made a further cut to 3%. These decisions, the Review explains, reflected the Bank’s assessment of economic and financial developments in Malta and abroad and were consonant with its monetary policy strategy, which is based on pegging the Maltese lira to a currency basket. In fact, during the second quarter, the premium on the Maltese lira widened as interest rates abroad were cut further in response to the continued weakness in the international economic environment. The ending of uncertainty over Malta’s relations with the European Union and the economic policy disciplines implied by membership, moreover, added to the credibility of the peg, which was also underpinned by a further rise in the Bank’s external reserves. At the same time, expectations that inflationary pressures were unlikely to emerge in the near term and that the economy would continue to expand at below its potential rate were seen as justifying an easing of the monetary policy stance. Similar considerations motivated the interest rate cut in September, as the external reserves expanded further, liquidity in domestic financial markets remained high and inflation continued to decline. The economy continued to be characterised by weak demand and rising unemployment, while short-term prospects were clouded by lower growth forecasts for the euro area.

The Review notes that the Maltese economy grew moderately during the second quarter of the year, with real GDP rising by just 0.9% compared with the corresponding quarter of 2002. Domestic demand decelerated, with Government consumption expenditure slowing down considerably and private consumption falling, while underlying investment grew less rapidly than in the first quarter. A large, negative inventory investment figure, which includes a statistical discrepancy, also dampened GDP growth significantly. In contrast, exports of goods and services recovered after the previous quarter’s contraction, with both earnings from tourism and manufacturing exports expanding at a faster pace than in the same quarter of 2002.

Developments on the fiscal side show that the deficit narrowed slightly, as a pick up in revenue offset a further growth in expenditure. The Review observes, however, that the fiscal stance remained strongly expansionary during the quarter, and that the deficit widened again in July.

Turning to the balance of payments, the Review notes that the current account swung into deficit during the second quarter of 2003, from the surplus registered during the corresponding quarter of 2002. This was mainly attributable to a widening of the merchandise trade gap that reflected an exceptional rise in exports in the June quarter last year. At the same time, net inflows on the capital and financial account picked up compared with the previous quarter but slowed down relative to the same quarter last year. The official reserves expanded for the fourth consecutive quarter.

The appreciation of the euro in international foreign exchange markets persisted through most of the second quarter but began to be reversed in late June. As a result, the Maltese lira continued to weaken against the euro and to appreciate against the US dollar, the pound sterling and the Japanese yen until mid-June. This trend was reversed during the following two months, when the lira appreciated against the euro and lost ground against the dollar and the yen.

With regard to monetary developments, the Review observes that following a slowdown in the previous two quarters, growth in broad money accelerated during the quarter reviewed, driven by a continued gradual pick up in domestic credit, mainly to the Government. The net foreign assets of the banking system also grew, but at a more moderate pace than in the previous quarters, reflecting the deterioration in the current account of the balance of payments and a deceleration in non-bank capital inflows.

The replies to the Bank’s latest business perceptions survey, which was carried out between July and August, showed that after the surge in optimism that had followed the referendum and election results, business sentiment had returned to its previous, relatively cautious mood. Furthermore, in subsequent months, the number of those registering as unemployed continued to rise, while the year-on-year inflation rate turned negative, suggesting that economic activity remained subdued even during the third quarter.

Meanwhile, in the light of new information concerning both the external environment and domestic developments, the Bank revised its outlook for the Maltese economy during 2003. Its forecast for real GDP growth has now been cut to a range of 1% - 1.3%, from the previous range of 3.1% - 3.7% published in its Annual Report in April. This revision was prompted by a deterioration in growth prospects for the semiconductor industry, the continued drop in inventories and the worsening in the external balance. Growth in 2003 is expected to be driven by domestic demand. Government consumption is forecast to rise, while investment growth is expected to accelerate, mainly underpinned by higher Government expenditure on capital projects. By contrast, external demand is expected to remain weak, with exports projected to grow only marginally, but imports are expected to rise more strongly, fuelled by public spending. As a result, the deficit on the external goods and services account is expected to widen to between 6.5% and 6.7% of GDP. Slow economic growth is also expected to push up the unemployment rate, albeit by less than had originally been anticipated. The twelve-month moving average inflation rate is projected to end the year in the 1.4% to 1.6% range.