12/04/2016

The Central Bank of Malta’s Annual Report 2015

The Central Bank of Malta has just released its Annual Report for 2015. The Report reviews the Bank's policies and operations during the year and includes detailed financial statements. An opening statement by the Governor is followed by an analysis of economic and financial developments in Malta and abroad. The Report also carries articles on the Bank's macro-econometric model, the diversification of the Maltese economy and the impact of structural reforms. These reforms include measures that promote women's participation and enhance labour market flexibility, generating improvements in productivity.

In his statement, the Governor noted that global economic activity remained subdued during 2015. While the euro area economy continued to recover, growth in emerging markets and developing economies decelerated. Global developments were influenced by the slowdown of the Chinese economy, declining commodity prices and the incipient normalisation of US monetary policy, which contrasted with the continued easing by several other major central banks, including the European Central Bank (ECB). This monetary policy divergence contributed to the depreciation of the euro vis-à-vis the US dollar.

The depreciation of the euro, along with lower oil prices and the accommodative stance of monetary policy supported the euro area economy. In fact, real gross domestic product (GDP) in the euro area grew by 1.6% in 2015, compared to 0.9% in 2014. The ECB is projecting the euro area economy to grow by 1.4% in 2016 and 1.7% in 2017.

Inflation in the euro area remained close to zero during the year, and dipped into negative territory on several occasions. However, the ECB demonstrated its determination and readiness to deliver on its inflation mandate. In March, the ECB introduced a Public Sector Purchase Programme (PSPP) adding purchases of public sector bonds to its existing asset purchase programme. In December, it then expanded the duration and scope of the programme and also reduced the deposit facility rate to -0.30%.

Additional monetary policy measures were announced in March 2016, when the Governing Council lowered the deposit facility rate to -0.40%. The main refinancing operations rate and the marginal lending facility rate were both reduced by 5 basis points, to 0.00% and 0.25%, respectively. Additionally, the monthly purchases under the asset purchase programme were augmented from €60 billion to €80 billion, and will include investment grade euro-denominated bonds issued by non-bank corporations established in the euro area. A new series of four targeted longer-term refinancing operations with a maturity of four years will also be launched, starting in June 2016.

Although it is premature to assess the effectiveness of these measures, credit to the euro area private sector has improved, partly reflecting lower funding costs for business. The PSPP has also helped to lower risk-free yields. At the same time, ongoing adjustments in banks' balance sheets and high non-performing loans in some countries continue to hamper loan growth.

Despite the unstable external environment, the Maltese economy showed remarkable resilience. Real GDP grew by 6.3% in 2015, exceeding the euro area average by a wide margin. Domestic demand was the main driver behind this growth, primarily through higher consumption and private investment. The Bank's projections point to an increase in real GDP of approximately 5% and 4.2% during 2016 and 2017 respectively, on the back of strong domestic demand.

The strong pace of economic expansion was reflected in the labour market. Employment continued to increase, with data from the Labour Force Survey pointing to a 2.0% rise in employment during the first nine months of 2015. Employment & Training Corporation data on the gainfully occupied population also show a further increase in full-time employment during the first eight months of the year. Unemployment continued its downward trend, with the unemployment rate reaching a historical low. The decline in the unemployment rate occurred despite an increase in the labour supply, which was partly supported by an inflow of foreign workers and measures aimed at increasing labour market participation. A recent Bank study shows that the proportion of foreign workers rose to 10.1% of the total workforce in 2014. The Governor notes that a higher participation rate is supporting the sustainability of pensions, and population aging remains a matter that deserves continued attention.

Turning to price developments, the average rate of inflation in Malta based on the Harmonised Index of Consumer Prices (HICP) rose to 1.2% in 2015, from 0.8% in 2014. The acceleration was mainly attributable to developments in prices of unprocessed food. Although price pressures in Malta were rather muted compared with historical trends, the annual inflation rate remained above that of the euro area but closer to the ECB target for inflation at below but close to 2%. The annual rate of inflation is expected to remain unchanged at 1.2% in 2016, before increasing to 1.8% in 2017.

As regards fiscal developments, the Bank estimates that the general government deficit declined to 1.6% of GDP in 2015, while the government debt ratio fell to 63.6%. Both are expected to narrow further in the coming two years. Given the favourable economic environment, this is an appropriate time for the introduction of fiscal buffers that would cater, if required, for future budgetary adjustment without breaching fiscal rules.

Turning to the Maltese banking sector, the Governor noted that Maltese banks follow a prudent business model, and remain well capitalized, with the capital adequacy ratio significantly above the regulatory minimum. Moreover, their liquidity is ample and their portfolios are well diversified. In addition, recourse to interbank and Eurosystem funding remained modest. In terms of bank soundness, Malta ranked among the top fifteen countries, according to the World Economic Forum. In fact, Malta compares relatively well with European counterparts in terms of various soundness indicators.

To further enhance resilience, in the beginning of 2016 the Maltese authorities introduced two macro-prudential capital buffers - the counter-cyclical capital buffer, and a buffer applied to Systemically Important Institutions, the latter to be phased in over a four-year period.

On the asset side, the loan portfolio remained the main component for the core domestic banks, notwithstanding slower loan growth during the year. The low interest rate environment continued to pose a challenge for the profitability of banks across the EU. Nevertheless, the return on assets and return on equity of the banking sector in Malta stood at 0.8% and 5.7% respectively. The return on assets for the core domestic banks was 0.7%, with the return on equity standing at 9.9%.

The Governor highlighted that competition within the banking sector has important policy implications. In particular, lending rates to SMEs remain higher than in other euro area countries and have not benefitted from a desirable level of pass through from monetary policy induced interest rate reductions. A recent report by the Malta Competition and Consumer Affairs Authority makes various recommendations on issues related to price transparency, barriers to expansion and consumer mobility, while the Bank is also participating in discussions with the core domestic banks to improve the situation. In addition, the Bank will be launching and operating a national Central Credit Register as an effective remedy for information asymmetries among lenders and between borrowers and lenders.

Turning to the Bank's operations, as a member of the Eurosystem, through the Governor's participation in the Governing Council of the ECB, and also through the contribution of staff members in various ESCB Committees, the Bank provides input into the formulation of monetary policy in the euro area. The Bank is also responsible for the implementation in Malta of the single monetary policy as determined by the Governing Council. In implementing the PSPP in Malta, during 2015 the Bank set up a dedicated portfolio of Maltese government debt securities while ensuring that reserves are being accumulated to provide a buffer against the risk related to these holdings. Since March 2015, total purchases of Malta Government securities under the PSPP reached a book value amount of €417.0 million.

In the light of a low yield environment, the Bank adopted a financial strategy that mitigates reinvestment risk, while expanding further its investment assets. Despite lower interest income, operating profit before transfers to provisions and reserves increased over 2014, reaching €75.0 million. In view of the larger investment assets portfolio, and in the context of the continuing uncertainty in financial markets, the Bank augmented its provisions by €16.1 million, and also transferred €8.9 million to reserves. The Bank passed on the amount of €50.0 million to the Government of Malta.

The Annual Report 2015 is available on the Central Bank of Malta's website at www.centralbankmalta.org

Governor's presentation at the launch of the Annual Report 2015.

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