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Business • February 22 2004

GDP forecast to remain below potential

Malta’s real gross domestic product growth has been forecast to remain below potential despite the brightened international outlook, the Central Bank of Malta forecasts in its quarterly review of last year’s last three months.Underpinning the forecast is the fact that domestic demand is expected to remain weak as fiscal tightening takes hold, with real disposable income not expanding significantly. Moreover, the tax measures announced in the latest Budget are expected to push up inflation, but underlying price pressures are expected to remain contained.

Business expectations
The Bank’s latest Business Perceptions Survey, carried out between October and November, reveals that the downturn in business sentiment persisted, with most respondents expecting the performance of the Maltese economy to worsen rather than improve over ensuing months. In line with data on GDP, many firms reported lower activity levels during the third quarter. Although firms generally did not expect faster growth rates in turnover in the short-term, they did feel that profits could continue to improve as a result of lower payroll costs.
In the latest survey, and for the first time since the last quarter of 2001, the majority of respondents expected the Maltese economy to worsen rather than improve over the coming months. Many firms participating in the survey, particularly those in construction, manufacturing and the distributive trades, reported that their activity levels or order books deteriorated during the third quarter. In terms of their businesses’ short-term outlook, while most respondents did not anticipate faster growth in turnover during the fourth quarter, they expected profits to recover as the drop in selling prices was expected to moderate and lower demand for labour was expected to reduce payroll costs.
Business sentiment deteriorated further during the last quarter of 2003. The proportion of firms expecting the economic situation to deteriorate over the coming six months nearly doubled from the level registered in the previous survey, reaching 45.5 per cent of the sample. Sentiment worsened considerably amongst most of the sampled manufacturing firms, the only exceptions being operators in the chemicals and the printing and publishing subsectors, who remained optimistic. Pessimism, which up to this quarter had been concentrated in manufacturing establishments producing food and beverages and machinery and equipment, also spread to distributive trades, industrial services, tourism and construction. At the same time, optimism amongst real estate and professional services firms declined significantly compared with the previous survey.
The latest survey gave mixed results on the performance of the export-oriented sectors. The number of manufacturing firms reporting above normal order books dropped slightly, while tourism activity improved marginally compared with the previous quarter, although it remained significantly below normal.
Export-oriented manufacturers, meanwhile, reported that turnover growth halved to just 0.8 per cent in the third quarter. This deceleration was mainly felt by the food and beverages and machinery and equipment sub-sectors, while clothing and footwear firms continued to report a drop in sales. On the other hand, the export performance of printing and publishing and chemicals manufacturers improved significantly. In reaction to the slowdown in turnover, the majority of establishments shed workers while average wage costs were maintained virtually unchanged. Nevertheless, profits were still reported to have contracted by 1.8 per cent, as selling prices declined across the board.
On their part, respondents from the tourism industry indicated that profits increased slightly during the third quarter. This improvement in profitability occurred in spite of a small contraction in turnover and a higher wage bill, the latter being the combined result of additional employment and a rise in average salaries. These developments were more than offset by an increase in selling prices.
Replies to the latest survey suggest that domestic demand was weak during the third quarter. Only real estate and finance and insurance firms reported an acceleration in sales, the former reflecting heightened activity in the property market. Operators in the other locally oriented sectors indicated that activity declined during the third quarter.
Manufacturing establishments catering for the domestic market continued to shed labour, while per capita wage costs diminished slightly. As a result, profits improved despite the fact that selling prices declined again during the third quarter. On the other hand, profitability fell in construction and distributive trades, as operators’ payroll costs rose during the quarter, on account of an intake of workers combined with a rise in average wages. Selling prices were also reported to have declined in these sectors by nearly one per cent.
The rise in turnover registered by the real estate and other services sectors contributed significantly towards the growth in their earnings. Respondents said that they were able to increase their selling prices by more than their average wage costs, boosting operating margins. Buoyant market conditions led these firms to employ more workers.
The majority of firms are not anticipating their activity to accelerate significantly in the fourth quarter, in line with their sentiments concerning overall economic performance. Participating tourism-related firms expect sales to drop by over three per cent, while respondents from the construction industry expect virtually unchanged turnover. On the other hand, distributive trade operators and finance and insurance firms predict a slight pick-up in sales compared with the third quarter, while real estate activity is predicted to expand further during the last quarter of 2003. As regards manufacturers, some exporting subsectors, such as clothing and footwear, are forecasting an increase in sales. Yet the major exporters, such as machinery and equipment, and the bulk of locally-oriented establishments expect their turnover to grow at a similar rate as in the third quarter.
Profits are projected to improve nearly in all sectors, particularly in export-oriented manufacturing and industrial services, mainly because selling prices should recover while the wage bill is expected to decline as reduced demand for labour should compensate for a slight acceleration in wage inflation. On the other hand, respondents from tourism and locally-oriented manufacturing are forecasting a deterioration in profitability. With regard to tourism, the expected decline appears to be the result of a projected drop in turnover. The reduction in profits forecast by locally-oriented manufacturers is concentrated in the food and beverages subsector where selling prices are expected to drop - probably in reaction to the removal of levies on imported food in 2004.
To summarise, replies to the latest business perceptions survey imply that employment should continue to decline during the last quarter of 2003, especially in manufacturing and tourism. Overall, turnover is expected to rise at a similar pace as in the third quarter, even though selling prices are set to drop by a lesser margin. These developments, though in part dampened by an expected marginal acceleration in wage inflation, should result in an improvement in profitability in most sectors.

Monetary policy
Monetary policy eased further during the period reviewed. The Bank cut the central intervention rate by twenty-five basis points to three per cent in September and then left it unchanged throughout the fourth quarter. These decisions reflected the Bank’s analysis of economic and financial developments in Malta and abroad, and were consonant with its monetary policy strategy of pegging the Maltese lira to a basket of major currencies. During the third quarter of 2003, the Bank’s external reserves continued to expand with high liquidity persisting in domestic financial markets. Inflation dropped further in the face of weak demand and rising unemployment. Meanwhile lower growth forecasts for the euro area suggested that economic activity in Malta would continue expanding at below its potential rate and that inflationary pressures were not expected to emerge in the near term.
The Bank’s external reserves increased in October, but declined in November and into December reflecting sluggish external demand and a weakening performance in Malta’s export-oriented sectors, particularly tourism. Domestic conditions in the fourth quarter were characterised by low inflation and rising unemployment.

Economic growth
The Review notes that economic growth picked up during the third quarter, with real GDP rising by 1.9 per cent over the corresponding quarter of 2002. The recovery, however, was not broadly based. Domestic demand remained weak, with private and Government consumption expenditure falling in real terms, although investment spending increased further. The external deficit on goods and service widened, as exports dropped while imports rose. Movements in the inventory changes component, which also includes a statistical discrepancy, boosted GDP growth significantly. The Review observes that inflation extended its downward trend, with the year-on-year rate dropping to 0.5 per cent in September, though it picked up in the following month. Meanwhile, the unemployment rate continued to rise over the quarter to stand at 5.5 per cent at the end of September compared with 5.2 per cent a year earlier.
The fiscal stance was less expansionary during the third quarter of 2003, as a considerable drop in expenditure lowered the deficit to less than half that recorded during the previous quarter. The fiscal estimates presented in the Budget for 2004 point to a deficit of 6.3 per cent of GDP in 2003. They also indicate that the deficit will decline further to 5.4 per cent of GDP in 2004, as a result of a package of measures, including an increase in the standard value added tax rate.
The December issue of the Quarterly Review, in its entirety, can be found on the Central Bank’s website at

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