INTERVIEW | Mario Vella: Adoption of Euro critical to Malta’s economic success

You were appointed Governor of the Central Bank of Malta after years in politics and at Malta Enterprise. How do you think your background helps you in your role today?

The aim of the Bank, at the end of the day, is to ensure financial and price stability and to implement monetary policy. These aims are meant to be of benefit to the real economy. The fact that I worked for over 30 years in the real economy – with special attention to foreign direct investment, which has been my main focus – means that I bring to the Bank quite a wealth of experience.

My academic experience in economics and development sociology is also a very valuable component of my ‘baggage’ as I strongly believe that central banks ought to care for the social impact of monetary policy.

Sometimes central banks are accused of not bothering with the real economy, but this is not the case here.

Speaking of your role, what are the main duties of the Central Bank’s governor?

Simply put, my role is to make sure the Bank works and does what it is meant to do. Financial stability requires the Bank to ensure that the financial system works, continues to work and is stable.

This might sound terse, but mine is not, and shouldn’t be, a sensational job.

My role within the  Bank and ECB is a statutory one, emerging from and clearly defined within the relevant laws.

I should note that there is a distinction here between our role and that of the Malta Financial Services Authority (MFSA). The MFSA is a regulator, and it supervises each of the banks and other related institutions. The Bank isn’t involved in that, and instead focuses on the whole system. You could say that the MFSA looks at the trees, while we look at the woods.

There is, however, an institutional connection between the MFSA and Bank, through a body called the Joint Financial Stability Board (JFSB), which I chair, with the MFSA attending all board meetings.

The Bank’s role within the JFSB is to ensure that there is a seamless connection between what the MFSA does and what the Bank does.

For the past few years, Malta registered a surplus in its public finances. How sustainable is such a result, and is the country putting all of its efforts into one or two major industries, namely iGaming and financial services?

GDP annual growth started from a low base, making the fast rate of growth at the beginning of this phase even more impressive. And the growth is also high by EU standards.

Arithmetically, if a value increases, then every further increase takes a bigger effort than when it started out. There is empirical evidence for this. Therefore, we expect a stabilisation of Malta’s economic growth in the coming years. All things being equal, we will still remain in the upper ranges of growth in Europe, however.

Another point to make is that Malta is a very complex country, economically speaking, with an extremely diversified economy compared to other EU countries.

Malta’s economy is more than iGaming and more than most of the other sectors which are most commonly spoken about and which are easier to sensationalise.

We sometimes forget that the backbone of the economy consists of the productive sectors, including industry and industrial services, which have been strengthening for over half a century. And it’s a good thing that this is so, because Malta has not put all of its eggs in one basket.

On average, our more important production establishments are around 50 years old. All the big industrial names in Malta have been here for a long time, although they might have changed their name over the years because global take-overs, mergers and acquisitions mean that country subsidiaries also change their name.

It is interesting that they have remained here for so long, because it raises the question of what kept them here. One should remember that, in a productive economy, corporate taxation is a factor – but not the only one. Clearly, something keeps these companies here which goes well beyond the taxation incentive.

The fact that the country always kept this strong industrial export backbone has kept us safe, and it is extremely important that we retain this. My feeling is that there is consensus that this backbone has to remain in place, and must be taken care of. At the end of the day, it’s a question of competitiveness and of safeguarding our productivity, which is easier said than done.

The important points here are firstly that GDP growth will plateau but still remain in the upper ranges, and secondly that Malta has a diversified economy which has to remain so. In addition, we need to stay productive.

In my view, the surplus is sustainable if we do the right thing. There is enough evidence to show that the surplus is structural and not contingent on one-offs. The passport scheme comes and goes, but there are other things which Malta’s economy does, and here diversification is critical.

Does this mean that the future looks all rosy?

Most countries have a problem with unemployment. Malta’s problem is the opposite of that – and it’s not any less of a problem.
We are concerned with the issue of labour shortages from a number of points of view.

One is that, if the country encounters a labour shortage, it has to do its best to raise the skill levels of the Maltese, and to attract more labour.

There will be a period – and this is where the country finds itself at the moment – that labour will come of its own accord, but this cannot last forever. The closer you come to the margins, the less automatic will be the inflow of foreign labour. So, we’ll need to make sure that we make it worthwhile for people to come to Malta and for them to stay long enough.

An issue which has been in the news, but rather superficially, relates to the fact that workers who come to Malta need not only a job, but also a place to live. This brings up the issue of rent.

The problem is not only – and not primarily – that the demand for rented premises is bound to have some effect on the price of rents, but that this causes an issue of financial stability. This is why the Bank is constantly measuring the effects on the fundamentals of the economy.

If foreign workers cannot afford rents – not the mention the impact this has on the Maltese – then we would constrict the rate of people coming to Malta. At the end of the day, workers want to live somewhere they can afford and that they like.

But if rents increase beyond a certain level, a worker will think twice before coming in the first place, and if they do come, they’ll stay for a shorter term.

It is in companies’ interests that workers learn the specifics of the job as fast as possible, which is a cost to the employer.

And it is not in their interest that the worker leaves after too a short period. One of the most important things encouraging workers to stay is that they have an affordable place to live and that they feel good in.

The banks have been hit with criticism, including from the Prime Minister, regarding their reluctance or refusal to open bank accounts and offer services to foreigners and foreign companies working within the ICT industry in Malta. What can the country do?

From the outset, I must point out that part of the Bank’s role is to monitor the liquidity of banks and their ability to handle any downside risks resulting from the impact of trade and finance on the real economy. The Bank does not regulate the banking sector – this is the MFSA’s role – and each bank sets its own risk appetite in the context of the compliance issues it faces.

Furthermore, the MFSA as regulator has already taken action on this through an awareness campaign on measures relating to the right to a basic account, which was already enshrined in banking legislation.

That said, it is true that banks are often criticised for being over-prudent, which isn’t necessarily a bad thing – up to a point – because it leads to caution when lending and it is what got them through the global financial crisis unscathed. In fact, Malta’s rates of non-performing loans have not only not increased, but have actually decreased.

Does it mean that the banks couldn’t be more creative? Of course they can. But in this particular case, it is good that banks do not place themselves at risk. And, I should note, they are managing to do this while remaining profitable.

Can we blame the banks for deciding not to open accounts? No. Let’s not be provincial and let’s look at the rest of Europe and the world.

Banks are increasingly open to issues of money laundering. We cannot urge them to be more careful and to undertake ‘know your client’ (KYC) investigations and at the same time expect them to keep doing their business as usual. The world is going through a difficult patch and it won’t be over tomorrow. We can’t blame them for being prudent enough.

When people are waiting for a bank’s decision as to whether it will open a bank account for them, it means the bank is doing its homework. Nowadays it’s not even only a matter of know your client, but know your client’s client.

The issue of correspondent banking is very closely related to this. And there is no magic solution to the issue.

The banks are quite a captive market locally, with a handful of main deposit banks. So, we need to continue encouraging banks to invest more in KYC, but reminding them that they also have to continue adhering to their social responsibilities.

With the ECB in place, does the Bank retain its autonomy or is it a mere rubber stamp for its European-level counterpart? Why do we still need national central banks?

The Bank is one of 19 banks of the euro area, which has a common monetary policy. But this policy was designed by all the EU19, and the rules give one country one vote on all matters. That may look like a cumbersome process, but there’s no alternative to it.

It is true that upon Malta’s accession to the EU and after the adoption of the euro, the Bank lost some of the autonomy it enjoyed in the past.

This is because, as a member of the Eurosystem, in key domains such as monetary policy it is subject to the decisions taken by the Governing Council of the European Central Bank.

One could also argue, however, that the Central Bank of Malta’s autonomy in the monetary policy sphere was limited in any case since the conduct of monetary policy was based upon a pegged exchange rate, which implied that the Bank always had to take into account the monetary policy stance of those countries whose currency was included in the Maltese Lira peg, which was predominantly the euro area.

Although adoption of the euro implied relinquishing a degree of autonomy, from a national perspective it allowed Malta to benefit from membership in a powerful single currency area. One could say that the euro adoption was a critical factor behind the recent successes enjoyed by the Maltese economy, especially the growth of the services industry.

Moreover, I think the ECB essentially saved the euro since the 2007/2008 financial crisis. The slogan coined by Draghi – “We’ll do whatever it takes” – has really meant doing all that it takes. Not all countries jumped for joy at this, and some governments had strong reactions to the ECB’s policies. But the ECB stood its ground, and we should be thankful for this.

This said, everything isn’t all smooth when it comes to monetary policy. There were moments when some said the ECB was encouraging populism through its policies. I think nobody takes these claims seriously any more, but there does exist such a thing as populism.

Regarding the second and third parts of your question, the Bank, as with other national central banks of the euro area, is not a mere rubber stamp. On the contrary, it participates fully in the decision-making process of the ECB. In particular, the Bank’s Governor is a member of the Governing Council of the ECB, with full voting rights according to its Statute.

National central banks play a key role in the formulation of monetary policy in the euro area. In this context, they bring valuable knowledge of their own economies and financial systems to bear. Moreover, the implementation of monetary policy is decentralised, meaning that the Central Bank of Malta is responsible for carrying out all monetary policy operations in Malta.

This includes the operation of standing deposit and lending facilities for Maltese banks, regular open market operations and asset purchases.
The Bank also plays an important role in managing part of the ECB’s foreign reserves, in running and overseeing payment systems, in issuing euro banknotes and coins to the public and in safeguarding financial stability.

In some respects, national central banks’ independence is better protected inside the European System of Central Banks (ESCB) – which consists of the ECB and the national central banks of the member states – than outside. This follows from an explicit prohibition in the law against external interference in day-to-day decisions and operations and the monetary financing prohibition.

National central banks carry out tasks other than those pertaining to the ECB, as long as there is no conflict between them. For example, national central banks may act as lender of last resort to banks in need of emergency liquidity.

The Bank recently set up a social research unit and has also completed an agreement with Queen Mary University of London (QMUL) on an academic visitors’ programme. How important is research for the Bank?

The Bank engages on a regular basis with both Maltese and foreign scholars. It has a well-established internship programme which is open to both Maltese and foreign students. We hosted PhD students from Belgian, Italian and UK universities in recent years. The agreement with QMUL is meant to further this interaction with foreign scholars and in this way ensure that our staff remain abreast of the latest academic developments in economics and financial analysis.

The agreement recently signed with QMUL is just one of a number of initiatives. For instance, in September we will be organising two short courses on monetary policy and macroeconomics with the University of Nottingham, which will be attended by central bankers from the EU, the Middle East and Africa.

Earlier this year we hosted a US Professor from the University of San Diego who visited as a Fulbright scholar to help develop our understanding of the behaviour of house prices.

We also have a technical cooperation agreement with the Bank of Italy, which is enabling us to enhance our macroeconometric models.
The Bank also organises a comprehensive range of lectures and conferences on topics which are not always directly related to the Bank and its sphere of operations but also to literature, heritage and culture, for example. A full list is available in the annual report.

Research is essential for a central bank. If you look at the Bank’s track record for the last three years, it is evident that the social research unit – which was set up recently – represents just a fraction of the Bank’s research, but it is also an innovation. Central banks need to be able to assess the social impact of monetary policy and of measures put in place to stabilise the financial system.

It is therefore important that a central bank has the necessary competences to assess the impact of policy which goes beyond economics and into the social sciences.

Operating without research is akin to driving a car at night without the headlights on.

The Bank has just set up the Central Bank of Malta Foundation. In the Bank’s official statement, it said the Foundation would be “administering funds intended to support projects of a national stature with lasting visibility”. Why did the Bank feel the need to set up its own foundation when there are already numerous others doing stellar work?

The aim is clearly to align the Foundation with particular sectors in which the Bank has already been active for many years, such as education, culture, scientific research, preservation of Maltese national heritage and social causes.

All that has happened is that it has now been put on a formal basis as foundation under the relevant law. The Foundation is basically doing what the Bank has been doing for a long time. The setting up of the Foundation is to ensure there is more transparency and accountability in the way the Bank funds certain initiatives.

The Foundation has an autonomous board, chaired by art historian Fr Marius Zerafa.

Malta is blessed to have such a strong corporate social responsibility presence but there are undoubtedly areas where the Bank can and will make a contribution.

By way of an example of initiatives the Bank supports, the Malta Philharmonic Orchestra (MPO) comes to mind as one of the most important causes.

Rita Schembri, Head of the Central Bank's Economic Analysis Department

How important is iGaming for Malta’s economy, and is the surplus the country has been achieving for the past years sustainable in the long-term?

The gaming and financial services sector are garnering a lot of attention lately. Gaming has indeed been an important driver of growth in Malta, but the most important contributions to our economy are not coming from gaming.

If you consider the contribution to nominal GDP from the various economic sectors, in the last five years gaming has indeed been a strong source of growth, but the sector of professional, scientific and technical activities has also grown significantly. This includes activities like advertising, legal consultancies, scientific research and development and veterinary services.

One of the reasons such professional services are growing is because they are essential in order to support the gaming and financial services sector – one can’t exist without the other. Therefore, there is a much greater multiplier effect from the gaming and financial services sector than some might realise. Moreover, all the other sectors had positive contributions throughout the past few years, so the growth was quite broad across the economy’s sectors.

When it comes to growth by the size of firms, the Bank’s chief economist concludes that a lot of the gap between Malta’s growth rate and that seen in the EU is actually driven by growth in SMEs. This makes the growth model more resilient to external shocks, because the country relies less on a few key players, and more on smaller enterprises.

In terms of Gross Value Added, the nominal data we have shows that, in 2018, the wholesale and retail sector contributed the greatest share in total Gross Value Added, at 21% This is followed by public administration and defence, at 16.8%. Arts and entertainment, which includes the gaming sector, actually came in third in terms of share of GVA, with 15%.

Our economy is therefore very diversified, and sectors which are relatively new are certainly not the only drivers of growth.

Regarding the sustainability of the surplus, you have to keep in mind that fiscal sustainability has different dimensions, and we should not only look at the fiscal balance – the surplus – but also at the debt.

The surplus is affected by many things, including the cyclical position of the economy. When the economy is doing well, you expect there to be a surplus. But the Bank and other institutions adjust the official figure to factor in the effect of the cycle and thus obtain the structural balance.

The structural balance has been in surplus since 2016, which is a good sign. It is also close to the headline or official balance, suggesting that most of our surplus is not affected by the cycle and by one-off outliers.

According to our projections we expect the structural balance to remain in surplus till 2021, and the government had committed to keep a surplus net of revenue from the Individual Investor Program (IIP).

Of course, in 2017 and 2018 we had quite a large surplus, partly due to the buoyancy in the economy which boosts revenue, and partly due to the IIP flow.

The expectation is that the surplus will decrease in the coming year, but it will be maintained and Malta will continue to be one of the best performers in the EU.

The Bank also publishes a debt sustainability assessment. The 2018 Annual Report’s conclusion was that the risks were low in this area, especially if the government adhered to its commitment of maintaining a structural surplus net of IIP. Malta’s debt is already low compared to other countries, but it will fall further.

If after 2021 the government returns to a deficit, the debt ratio will start rising, but it won’t be at an alarming pace.

Risks here include an ageing population and Malta’s relatively high share of government guarantees.