Session I

1. THE MALTESE
AND CYPRIOT ECONOMIES:
WEATHERING THE GLOBAL RECESSION
Lino Briguglio, University of Malta
Andreas Antoniou, Phillips University, Cyprus
Gordon Cordina, University of Malta
Nadia Farrugia, University of Malta
Presentation prepared for the Conference
“Sustaining Development in Small States in a Turbulent Global Economy”
Commonwealth Secretariat, Marlborough House, London
6-7 July 2009
1

2. INTRODUCTION
Given the high degree of vulnerability to external shocks which
characterise small states, one expects that these states, more
than any other country grouping, will be highly adversely
affected by the current turmoil.
However each region has its own specific circumstances which
can not easily be generalised.
As we shall be shown in this presentation, Malta and Cyprus, the
two island states members of the EU, are not likely to be as
heavily impacted as most other EU member states.
2

3. INTRODUCTION
The global financial crisis and resulting recession is expected to
have profound immediate and long term implications for many
small states.
Recent evidence from the IMF’s World Economic Outlook and
UNDESA indicate that the smallest and most vulnerable states
are already experiencing large terms of trade shocks, declining
aid, reduced access to external financing, loss of employment
and increasing difficulty in both maintaining the existing
progress towards their MDG objectives and making further
advances.
3

4. AREAS OF CONCERN FOR SMALL STATES
For most small states, the major areas of concerns are:
• Drop in remittances from the Diaspora, especially in the
Caribbean and Pacific, where they are often the largest or
second largest source of foreign exchange;
• Drop in export commodity prices, as a result of the dramatic
reduction in global demand;
• Protectionist tendencies in European and North American
markets affecting all exports, across the board;
• Drop in tourism revenues;
• Drop in construction activity, especially linked to the tourist
industry and residences bought by expatriates and
foreigners, across the board; 4

5. AREAS OF CONCERN FOR SMALL STATES
• Drop in (the already very low) FDI, especially those linked to
tourism, construction, and commodity exports, across the
board;
• Drop in capital flows due to enhanced political risk, the “flight
to quality”, and the focus on short term end of yield curve,
across the board;
• Drop in (already low) SME lending, due to the sharp
contraction in liquidity and increased risk aversion, even from
indigenous banks who take a very short term view, across the
board;
5

6. AREAS OF CONCERN FOR SMALL STATES
• Increase in youth unemployment and crime and illegal
immigration, with a growing number of Caribbean, Pacific
and Mediterranean countries becoming increasingly
vulnerable to these threats to human security;
• Increase in the levels of public debt;
• Renewed and concerted assault by G8 and G22 on so-called
“Tax Havens”, in a drive by OECD countries to enhance their
fiscal revenues, which affects countries which rely on their
International Financial Services Sectors;
• Regulation “externalities” as a result of calls for enhanced,
costly, national and international regulation and supervision
thus putting additional pressures on already severely
capacity-constrained administrations, across the board; 6

7. THE MALTESE AND CYPRIOT ECONOMIES
Location
Malta and Cyprus are both located in the Mediterranean Sea.
They both acceded to the EU in May 2004 and adopted the Euro
in January 2008.
Cyprus
Malta 7

8. THE MALTESE AND CYPRIOT ECONOMIES
Some Comparative Data
Malta Cyprus
Population ’000 (2009) 413 793
Per Capita GDP in PPS as an % 76.3% 94.6%
of the EU 27 (2008)
GDP (2008) $10 billion $25 billion
Per Capita GDP $ ‘000 (2008) 23 32 (Greek Cypriots)
Territory Size 316 KM2 9,251 KM2
Population Density 1250 per KM2 90 per KM2
Life Expectancy M=77.1 F= 81.6 M=75.0 F=
80.0 8

9. THE MALTESE AND CYPRIOT ECONOMIES
Vulnerable Economies
Like many other small states, Cyprus and Malta are inherently
highly vulnerable to external shocks. This vulnerability stems
from a number of inherent and permanent economic features,
including:
• a high degree of economic openness, which renders the
economy particularly susceptible to economic conditions in
the rest of the world;
• dependence on a narrow range of exports, giving rise to risks
associated with lack of diversification;
• dependence on strategic imports, in particular energy and
industrial supplies, exacerbated by limited import substitution
possibilities.
9

10. THE MALTESE AND CYPRIOT ECONOMIES
Additional Constraints
Small size leads to additional constraints, such as a limited ability
to reap the benefits of economies of scale, high infrastructural,
administrative and other overhead costs, and the prevalence of
natural monopolies and oligoplistic structures, which lead to
high consumer costs.
Small size also creates problems associated with public
administration mostly due to the fact that many government
functions tend to be very expensive per capita when the
population is small, due to the fact that certain expenses are not
divisible in proportion to the number of users.
10

11. THE MALTESE AND CYPRIOT ECONOMIES
Economic Resilience
However, the extent to which the Maltese and the Cypriot
economies can cope with their inherent economic vulnerability
depends on their economic resilience, that is the policy-induced
ability of their economies to withstand or recover from the
effects of adverse shocks and to benefit from positive shocks.
In Malta and Cyprus economic governance is overall of a
relatively high level. EU accession has improved macroeconomic
management and market efficiency.
In addition, the adoption of the Euro in 2008 meant that both
Malta and Cyprus had to adhere to the Maastricht criteria, again
leading to improvements in macroeconomic management and
improved market efficiency . 11

12. MALTA AND THE GLOBAL FINANCIAL CRISIS
Economic Growth
Indicators of economic growth over the past decade show that the
Maltese economy had to grapple with the effects of a global
economic slowdown around the turn of the century and continued
to experience relatively mild growth until 2004, mainly due to an
urgent need for consolidation of its fiscal position with a view of
eventual adoption of the euro currency.
A significant recovery from these external and internal policy
shocks was registered between 2005 and 2007, when real
economic growth averaged around 3.5% per annum. With the
onset of the global recession in 2008, the growth of the Maltese
economy slowed down markedly, evidence of its pronounced
openness. 12

13. MALTA
Sectors most highly hit by the global crisis
The sectors of activity which were immediately hit included
mainly manufacturing oriented towards mass markets, such as
suppliers to the automotive industry and to producers of
electronic goods. Tourism was also very negatively affected.
As a result the Maltese economy has entered in a recession in
2009. A slight recovery in activity is expected by 2010.
13

14. MALTA
Developments in Real Economic Growth
(Source: Eurostat)
14

15. MALTA
Malta’s business cycle
Malta’s business cycle was very much synchronized with that of
the EU15 countries between 2000 and 2008, but business cycle
fluctuations in Malta tended to be three times as pronounced as
those of the EU15 group. This is explainable by Malta’s openness to
trade with these countries, whereby shocks to international
demand would influence its output to a relatively large extent.
According to EU Commission forecasts, this relationship is
expected to be broken in 2009 and 2010, with Malta falling into
recession but to a much moderate extent than the group of EU15
countries. Indeed, EU Commission forecasts indicate that whereas
the EU15 group of countries are expected to experience a drop in
GDP of over 4% in 2009, Malta’s GDP is expected to drop, but by
only 0.9%, in the same year. 15

16. MALTA
Confidence in the financial system
The principal cause of the economic crisis around the world,
namely the collapse of the confidence in the financial system
which led to a freezing of credit lines and to substantial
increases in interest rate risk margins, is largely absent from
Malta. This may be ascribed to a number of factors, including:
• sound banking practices thanks to which Maltese banks did not
enter into risks that were not fully understood
• an almost complete reliance on domestic retail deposits, which
constitute a stable source of financing, rather than the
significantly more volatile wholesale funds
• and strong regulatory framework which is in line with
international best practices
• the introduction of euro, which led the credibility of a global
16
currency to the domestic financial system.

17. MALTA
Expansionary fiscal stance
Another reason for the expected relatively buoyant performance
of aggregate demand in Malta is the continued expansionary fiscal
stance. Malta had one of the highest fiscal deficit to GDP ratios
among EU countries in 2008, amounting to 4.7%. This was
conditioned by two exceptional factors, namely the provision of
subsidies to households on electricity and water services, as well as
redundancy payments to workers upon the closure of the ship-
repair industry. Exceptional as they were, these payments
contributed to sustain aggregate demand in 2008. For 2009, the
Government is implementing a fiscal stimulus package amounting
to 1.6% of GDP, in line with practices in other EU Member States.
This effort will mostly go to capital expenditure, investment in
human capital and a reform of taxation towards promoting energy-
17
efficient transport.

18. MALTA
Longer term dangers of the fiscal stimulus
The fiscal stimulus efforts are at this stage necessary to act as a
buffer against the downturn in external demand. They could
however delay the eventual recovery of the Maltese economy in
line with international developments if the mechanisms for
revenue growth are not sufficient, thereby leaving the fiscal
accounts with a structural deficit, and if expenditure resources
are not deployed productively
18

19. MALTA
Investment and aggregate demand
Aggregate demand in 2009 and 2010 is expected to be
supported by an expansion in investment expenditure. This will
in part reflect public expenditure referred to above, but it will
also result from the expenditure on projects to be financed by
European Union Structural Cohesion and other Funds.
As an Objective 1 country, Malta will be benefiting from funding
amounting to €1.15 billion in the period 2007-2013. This is
equivalent to around 2% of GDP per year.
19

20. MALTA
The resilience of the Maltese economy
The argument regarding the relative resilience of the Maltese
economy in this recessionary period can be explored from a
production perspective. Malta’s vulnerability lies in those
sectors of economic activity which are mostly export-oriented,
while it is less resilient in those sectors which lack
competitiveness. Vulnerable sectors include the tourism sector,
namely transport & communication and hotels & restaurants,
and high-tech manufacturing, namely electrical & optical, which
depend mainly on foreign demand. It is less resilient in those
sectors which lack competitiveness, such as other
manufacturing.
20

21. MALTA
Effects on Employment
Employment is likely to be affected by the recession.
After increasing significantly in 2007, employment growth
increased by just over 1% during 2008, while in 2009 such
growth is expected to be negative. Similar to GDP growth,
employment growth during 2010 is expected to rise marginally.
The defence of jobs is crucial to overcome the downturn and to
minimize the impact on the economy’s living standards.
However, it should be cautioned that short-term and temporary
measures to curtail job losses do not come at the expense of
labour market flexibility, as this would jeopardise the eventual
recovery and result in less potential growth when jobs recover in
the medium term. 21

22. CYPRUS
Benefits of EU accession
Like Malta, Cyprus has benefited from its accession to the EU
and the adoption of the Euro via, inter alia, the implementation
of structural reforms.
The adoption of the Euro as from January 2008, has protected
the Cypriot economy from the severe implications of the current
financial crisis.
22

23. CYRPUS
Relatively good performance
In Q4 of 2008, the real (seasonally adjusted) GDP growth rate in
Cyprus was nearly 3 per cent, the highest in the Eurozone, while
for the entire year the rate was 3.7 per cent, the third highest in
the Eurozone. [1],
This growth was achieved in conditions of near full employment,
with unemployment rate for the same year 3.7 per cent, while
employment grew at 2.8 per cent and inflation has kept under 2
per cent.
[1] See for more details, see Cyprus Ministry of Finance, Cyprus, a well managed and resilient
Euro member: Investors’ Presentation. May 2009; see also, Η Κυπριακή Οικονομία-
Ανασκόπηση και Προοπτικές. Παρουσίαση, Υπουργός Οικονομικών, 3ο Συνέδριο Οικονομίας
23
ΟΕΒ, 26. 3. 2009, http://www.mof.gov.cy.

24. CYRPUS
Resilient Economy
In 2009, despite an unavoidable deceleration in its rate of
growth, resulting from the particularly adverse external
environment, the economy is coping relatively well. Overall the
financial sector remains sound, with a strong liquidity position
and a comfortable capital adequacy as well as sufficient
profitability. Indeed, in Q1 of 2009, GDP grew at an impressive
(under the circumstances) 1.6 per cent, the only economy in the
EU27 to have a positive growth, while for 2009, it is now
expected to grow at around 1 per cent. This, although positive, is
well below the one anticipated at the end of 2008, namely 2.9
per cent. It is also worth noting that this positive growth rate is
expected to be achieved again under conditions of near full
employment and price stability. 24

25. CYRPUS
Public finances
The public finances will inevitably show deterioration this year,
being negatively affected by the slowdown of the economy, as
well as the changed composition of growth.
A deficit of around 2-2.5% of GDP is expected. In this respect, it
is worth observing that the fiscal policy will remain prudent.
Indicative of the sound fundamentals of the Cypriot economy,
has been the response of European investors to the
government’s recent Euro bond EUR billion 1.5 issue which was
oversubscribed by over 450%, at a relatively favourable cost
(3.75 per cent).
25

26. CYRPUS
Mild repercussions
Given these relatively mild repercussions of the current GFC on
the Cyprus economy the policy response by the Government and
the Central Bank, have been, muted, cautious and targeted. In
the heals of an already modestly expansionary 2009-10 budget,
the response to the crisis followed a two-prone approach, a
macroeconomic stimulus accompanied by a number of targeted
measures, aiming at a positive impact on GDP 2009, of around
1.5 per cent
26

27. CYPRUS
Policy responses
More specifically, an additional fiscal stimulus package of EUR
million 470 was announced to be implemented in two packages,
the first in December 2008 and the second, in February 09. The
stimulus focused on four strategic sectors: infrastructure
projects/employment, tourism, construction and banking and
financial sector, and was accompanied by a series of other policy
initiatives aimed at accelerating and facilitating budget
implementation.
27

28. CYRPUS
Investment and fiscal stimulus
In particular, EUR million 207 were earmarked for infrastructure
projects and pro-employment policies, EUR million 63 for the
tourism sector and EUR million 200 for the construction and
housing sector. In addition, with a trusted and well regulated
banking and financial system and a robust banking sector, the
initiatives regarding the financial sector focused on a series of
major liquidity injections through the issue of government
bonds, EUR million 315, temporary deposits of government
liquidity in the banking sector, EUR million 700, the extensive
use of guarantees to facilitate access to low-interest sources of
finance by the banks, the injection of some EUR million 300
earmarked for low-interest loans to SMEs, and moral suasion for
the reduction of interest rates, which nevertheless remain
unusually high. 28

29. CYRPUS
Other policy initiatives
Other policy initiatives included, the acceleration/simplification
of public tender procedures, the continued implementation of
the structural reforms under the EU’s National Reform
Programme, but also the on ongoing modernisation of the public
sector with a view to reducing wage-related expenditures and
raising total productivity, the enhancement of public debt and
cash management systems, further improvement in tax
collection, and the continued close monitoring of the liquidity
and capital adequacy of the three major banking groups.
29

30. CYRPUS
Credit rating
It is therefore not surprising to note that despite the global
financial crisis, Cyprus is still rated in the double A category by
two of the three major rating agencies, Moody’s and Fitch, and
A+/Stable by Standard and Poor.
30

31. CONCLUSIONS
Why Cyprus and Malta have been “spared”
The current global crisis is and will be presenting
difficulties to the Maltese and Cypriot economies, but the
effects are not as dramatic as is the case in the USA and the UK.
These effects have been relatively subdued due to:
• the soundness of the financial system
• the provision of fiscal stimuli
• investment projects expected in the short term
• a reduction in inflation
• resilience in the productive sectors of the economy
31

32. CONCLUSIONS
Short-run and long-run solutions
In order to improve the resilience of the Maltese and the
Cypriot economies and thus reduce the negative impacts of the
global recession, focus needs to be placed on timely and
targeted solutions in the short-term.
But in the medium and long term, these small states need to
focus on more specific niche markets, which would be less
susceptible to fluctuations in foreign demand.
32

33. CONCLUSIONS
Supply side policies
It is important that these small states focus on supply-side
policies to render their economies more competitive and
consequently more resilient.
Indeed, it may argued that in the case of small economies,
where market failure is more prevalent and the supply side is
burdened with additional constraints, the use of supply-side
policies is even more important than in larger countries.
Such policies should be aimed at improving the proper
functioning of markets and overcome the additional costs which
such countries face due to their inability to reap scale
economies and their lack of economic diversification. 33

34. CONCLUSIONS
Small states will remain vulnerable, but they can do something
about it
It is important to note that the relative good performance that
the Maltese and Cypriot economies may be enjoying at present,
relative to other larger economies, does not negate their
economic vulnerability. They will remain very open to external
shocks and highly dependent on strategic imports.
However, the resilience elements that these economies have
developed over the years, including the strength and stability of
the financial system, and the growth in investment in new
economy services, are assisting them to better weather these
difficult times.
34