Possessing few indigenous raw materials and a very small domestic market, Malta has based its economic development on the promotion of tourism, accounting for roughly 30% of GDP, and exports of manufactured goods, mainly semi-conductors, which account for some 75% of total Maltese exports. Since the beginning of the 1990s, expansion in these activities has been the principal engine for strong growth in the Maltese economy.

Tourist arrivals and foreign exchange earnings derived from tourism have steadily increased since the late 1970s. Following the September 11 attacks, the tourist industry has suffered some setbacks worldwide. Maltese tourist arrivals fell by a cumulative 7% during 2001 and 2002. At the same time, the bursting of the high tech bubble dampened exports and private investments.

Despite these adverse developments, the relatively flexible labor markets kept unemployment fairly steady at 7.2 (Labor Force Survey Jan – March 2004) Following a decline in GDP in 2001, a modest recovery began in 2002, with some improvements in the tourist sector in the second half of the year. Employment growth, however, remained weak.

The recent low economic growth coupled with corporate bond preference by the private sector has contributed to a weak demand for bank loans. Combined with the strong growth in deposits in the past couple of years, this has led to a rapid buildup of liquidity in the banking system and pressures to reduce interest rates that are fully liberalized. The banking system remains highly concentrated with two of the four local banks accounting for about 90% of total loans and deposits.

The Maltese Government has pursued a policy of gradual economic liberalization, taking some steps to shift the emphasis in trade and financial policies from reliance on direct government intervention and control to policy regimes that allow a greater role for market mechanisms. Malta’s accession into the EU will mark the total dismantling of protective import levies on industrial products, increasing the outward orientation of the economy. Malta maintains a long-standing exchange rate peg to a basket of currencies – currently composed of the euro, pound sterling and dollar. The peg has delivered low inflation and served Malta well, especially during the period of liberalization.

The fiscal situation remains difficult despite some progress in consolidating public finances. The budget deficit was brought down from 10.7% of GDP in 1998 to 9.7% of GDP in 2003 (still high by EU standards), mainly through increases in tax rates and improved collection of taxes due. Current expenditures were reduced in the late 1990s but have crawled back up. The public sector wage bill and subsidies to public enterprises were mainly responsible for this increase. Substantial privatization proceeds have limited the increase in public debt, which grew from 24% of GDP in 1990 to almost 72.01% in 2003.

The Maltese Government is expected to shortly announce reforms to the pension and welfare system and reduce the public sector involvement in the economy as part of the medium- term fiscal consolidation plan. According to the Maltese government plans, the fiscal deficit is expected to go down to 3.5% of GDP by the end of 2005. Economic growth was 1.6% in 2003.