## Closing Malta’s Infrastructure Gap (cr1820)

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**Canonical URL:** [Closing Malta’s Infrastructure Gap (cr1820)](https://www.imf.org/-/media/files/publications/cr/2018/cr1820.pdf)

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---

### Introduction and main findings
- Malta’s public infrastructure has been strained by rapid economic growth and rising immigration.
- The public capital stock is estimated as comparatively small and declining.
- Authorities are upgrading energy infrastructure and adopted a National Transport Strategy and Transport Master Plan in 2016.
- An estimated €700 million (around 6½ percent of projected 2017 GDP) investment over 7 years is foreseen for upgrading the road network.
- Main findings:
  - Malta’s infrastructure gap vis-à-vis the EU is large in some areas; estimated public capital stock is comparatively small and declining.
  - A temporary increase of one percentage point of GDP in public investment over 7 years in a budget-neutral manner would raise the net present value of GDP by around 5¼ percent of GDP over 30 years; a permanent increase of the same magnitude would boost that gain to 12 percent.
  - Lifting public spending efficiency to the frontier would increase the GDP gains to around 8 percent (temporary) and 18¼ percent (permanent).
  - Infrastructure financing should ideally be budget neutral: reallocating current spending to capital expenditure, improving investment efficiency, better use of EU funds, public-private partnerships with the new Malta Development Bank, and savings from spending reviews are recommended.

### Public infrastructure — state of play and gaps
- Measurement:
  - Public capital stock used as an approximation of infrastructure; IMF public capital database uses the perpetual inventory method for 170 countries.
- Key statistics and comparisons:
  - Malta’s public capital stock: around $6,000 per capita and around 20 percent of GDP — the smallest among EU countries and implying the widest negative gap.
  - Public capital stock has been on a decline since the mid-2000s; public investment rates are among the lowest in the EU.
- Physical infrastructure gaps (difference vis-à-vis EU average):
  - Road network length per inhabitant is below the EU average; road density gap (km per 1,000 people) is negative for Malta.
  - Air passengers per capita are well above-average.
  - Broadband and cellular phone subscriptions are above average.
  - Electricity generation in Malta lags most EU countries.
- Energy sector indicators:
  - Share of fossil fuels in energy consumption: 85 percent (2015).
  - Import dependency on fossil fuels: 98 percent (2015).
- Qualitative measures:
  - Survey-based quality indicators (World Economic Forum) indicate weaknesses in road infrastructure and electricity supply compared to the EU average, while air transport and port quality are perceived above-standard.

### Box — Road transport and energy challenges (summary)
- Road transport
  - Malta’s road network is among the densest per square kilometer but below EU average per capita, given high population density.
  - Quality perception of road infrastructure is poor.
  - Estimated external cost of road congestion: €118 million in 2012 (Attard et al., 2015).
  - Overall external cost of transport (including accidents, air pollution, climate change, noise): €274 million in 2012 — equal to almost 4 percent of 2012 GDP.
  - “No policy change” scenario projects congestion cost rising to €154 million by 2030 and overall external cost to €322 million by 2030.
  - Policy response: National Transport Strategy and targeted road improvements, including repair, asphalting, widening, new junctions, and re-surfacing (estimated investment around €700 million). Demand-side measures include limited free bus usage for minors and tax credits for firms providing employee transport.
  - Car ownership: high passenger cars per 1,000 inhabitants relative to peers.
- Energy
  - Historical reliance on imported fossil fuels with shortcomings in electricity supply (interruptions, voltage fluctuations).
  - Infrastructure upgrades: 95-kilometer interconnector cable to Sicily operational since 2015; new gas-fired power unit; conversion of existing plant from heavy fuel to natural gas; upgraded LNG terminal; planned gas pipeline to Sicily; emphasis on photovoltaic renewable energy.
  - Central Bank of Malta study suggests the interconnector, gas-fired generation, and decommissioning of the Marsa fuel power station raise long-term output via reduction in marginal costs (Rapa, 2017).

### Macro effects of boosting public infrastructure — modeling approach and scenarios
- Model and calibration:
  - Uses EUROMOD version of the IMF’s Flexible System of Global Models (FSGM), calibrated to Malta.
  - FSGM is a semi-structural model combining micro-founded and reduced-form components.
  - Public investment affects aggregate demand and accumulates into a public capital stock; permanent increases raise economy-wide productivity.
  - Model applies a depreciation rate of 4 percent for public capital. Maintenance costs are not explicitly modeled.
- Simulated scenarios and assumptions:
  - Temporary public investment shock:
    - Public investment increases by 1 percent of GDP over a period of 7 years, raising the ratio of public investment to GDP from 3 to 4 percent.
    - This scenario corresponds broadly to the authorities’ €700 million road overhaul plan.
  - Permanent public investment shock:
    - Same magnitude (1 percent of GDP) but on a permanent basis.
  - Financing:
    - Assumed budget-neutral reallocation from government transfers to government investment.
  - Efficiency:
    - Baseline public investment efficiency assumed at 80 percent.
    - Alternative scenario increases public investment efficiency to 100 percent to show potential additional macro benefits.

### Model results and macroeconomic findings
- Short-term and long-term channels:
  - Short-term GDP effects materialize via the fiscal impulse; long-term GDP is affected through increased productivity from an expanded public infrastructure stock.
- Net present value (NPV) of additional GDP following a temporary investment shock (public investment increase by 1 percent of GDP over 7 years; NPV discounted over 30 years at a 3 percent interest rate):
  - 5¼ percent of GDP within 30 years with 80 percent efficiency.
  - Around 8 percent of GDP with 100 percent efficiency.
- NPV of additional GDP for a permanent increase in public investment:
  - Around 12 percent of GDP with 80 percent efficiency.
  - Around 18¼ percent of GDP with 100 percent efficiency.
- Note: A modeling exercise with assumed external financing (e.g., additional EU funds) pointed to very similar effects for real GDP.

### Fiscal policy implications and financing recommendations
- Fiscal balance and cost-benefit:
  - The benefit of additional infrastructure must be balanced with fiscal cost; careful cost-benefit analysis and project-by-project assessment are necessary.
  - To ensure stable public finances over the medium term, increased public investment spending should ideally be budget neutral.
- Potential financing and efficiency-enhancing avenues:
  - Reallocation of budget resources, facilitated by savings from Malta’s recent comprehensive spending reviews and potential further spending reviews.
  - Increased and more balanced absorption of EU funds for co-financed projects.
  - Use of private-public partnerships where appropriate, aided by new financing instruments of the soon-to-be-operational Malta Development Bank, in line with EU regulations and with prudent risk assessment and robust governance structures.
- Growth feedback:
  - Higher infrastructure investment can spur growth and thus generate corresponding increases in tax revenues that will contribute to financing public investment.

### Public spending patterns and reallocation potential
- Capital expenditure trends:
  - Share of capital expenditure (including capital transfers) fell from an annual average of 12.7 percent of total primary expenditure between 1999 and 2007 to 10 percent in 2008-2016.
  - In percent of GDP, capital expenditure decreased from 4.9 to 3.9 percent over the same periods.
- Reallocation potential:
  - There may be room to increase the share of capital expenditure without affecting total expenditure by reallocating from current to capital spending.
- Composition issues (relative to EU averages):
  - Malta records relatively high capital spending on environmental, health-related and cultural projects.
  - Capital spending is comparatively modest on areas important to infrastructure: general public services, public order, housing, and (in economic affairs) slightly below the EU average.
- Recommendation:
  - Raise capital spending focused on areas most lagging behind to support infrastructure development.

### Public investment efficiency and governance recommendations
- IMF staff efficiency indicators:
  - Physical infrastructure indicator: 76 percent (public investment efficiency).
  - Qualitative, survey-based indicator: 84 percent.
- Efficiency gap:
  - Malta’s efficiency gaps amount to around 20 percent relative to the efficiency frontier.
  - Moving towards the efficiency frontier could yield significantly more physical infrastructure and better infrastructure quality for the same public capital stock and income per capita.
- Suggested efficiency improvements:
  - Review administrative procedures, address bottlenecks, remove overlapping responsibilities, and adopt a holistic public investment management approach across government departments.

---

### Since 2011, traditional bank lending to nonfinancial corporations (NFCs) has been on a declining trend in Malta

### Background and recent trends in corporate financing
- Loans to NFCs contracted from approximately 62 percent of GDP (53 percent of total bank loans) in 2009 to 31 percent of GDP (35 percent of total bank loans) in the first half of 2017, owing to both demand and supply side factors (Darmanin, 2017).
- NFCs’ nonbank financing increased from 59 percent of GDP in 2009 to 95 percent of GDP in the first half of 2017, representing mainly an increase in inter-company loans, but also loans from nonbank financial institutions.
- Private sector gross fixed capital formation (GFCF) increased to around 25 percent of GDP in 2015 and 2016, from 17 percent of GDP in 2014.
- The largest sectoral contributors to increases in GFCF were the energy and aviation sectors.
- The average interest rate paid by Maltese companies in the first half of 2017 stood at approximately 200 basis points above the euro area average.
- Among euro area peers, only Greece and Cyprus have higher average interest rates for corporate loans.
- Two domestic banks provide about 80 percent of the bank loans to the NFC sector.

### Disintermediation and nonbank financing patterns
- Between 2007 and 2017, loans remained the primary source of corporate funding, amounting to 80 percent of overall non-equity liabilities.
- Banks’ share in overall corporate loans fell from 49 to 25 percent between 2007 and 2017.
- Intercompany loans increased from 25 to 45 percent of corporate loans between 2007 and 2017.
- External borrowing continued to provide approximately a fifth of loan financing, including direct investment financing from parent corporates.
- Credit from NBFIs was 2 percent of corporate loans in the period referenced, growing fast.
- Households’ holdings of corporate debt securities increased approximately fourfold between 2007 and 2017.
- Issues of debt securities by Maltese firms are often sold to households through financial brokerages; most issues are not rated.

### New bank lending, SME access, and cost of credit
- New bank lending to NFCs declined significantly across all categories of firm size.
- Credit supply constraints disproportionately affect SMEs; the volume of bank loans extended to SMEs—proxied by smaller loan sizes—takes a tiny share of new loans.
- The interest rate spread for small loans over larger loans has been increasing significantly.
- The 2016 EU Survey on the Access to Finance of Enterprises (SAFE and Zerafa, 2017) showed that 7 percent of respondents highlighted access to finance as the most important concern.
- About a quarter of Maltese firms surveyed reported that retained earnings became a significant source of financing for investment and working capital.

### Intercompany lending — characteristics and risks
- Intercompany loans between domestic corporates represented approximately 30 percent of corporate non-equity liabilities in 2017, up from 15 percent in 2007.
- The share of intercompany loans in Malta is the largest in the euro area when compared to peer countries.
- Around half of intercompany loans are long-term (above one year of maturity).
- Risks identified:
  - Long-term, illiquid claims within the corporate sector could transmit a negative shock to profitability and increase corporate defaults.
  - Potential spillovers to the banking system if lending corporates financed activities using bank loans.
  - Intercompany lending is not subject to diversification principles, enabling concentrated exposures to specific borrowers or sectors.
- Regulatory note:
  - Loans between unrelated entities are in principle subject to licensing by the Malta Financial Services Authority (MFSA), but the phenomenon has not been fully assessed due to lack of granular data and the assumption that most loans reflect intra-group activity.

### Foreign direct investment and NBFI lending
- Nonfinancial corporate liabilities to foreign parent corporations stand at approximately 30 percent of GDP.
- Direct investment from foreign corporates is considered generally stable but may provide a channel for cross border spillovers with effects on growth, employment, fiscal, and external positions.
- Corporate loans by domestic NBFIs were about 2 percent of GDP in 2017Q2.
- Corporate loans by NBFIs have quadrupled since 2007.
- Domestic NBFIs provide credit mainly as long-term loans and trade credit; some lending may reflect FDI funding channeled through domestic SPEs.
- Domestic institutional investors (insurers and investment funds) do not play a significant role in corporate financing.
- New NBFI categories:
  - Loan funds: invest in loans to unlisted companies and SMEs; cannot lend to financial institutions or individuals; established as “professional investor funds” whose liabilities cannot be sold to retail investors. They currently do not originate loans but invest in existing loan portfolios and are currently small.
  - Factoring companies: buy invoices and accounts receivable at a discount.
- Trade credit:
  - According to SAFE 2016, over 80 percent of Maltese firms reported trade credit as a relevant source of financing.
  - NBFIs hold approximately a quarter of trade credit claims on corporates, including significant claims by holding companies on local subsidiaries.

### Policy implications and recommendations for corporate finance
- Restoring the bank lending channel for corporates:
  - Advancing resolution of distressed legacy loans would help restore bank lending to corporates and support monetary policy transmission.
  - The recently introduced Banking Rule requiring banks to reduce their NPL ratio to below six percent is a welcome step to free resources and reduce corporate lending costs.
  - Improvements in the insolvency process, in addition to recent amendments to the Companies Act, remain critical.
- SME lending via the Malta Development Bank (MDB):
  - The MDB was established in May 2017 with the MDB Act; Board of Directors and Supervisory Board were recently appointed; operations expected to commence in 2018, providing SME loans via commercial banks.
  - MDB structure should ensure adequate checks and well-designed origination rules to avoid evergreening or guaranteeing existing bad loans, given government’s already large contingent liabilities.
  - The MDB is designed to complement other initiatives such as the Joint Assistance Initiative for Maltese Enterprises (JAIME).
- Monitoring and oversight:
  - Step up efforts to better monitor intercompany liabilities to mitigate financial stability risks.
  - Strengthen regulation and macroprudential oversight of NBFIs: improve monitoring of NBFI activity, improve disclosure and reporting frameworks for NBFIs, and enhance statistical and balance sheet coverage via pooled CBM and MFSA resources.

---

### The gaming industry in Malta — overview, contributions, and risks

### Sector significance and key indicators (selected years 2014–2016)
- The gaming industry has become one of the largest and most dynamic sectors in the Maltese economy, contributing to production, exports, taxes, employment, and productivity.
- The share of Arts, Entertainment and Recreation (which includes gaming) in overall nominal gross value added (GVA) expanded by about 9 percentage points during 2004-14, compared with an EU average of about 0.2 percent.
- The gaming industry accounted for more than a quarter of nominal GVA growth during 2012-16.
- Key indicators:
  - Gross value added (€m): 795.3 (2014), 901.4 (2015), 1,010.7 (2016)
  - % of total GVA: 10.7 (2014), 11.1 (2015), 11.6 (2016)
  - Number of operating firms: 289 (2014), 276 (2015), 266 (2016)
  - Gaming tax revenue (€m): 52.6 (2014), 55.2 (2015), 56.3 (2016)
  - % of corporate tax revenue: 10.3 (2014), 9.4 (2015), 8.7 (2016)
  - Exports (€m) proxied by Personal/Cultural/Recreation sector: 2,512.3 (2014), 2,906.3 (2015), 3,181.8 (2016)
  - % of total exports: 20 (2014), 22 (2015), 23 (2016)

### Success factors and challenges
- Success factors:
  - First-mover advantage as the first EU country to regulate remote gaming in 2004.
  - Business-friendly tax environment, political stability, English-speaking population.
  - Maltese regulatory model described as simple and effective.
- Challenges:
  - Skills gap and digital skills shortages.
  - Weak infrastructure.
  - Risks from changes to online gaming regulation in other EU countries.

### Box 1 — Gaming in the EU (highlights)
- EU market:
  - EU gambling market revenues: €85 billion in 2011; expanding at an annual rate of around 3 percent.
  - Online gaming revenues: increased from €9 billion in 2011 to €13 billion in 2015 (~14 percent of overall market).
  - Number of online gamblers in the EU: above 7 million.
  - No specific EU legislation for online gaming services; member states use a mix of monopolistic regimes and licensing systems.
  - A 2015 framework for EU cross-country cooperation focuses on risks including online gambling addiction, financial and identity fraud, privacy breaches, money laundering, and match-fixing.
- Malta-specific EU comparisons:
  - Arts, Entertainment and Recreation sector’s share in Malta’s nominal GVA: 4 percent in 2004 to nearly 14 percent in 2016.
  - Gaming alone (Gambling and Betting Activities in NACE) accounted for almost 12 percent of Malta’s GVA in 2016.
  - Average annual growth rate of nominal GVA generated by Arts, Entertainment and Recreation: above 17 percent in 2012-2016 (estimated deceleration since 2015).
  - Number of remote gaming operators: 266 at end-2016; recovered to 282 in June 2017.
  - Remote gaming generates around 90 percent of the gaming industry’s value added.
  - CBM study (2010 input-output tables): sector ranks second out of 40, contributing roughly 10 percent of Malta’s total output.
  - Inter-industry linkages mostly limited to support services (consultancy, law firms, data centers, web hosting, hardware and gaming software development, IT security auditing).

### Trade, fiscal contribution, and labor
- Trade and services surplus:
  - Malta’s services surplus surged from 12 percent of GDP in 2004 to 30 percent of GDP in 2016.
  - The Personal/Cultural/Recreation sector surplus increased from 3 to 31 percent of GDP between 2004 and 2016; sectoral imports grew from 0.1 to 1.4 percent of GDP.
  - More than 80 percent of these exports are destined to other EU member states.
- Gaming taxes and fiscal contribution:
  - Malta has set a gaming tax cap of €466,000 per year to attract investors.
  - Between 2014 and 2016, gaming tax revenues remained unchanged at 0.6 percent of GDP.
  - Gaming taxes represented about 9 percent of corporate income tax revenue in that period.
  - Share of gaming taxes in total tax revenues decreased from 2.3 to 2.1 percent between 2014 and 2016.
  - In 2016, the industry generated €56.3 million in gaming taxes, a 7 percent increase relative to 2014.
- Employment and wages:
  - Malta Gaming Authority estimated overall employment associated with gaming: 8,950 full-time equivalent (FTE) jobs in June 2016 (around 4.4 percent of the economy total).
  - Focusing only on gaming firms: 6,407 FTE jobs in June 2017; roughly 85 percent accounted for by remote gaming.
  - Job expansion: annual average rate of almost 30 percent in 2015-2016.
  - Remote gaming firms employ non-Maltese employees amounting to 67 percent of the total (Malta Gaming Authority, 2017).
  - Foreign workers occupy 55 percent of technical positions, 61 percent of professional posts, and 70 percent of senior management roles in remote gaming firms.
  - Jobsplus statistics: foreign workers in Arts, Entertainment and Recreation sector increased from one-third in 2010 to 57 percent in 2016.
  - To attract international workforce, there is a 15 percent tax cap on the salaries of certain highly-qualified positions occupied by foreign workers in the gaming industry and other activities (Malta Highly-Qualified Persons Rules).
  - Labor compensation per employee in Arts, Entertainment and Recreation grew by more than 6 percent per year during 2004-2015, on average, compared to nearly 3 percent in the overall economy.
  - Wage pressures have escalated recently, reflecting high labor turnover (especially among foreign employees) and strong inter-firm competition for workers.

### Productivity, structural change, and regulation
- Productivity decomposition (2000-2016):
  - Nominal labor productivity increased by more than 4 percent per annum, on average.
  - Roughly a fifth of that growth was accounted for by structural change (0.8 percent), with the remainder explained by productivity gains within individual sectors.
  - The Arts, Entertainment and Recreation sector contributed 0.7 percent to the structural change component.
  - Real labor productivity grew by slightly above 1 percent, on average, during 2000-2016.
- Regulatory and AML/CFT reforms:
  - Objectives: eliminate duplication, simplify regulatory burden, boost innovation in the B2B segment, adopt a risk-based approach to compliance.
  - New licensing framework aims to enhance regulatory efficiency, introduce flexibility for technological developments (e.g., cryptocurrencies), and meet consumer protection standards.
  - Recent legislative and regulatory amendments transposing the EU’s Fourth AML Directive (December 2017) bring the remote gaming sector within the AML/CFT framework.
  - Malta Gaming Authority stepped up collaboration with the Financial Intelligence Analysis Unit; an internal AML unit was created within the Gaming Authority.
  - AML/CFT supervision will follow a risk-based approach, jointly carried out by the Gaming Authority and the Financial Intelligence Analysis Unit; authorities are elaborating a risk profile of all gaming operators.
- Money laundering risks:
  - European Commission’s Supranational Risk Assessment Report (June 2017) highlighted vulnerability of certain gambling services, such as online gaming, to money laundering.
  - The Malta Gaming Authority has suspended or cancelled licenses of a number of gaming operators investigated by Italian agencies in connection with money laundering.
  - Parliament approved amendments to the Prevention of Money Laundering Act and the Prevention of Money Laundering and Funding of Terrorism Regulations to transpose the Fourth AML Directive into Maltese law.
  - Supervision will be risk-based, jointly conducted, with profiling of operators and enforcement recommendations by the Financial Intelligence Analysis Unit.

### Growth outlook, consolidation, and policy priorities
- Prospects:
  - The Malta Gaming Authority expects further growth in revenue and employment for remote gaming operators over the next few years.
  - New investments likely as many foreign companies remain confident in Malta as a start-up location.
  - Brexit effects are uncertain but may present opportunities as operators licensed in the UK and British territories may relocate to Malta as a gateway to the EU.
  - Possible international corporate tax reforms may negatively affect the sector.
- Market structure:
  - Recent merger and acquisition activity led to a decline in the number of remote gaming operators (with partial recovery in H1 2017); consolidation is expected to continue.
  - Operators are seeking customers outside Europe; Malta could expand as a provider of gaming-related services through growth in the B2B segment.
- Key policy priorities:
  - Address weak infrastructure and ICT/digital skills gaps.
  - Facilitate attraction of foreign workers while mitigating pressures on property and rental markets.
  - Improve education and training (e.g., European Gaming Institute of Malta launched).
  - Upgrade infrastructure and expand modern office space availability.

*Prepared by IMF staff.*

### References _______________________________________________________________________________ 12

### Closing Malta’s Infrastructure Gap

### Introduction
- Malta’s public infrastructure has been strained by rapid economic growth and rising immigration.
- The public capital stock is estimated as comparatively small and declining, potentially constraining future growth.
- Authorities are upgrading energy infrastructure and adopted a National Transport Strategy and Transport Master Plan in 2016.
- An estimated €700 million (around 6½ percent of projected 2017 GDP) investment over 7 years is foreseen for upgrading the road network.
- Main findings:
  - Malta’s infrastructure gap vis-à-vis the EU is large in some areas; estimated public capital stock is comparatively small and declining.
  - A temporary increase of one percentage point of GDP in public investment over 7 years in a budget-neutral manner would raise the net present value of GDP by around 5¼ percent of GDP over 30 years; a permanent increase of the same magnitude would boost that gain to 12 percent.
  - Lifting public spending efficiency to the frontier would increase the GDP gains to around 8 percent (temporary) and 18¼ percent (permanent).
  - Infrastructure financing should ideally be budget neutral: reallocating current spending to capital expenditure, improving investment efficiency, better use of EU funds, public-private partnerships with the new Malta Development Bank, and savings from spending reviews are recommended.

### Public Infrastructure in Malta — The State of Play
- Measuring infrastructure:
  - Public capital stock is used as an approximation of infrastructure, with caveats on valuation and depreciation.
  - IMF public capital database uses the perpetual inventory method for 170 countries.
- Key statistics and comparisons:
  - Malta’s public capital stock: around $6,000 per capita and around 20 percent of GDP — the smallest among EU countries and implying the widest negative gap.
  - Public capital stock has been on a decline since the mid-2000s; public investment rates are among the lowest in the EU.
- Physical infrastructure gaps (difference vis-à-vis EU average):
  - Road network length per inhabitant is below the EU average; road density gap (km per 1,000 people) is negative for Malta.
  - Air passengers per capita are well above-average.
  - Broadband and cellular phone subscriptions are above average.
  - Electricity generation in Malta lags most EU countries.
- Energy sector indicators:
  - Share of fossil fuels in energy consumption: 85 percent (2015).
  - Import dependency on fossil fuels: 98 percent (2015).
- Qualitative measures:
  - Survey-based quality indicators (World Economic Forum) indicate weaknesses in road infrastructure and electricity supply compared to the EU average, while air transport and port quality are perceived above-standard.

### Box: Addressing Malta’s Road Transport and Energy Challenges
- Road transport:
  - Malta’s road network is among the densest per square kilometer but below EU average per capita, given high population density.
  - Quality perception of road infrastructure is poor.
  - Estimated external cost of road congestion: €118 million in 2012 (Attard et al., 2015).
  - Overall external cost of transport (including accidents, air pollution, climate change, noise): €274 million in 2012 — equal to almost 4 percent of 2012 GDP.
  - “No policy change” scenario projects congestion cost rising to €154 million by 2030 and overall external cost to €322 million by 2030.
  - Policy response: National Transport Strategy and targeted road improvements, including repair, asphalting, widening, new junctions, and re-surfacing (estimated investment around €700 million). Demand-side measures include limited free bus usage for minors and tax credits for firms providing employee transport.
  - Car ownership: Malta shows high passenger cars per 1,000 inhabitants relative to peers.
- Energy:
  - Historical reliance on imported fossil fuels with shortcomings in electricity supply (interruptions, voltage fluctuations).
  - Infrastructure upgrades: 95-kilometer interconnector cable to Sicily operational since 2015; new gas-fired power unit; conversion of existing plant from heavy fuel to natural gas; upgraded LNG terminal; planned gas pipeline to Sicily; emphasis on photovoltaic renewable energy.
  - Central Bank of Malta study suggests the interconnector, gas-fired generation, and decommissioning of the Marsa fuel power station raise long-term output via reduction in marginal costs (Rapa, 2017).

### The Macro Effects of Boosting Public Infrastructure
- Modeling approach:
  - Uses EUROMOD version of the IMF’s Flexible System of Global Models (FSGM), calibrated to Malta.
  - FSGM is a semi-structural model combining micro-founded and reduced-form components.
  - Public investment affects aggregate demand and accumulates into a public capital stock; permanent increases raise economy-wide productivity.
  - Model applies a depreciation rate of 4 percent for public capital. Maintenance costs are not explicitly modeled.
- Simulated scenarios and assumptions:
  - Temporary public investment shock:
    - Public investment increases by 1 percent of GDP over a period of 7 years, raising the ratio of public investment to GDP from 3 to 4 percent.
    - This scenario corresponds broadly to the authorities’ €700 million road overhaul plan.
  - Permanent public investment shock:
    - Same magnitude (1 percent of GDP) but on a permanent basis.
  - Financing:
    - Assumed budget-neutral reallocation from government transfers to government investment.
  - Efficiency:
    - Baseline public investment efficiency assumed at 80 percent.
    - Alternative scenario increases public investment efficiency to 100 percent to show potential additional macro benefits.
- Model results (summary from main findings):
  - Temporary shock (1 percent of GDP for 7 years), budget-neutral, baseline efficiency (80 percent): net present value of GDP gain around 5¼ percent of GDP over 30 years.
  - Permanent shock (1 percent of GDP indefinitely), baseline efficiency: net present value of GDP gain 12 percent.
  - Raising investment efficiency to 100 percent increases gains to around 8 percent (temporary) and 18¼ percent (permanent).

*Prepared by Uwe Böwer; model support by Ben Hunt and Keiko Honjo; paper benefited from workshop comments hosted by the Ministry of Finance.*

### 13.      Results point to significant GDP benefits of increased public investment. In line with the

### Results point to significant GDP benefits of increased public investment

### Main macroeconomic findings
- Short-term GDP effects materialize via the fiscal impulse; long-term GDP is affected through increased productivity from an expanded public infrastructure stock.
- Net present value (NPV) of additional GDP following a temporary investment shock (public investment increase by 1 percent of GDP over 7 years; NPV discounted over 30 years at a 3 percent interest rate):
  - 5¼ percent of GDP within 30 years with 80 percent efficiency.
  - Around 8 percent of GDP with 100 percent efficiency.
- NPV of additional GDP for a permanent increase in public investment:
  - Around 12 percent of GDP with 80 percent efficiency.
  - Around 18¼ percent of GDP with 100 percent efficiency.
- Note: A modeling exercise with assumed external financing (e.g., additional EU funds) pointed to very similar effects for real GDP.

### Fiscal policy implications and financing
- The benefit of additional infrastructure must be balanced with fiscal cost; careful cost-benefit analysis and project-by-project assessment are necessary.
- To ensure stable public finances over the medium term, increased public investment spending should ideally be budget neutral.
- Potential financing and efficiency-enhancing avenues:
  - Reallocation of budget resources, facilitated by savings from Malta’s recent comprehensive spending reviews and potential further spending reviews.
  - Increased and more balanced absorption of EU funds for co-financed projects.
  - Use of private-public partnerships where appropriate, aided by new financing instruments of the soon-to-be-operational Malta Development Bank, in line with EU regulations and with prudent risk assessment and robust governance structures.
- Higher infrastructure investment can spur growth and thus generate corresponding increases in tax revenues that will contribute to financing public investment.

### Public spending patterns and reallocation potential
- Capital expenditure trends:
  - Share of capital expenditure (including capital transfers) fell from an annual average of 12.7 percent of total primary expenditure between 1999 and 2007 to 10 percent in 2008-2016.
  - In percent of GDP, capital expenditure decreased from 4.9 to 3.9 percent over the same periods.
- There may be room to increase the share of capital expenditure without affecting total expenditure by reallocating from current to capital spending.
- Composition issues (relative to EU averages):
  - Malta records relatively high capital spending on environmental, health-related and cultural projects.
  - Capital spending is comparatively modest on areas important to infrastructure: general public services, public order, housing, and (in economic affairs) slightly below the EU average.
- Recommendation: Raise capital spending focused on areas most lagging behind to support infrastructure development.

### Public investment efficiency and gaps
- IMF staff efficiency indicators:
  - Physical infrastructure indicator: 76 percent (public investment efficiency).
  - Qualitative, survey-based indicator: 84 percent.
- Malta’s efficiency gaps amount to around 20 percent relative to the efficiency frontier.
- Moving towards the efficiency frontier could yield significantly more physical infrastructure and better infrastructure quality for the same public capital stock and income per capita.
- Suggested efficiency improvements: review administrative procedures, address bottlenecks, remove overlapping responsibilities, and adopt a holistic public investment management approach across government departments.

### Infrastructure gaps and policy conclusions
- Major infrastructure gaps identified:
  - Roads: smaller network per capita and poor quality; high car ownership and rapidly rising congestion.
  - Energy: lagging generation capacity, large dependency on fuel imports for power generation, and weak reliability of electricity supply.
  - Malta has the EU’s smallest estimated public capital stock per capita.
- Model estimations confirm strong growth potential from enhanced infrastructure:
  - Temporary 1 percent of GDP increase in public investment over 7 years -> long-term GDP rise of around 5¼ percent (current efficiency) and 8 percent (efficiency frontier).
  - Permanent increase -> long-term GDP rise of around 12 percent (current efficiency) and 18¼ percent (efficiency frontier).
- Authorities’ plans:
  - Transport strategy and road overhauls underway.
  - Energy infrastructure upgrades proceeding to diversify supply and increase security.
- Policy guidance:
  - Implement infrastructure plans in a budget-neutral manner where possible.
  - Consider permanent rebalancing from current to capital expenditure to magnify GDP gains.
  - Finance responsibly using savings from spending reviews, public-private partnerships, and EU funds in line with EU regulations.
  - Strengthen public investment efficiency through administrative reforms and coordinated public investment management.

*Source: IMF staff.*

### 1.      Since 2011, traditional bank lending to nonfinancial corporations (NFCs) has been on a

### Since 2011, traditional bank lending to nonfinancial corporations (NFCs) has been on a declining trend in Malta.

### Background and recent trends
- Loans to NFCs contracted from approximately 62 percent of GDP (53 percent of total bank loans) in 2009 to 31 percent of GDP (35 percent of total bank loans) in the first half of 2017, owing to both demand and supply side factors (Darmanin, 2017).
- NFCs’ nonbank financing increased from 59 percent of GDP in 2009 to 95 percent of GDP in the first half of 2017, representing mainly an increase in inter-company loans, but also loans from nonbank financial institutions.
- Private sector gross fixed capital formation (GFCF) increased to around 25 percent of GDP in 2015 and 2016, from 17 percent of GDP in 2014.
- The largest sectoral contributors to increases in GFCF were the energy and aviation sectors.
- The average interest rate paid by Maltese companies in the first half of 2017 stood at approximately 200 basis points above the euro area average.
- Among euro area peers, only Greece and Cyprus have higher average interest rates for corporate loans.
- Two domestic banks provide about 80 percent of the bank loans to the NFC sector.

### Disintermediation and nonbank financing
- Between 2007 and 2017, loans remained the primary source of corporate funding, amounting to 80 percent of overall non-equity liabilities.
- Banks’ share in overall corporate loans fell from 49 to 25 percent between 2007 and 2017.
- Intercompany loans increased from 25 to 45 percent of corporate loans between 2007 and 2017.
- External borrowing continued to provide approximately a fifth of loan financing, including direct investment financing from parent corporates.
- Credit from NBFIs was 2 percent of corporate loans in the period referenced, growing fast.
- Households’ holdings of corporate debt securities increased approximately fourfold between 2007 and 2017.
- Issues of debt securities by Maltese firms are often sold to households through financial brokerages; most issues are not rated.

### New bank lending and SME access
- New bank lending to NFCs declined significantly across all categories of firm size.
- Credit supply constraints disproportionately affect SMEs; the volume of bank loans extended to SMEs—proxied by smaller loan sizes—takes a tiny share of new loans.
- The interest rate spread for small loans over larger loans has been increasing significantly.
- The 2016 EU Survey on the Access to Finance of Enterprises (SAFE and Zerafa, 2017) showed that 7 percent of respondents highlighted access to finance as the most important concern.
- About a quarter of Maltese firms surveyed reported that retained earnings became a significant source of financing for investment and working capital.

### Large intercompany lending: characteristics and risks
- Intercompany loans between domestic corporates represented approximately 30 percent of corporate non-equity liabilities in 2017, up from 15 percent in 2007.
- The share of intercompany loans in Malta is the largest in the euro area when compared to peer countries.
- Around half of intercompany loans are long-term (above one year of maturity).
- Risks identified:
  - Long-term, illiquid claims within the corporate sector could transmit a negative shock to profitability and increase corporate defaults.
  - Potential spillovers to the banking system if lending corporates financed activities using bank loans.
  - Intercompany lending is not subject to diversification principles, enabling concentrated exposures to specific borrowers or sectors.
- Loans between unrelated entities are in principle subject to licensing by the Malta Financial Services Authority (MFSA), but the phenomenon has not been fully assessed due to lack of granular data and the assumption that most loans reflect intra-group activity.

### Foreign direct investment and external funding
- Nonfinancial corporate liabilities to foreign parent corporations stand at approximately 30 percent of GDP.
- Direct investment from foreign corporates is considered generally stable but may provide a channel for cross border spillovers with effects on growth, employment, fiscal, and external positions.

### Nonbank financial institutions (NBFIs) lending
- Corporate loans by domestic NBFIs were about 2 percent of GDP in 2017Q2.
- Corporate loans by NBFIs have quadrupled since 2007.
- Domestic NBFIs provide credit mainly as long-term loans and trade credit; some lending may reflect FDI funding channeled through domestic SPEs.
- Domestic institutional investors (insurers and investment funds) do not play a significant role in corporate financing.
- Among NBFIs:
  - Loan funds are a newly established category that invest in loans to unlisted companies and SMEs; they cannot lend to financial institutions or individuals and are established as “professional investor funds” whose liabilities cannot be sold to retail investors. They currently do not originate loans but invest in existing loan portfolios and are currently small.
  - Factoring companies buy invoices and accounts receivable at a discount.
- Trade credit is relevant: according to SAFE 2016, over 80 percent of Maltese firms reported trade credit as a relevant source of financing.
- NBFIs hold approximately a quarter of trade credit claims on corporates, including significant claims by holding companies on local subsidiaries.

### Policy implications and recommendations
- Restoring the bank lending channel for corporates:
  - Advancing resolution of distressed legacy loans would help restore bank lending to corporates and support monetary policy transmission.
  - The recently introduced Banking Rule requiring banks to reduce their NPL ratio to below six percent is a welcome step to free resources and reduce corporate lending costs.
  - Improvements in the insolvency process, in addition to recent amendments to the Companies Act, remain critical.
- SME lending by the Malta Development Bank (MDB):
  - The MDB was established in May 2017 with the MDB Act; Board of Directors and Supervisory Board were recently appointed; operations expected to commence in 2018, providing SME loans via commercial banks.
  - MDB structure should ensure adequate checks and well-designed origination rules to avoid evergreening or guaranteeing existing bad loans, given government’s already large contingent liabilities.
  - The MDB is designed to complement other initiatives such as the Joint Assistance Initiative for Maltese Enterprises (JAIME).
- Monitoring intercompany lending:
  - Stepping up efforts to better monitor intercompany liabilities would help mitigate financial stability risks.
  - Better granular assessment is needed given the systemic size and concentration of intercompany lending.
- Strengthening regulation and macroprudential oversight of NBFIs:
  - Improve monitoring of NBFI activity to prevent excessive corporate leverage or large indirect exposures of banks to corporates.
  - Improve disclosure and reporting frameworks for NBFIs; sectoral balance sheets are not available for all types of NBFIs.
  - The Central Bank of Malta (CBM) and the MFSA are in the process of pooling resources to improve statistical and balance sheet coverage of NBFIs.

### The gaming industry in Malta — overview and significance
- The gaming industry has become one of the largest and most dynamic sectors in the Maltese economy, contributing to production, exports, taxes, employment, and productivity.
- The share of Arts, Entertainment and Recreation (which includes gaming) in overall nominal gross value added (GVA) expanded by about 9 percentage points during 2004-14, compared with an EU average of about 0.2 percent.
- The gaming industry accounted for more than a quarter of nominal GVA growth during 2012-16.
- Key indicators (selected years 2014–2016):
  - Gross value added (€m): 795.3 (2014), 901.4 (2015), 1,010.7 (2016)
  - % of total GVA: 10.7 (2014), 11.1 (2015), 11.6 (2016)
  - Number of operating firms: 289 (2014), 276 (2015), 266 (2016)
  - Gaming tax revenue (€m): 52.6 (2014), 55.2 (2015), 56.3 (2016)
  - % of corporate tax revenue: 10.3 (2014), 9.4 (2015), 8.7 (2016)
  - Exports (€m) proxied by Personal/Cultural/Recreation sector: 2512.3 (2014), 2906.3 (2015), 3181.8 (2016)
  - % of total exports: 20 (2014), 22 (2015), 23 (2016)
- Success factors:
  - First-mover advantage as the first EU country to regulate remote gaming in 2004.
  - Business-friendly tax environment, political stability, English-speaking population.
  - Maltese regulatory model described as simple and effective.
- Challenges:
  - Skills gap and digital skills shortages.
  - Weak infrastructure.
  - Risks from changes to online gaming regulation in other EU countries.
- The note analyzes sector contributions to GVA, trade, taxes, employment, and productivity; describes amendments to regulatory framework including financial integrity measures; and discusses prospects and challenges for expansion.

*Prepared by IMF staff as presented in the source content.*

### Box 1. Gaming in the EU

### Box 1. Gaming in the EU

### EU market size and structure
- The EU gambling market generated revenues for €85 billion in 2011 and is expanding at an annual rate of around 3 percent.
- Online gaming revenues are estimated to have increased from €9 billion in 2011 to €13 billion in 2015, representing around 14 percent of the overall gambling market.
- The number of online gamblers in the EU is above 7 million.
- There is no specific EU legislation for online gaming services; member states use a mix of monopolistic regimes and licensing systems (an increasing number, including Malta, have adopted licensing systems for more than one operator).
- Diverse licensing regimes imply that gaming operators targeting customers in different countries need to hold multiple licenses.
- A framework for EU cross-country cooperation was agreed in 2015 to exchange information, best practices, and assist national gaming authorities in their supervisory function, focusing on risks including online gambling addiction, financial and identity fraud, privacy breaches, money laundering, and match-fixing in sports.

### Contribution to employment and exports (EU and Malta)
- For most EU countries:
  - On average, less than 1 percent of total employment in the EU is accounted for by Arts and Recreation activities including gambling and betting.
  - For the majority of member states, the share of gaming exports (included in the Personal/Cultural/Recreation sector) in total exports of services is below 1 percent.
- Malta (country-specific highlights):
  - The Arts, Entertainment and Recreation sector’s share in Malta’s total nominal gross value added (GVA) increased from 4 percent in 2004 to nearly 14 percent in 2016.
  - The gaming industry alone (Gambling and Betting Activities in NACE) accounted for almost 12 percent of Malta’s GVA in 2016.
  - The average annual growth rate of nominal GVA generated by Arts, Entertainment and Recreation was above 17 percent in the 2012-2016 period, with an estimated deceleration since 2015.
  - Reflecting merger activity, the number of remote gaming operators declined but recovered from 266 at end-2016 to 282 in June 2017.
  - The remote gaming business generates around 90 percent of the gaming industry’s value added.
  - A Central Bank of Malta (CBM) study (using 2010 input-output tables) finds the sector encompassing gaming ranks second out of 40, contributing to roughly 10 percent of Malta’s total output.
  - The inter-industry linkages of gaming operators in Malta are mostly limited to support services (consultancy and law firms, data centers, web hosting, hardware and gaming software development, IT security auditing).

### Trade, services surplus, and taxes
- Malta’s services surplus surged from 12 percent of GDP in 2004 to 30 percent of GDP in 2016.
- The surplus in the Personal/Cultural/Recreation sector (which includes remote gaming) increased from 3 to 31 percent of GDP between 2004 and 2016; sectoral imports grew from 0.1 to 1.4 percent of GDP over the same period.
- More than 80 percent of these exports are destined to other EU member states.
- Gaming taxes and fiscal contribution in Malta:
  - Malta has set a gaming tax cap of €466,000 per year to attract investors.
  - Between 2014 and 2016, gaming tax revenues remained unchanged at 0.6 percent of GDP.
  - Gaming taxes represented about 9 percent of corporate income tax revenue in that period.
  - The share of gaming taxes in total tax revenues decreased from 2.3 to 2.1 percent between 2014 and 2016.
  - In 2016, the industry generated €56.3 million in gaming taxes, a 7 percent increase relative to 2014.

### Employment, foreign workforce reliance, and wages (Malta)
- Employment levels and composition:
  - A Malta Gaming Authority study estimated overall employment associated with the gaming industry at 8,950 full-time equivalent (FTE) jobs in June 2016, representing around 4.4 percent of the economy total.
  - Focusing only on gaming firms, the number of FTE jobs was 6,407 in June 2017, of which roughly 85 percent was accounted for by the remote gaming segment.
  - Job expansion was significant, growing at an annual average rate of almost 30 percent in 2015-2016.
- Reliance on foreign workers:
  - Remote gaming firms employ non-Maltese employees amounting to 67 percent of the total (Malta Gaming Authority, 2017).
  - Foreign workers occupy 55 percent of technical positions, 61 percent of professional posts, and 70 percent of senior management roles in remote gaming firms.
  - Jobsplus statistics show the percentage of foreign workers in the Arts, Entertainment and Recreation sector increased from one-third in 2010 to 57 percent in 2016.
  - To attract international workforce, there is a 15 percent tax cap on the salaries of certain highly-qualified positions occupied by foreign workers in the gaming industry and other activities (Malta Highly-Qualified Persons Rules).
- Wage growth:
  - Labor compensation per employee in Arts, Entertainment and Recreation grew by more than 6 percent per year during 2004-2015, on average, compared to nearly 3 percent in the overall economy.
  - Wage pressures have escalated recently, reflecting high labor turnover (especially among foreign employees) and strong inter-firm competition for workers.

### Productivity and structural change
- A decomposition framework (McMillan et al., 2014) is used to separate economy-wide labor productivity growth into:
  - A “within” component: productivity gains in individual sectors.
  - A “structural change” component: labor reallocations across sectors.
- Key quantitative findings for Malta (2000-2016):
  - Nominal labor productivity increased by more than 4 percent per annum, on average.
  - Roughly a fifth of that growth was accounted for by structural change (0.8 percent), with the remainder explained by productivity gains within individual sectors.
  - The Arts, Entertainment and Recreation sector contributed 0.7 percent to the structural change component, underlining gaming’s role as a driver of growth-enhancing structural change.
  - Labor reallocated from lower-productivity sectors (Industry, Construction) to higher-productivity service activities including Arts, Entertainment and Recreation, Communication, and Finance.
  - Real labor productivity grew by slightly above 1 percent, on average, during 2000-2016.

### Regulation, AML/CFT, and financial integrity risks
- Regulatory reform objectives:
  - Eliminate duplication of administrative requirements, simplify regulatory burden, boost innovation in the B2B segment, and adopt a risk-based approach to compliance.
  - The new licensing framework seeks to enhance regulatory efficiency, introduce flexibility to deal with technological developments (e.g., role of cryptocurrencies in gaming activities), and meet consumer protection standards.
  - Reforms are accompanied by stronger emphasis on effective enforcement of compliance.
- AML/CFT scope and recent changes:
  - Under the previous regulation, only casino licensees were subject to AML/CFT requirements.
  - Recent legislative and regulatory amendments transposing the EU’s Fourth AML Directive (December 2017) bring the remote gaming sector within the AML/CFT framework.
  - The Malta Gaming Authority has stepped up collaboration with the Financial Intelligence Analysis Unit; an internal AML unit was created within the Gaming Authority to conduct supervision.
  - AML/CFT supervision will follow a risk-based approach, jointly carried out by the Gaming Authority and the Financial Intelligence Analysis Unit. Authorities are elaborating a risk profile of all gaming operators to guide supervision; the Financial Intelligence Analysis Unit will evaluate supervisory reviews and recommend enforcement actions where appropriate.

- Box 2 summary — Money Laundering Risks in the Gaming Sector:
  - The European Commission’s Supranational Risk Assessment Report (June 2017) highlighted the vulnerability of certain gambling services, such as online gaming, to money laundering risks (operations by gaming companies undertaking or facilitating money laundering and players targeting the industry).
  - The Malta Gaming Authority has suspended or cancelled licenses of a number of gaming operators investigated by Italian agencies in connection with money laundering.
  - Parliament approved amendments to the Prevention of Money Laundering Act and the Prevention of Money Laundering and Funding of Terrorism Regulations to transpose the Fourth AML Directive into Maltese law.
  - Supervision will be risk-based, jointly conducted, with profiling of operators and enforcement recommendations by the Financial Intelligence Analysis Unit.

### Growth outlook, consolidation, and challenges ahead
- Prospects and drivers:
  - The Malta Gaming Authority expects further growth in revenue and employment for remote gaming operators over the next few years.
  - New investments are likely as many foreign companies in remote gaming remain confident in Malta as a start-up location.
  - Brexit effects are uncertain but may present opportunities as operators licensed in the UK and British territories may relocate to Malta as a gateway to the EU.
  - Possible international corporate tax reforms may negatively affect the sector.
- Market structure and consolidation:
  - Recent merger and acquisition activity led to a decline in the number of remote gaming operators (with partial recovery in H1 2017); consolidation is expected to continue due to market competition and regulatory cost pressures (higher taxation, rising costs of licensing and compliance as more EU countries develop licensing regimes).
  - Operators are seeking customers outside Europe; Malta could expand as a provider of gaming-related services through growth in the B2B segment.
- Key challenges:
  - Weak infrastructure and ICT/digital skills gaps constrain sustained growth.
  - Policy priorities include facilitating attraction of foreign workers (mitigating pressures on property and rental markets), improving education and training (e.g., European Gaming Institute of Malta launched to increase domestic supply of gaming-sector workers), upgrading infrastructure, and expanding modern office space availability.

_International Monetary Fund — Box 1. Gaming in the EU (extracted from the Malta country chapter)._

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1820.pdf_