## sipea2026022

## Source details

**Canonical URL:** [sipea2026022](https://www.imf.org/-/media/files/publications/selected-issues-papers/2026/english/sipea2026022.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/selected-issues-papers/2026/english/sipea2026022.pdf.md)
- [Structured JSON version](/-/media/files/publications/selected-issues-papers/2026/english/sipea2026022.pdf.json)

---

### Introduction: Purpose and GaR concept
- Growth-at-Risk (GaR) links current financial and economic conditions to a probability distribution of future real GDP growth over one- to two-year horizons.
- GaR focuses on tail risks: the lowest GDP growth rate with only a 5 percent chance of being lower (example: "If GaR is 2 percent, it means that there is a 5 percent probability that growth will fall below 2 percent over the specified horizon").
- GaR complements point forecasts by estimating the distribution and the likelihood of extreme negative growth scenarios.

### Malta’s macro-financial context: credit, housing, external openness, and buffers
- Growth and labor market
  - Real GDP growth averaged close to 7 percent per year from 2013 to 2019.
  - Real GDP growth remained above 5 percent in 2020-2024.
  - Growth in 2025 moderated to its estimated potential rate of about 4 percent.
  - Unemployment is at historic lows of about 2.9 percent.
  - Inflation has receded to around 2–3 percent.
  - Growth rate in 2024 was 6.85 percent (noted as at the 60th percentile of the historical distribution).
- Openness and external exposure
  - Total exports of goods and services at about 120 percent of GDP.
  - Current account surplus of around 6-7 percent of GDP.
  - Budget deficit declined to about 3.5 percent of GDP in 2024; public debt falling to below 50 percent of GDP (public debt noted at about 47 percent of GDP later).
- Credit and housing markets
  - Bank lending concentration in mortgages and construction loans: at end-2024 these accounted for 72 percent of banks’ private-sector loan portfolios, up from 60 percent a decade ago.
  - Household credit growth: household credit grew by 8–9 percent annually in recent years.
  - Mortgage interest rates around 3 percent.
  - Household debt approximately 60 percent of GDP, predominantly variable rate mortgages.
  - Residential property prices rose by 6.7 percent in 2024; price-to-income ratio stabilized at about 90 percent since the early 2020s.
  - Rental yields have edged up to about 6 percent.
- Financial conditions and buffers
  - Domestic financial conditions remained accommodative through 2024-25 (low mortgage interest rates, ample liquidity, moderate sovereign bond yields).
  - Public debt at about 47 percent of GDP and an A+ sovereign rating.
  - Central Bank stress tests: Tier 1 ratio of 21 percent; LCR more than 350 percent.
  - Domestic FCI correlated with Euro Area FCI; Euro Area FCI tightened in 2022-2023 with ECB rate hikes.

### GaR framework: variables, dimensionality reduction, and estimation
- Key composite factors included as predictors:
  - Domestic Financial Conditions: Malta-specific FCI (interest rates, spreads, equity performance, sovereign spreads, 10-year sovereign bond yields).
  - Domestic Risk Indicators: real house price growth, house price-to-income, house price-to-rent, real credit growth, credit to GDP.
  - Domestic Macroeconomic Fundamentals: recent trend (4-quarter moving average) real GDP growth and inflation.
  - External (Euro Area) Financial Conditions: Euro Area-wide FCI (credit spreads, volatility, investor sentiment, capital flows).
  - External (Euro Area) Macroeconomic Indicators: Euro Area GDP growth and inflation.
- Dimensionality reduction:
  - Principal component analysis (PCA) applied within each group.
  - The first principal component of each group (around 60 percent of group variance in the analysis) is used as the representative factor.
  - Final model uses five factors: domestic FCI, domestic risk, domestic macro, euro area FCI, euro area macro.
- Estimation approach:
  - Quantile regression in a local projections framework forecasting GDP growth h quarters ahead (h=4 for one-year, h=8 for two-year).
  - Separate regressions estimated for τ = 0.05 (5th percentile) and τ = 0.5 (median).
  - The one-year GaR regression form: g_{t+4, τ} = α_τ + β_τ ⋅ FCI_t + γ_τ ⋅ X_t + ε_{t+4, τ}, where coefficients vary by quantile.
  - A skewed T-distribution is fitted to the estimated quantiles to obtain the full forecast distribution.

### Baseline results: GaR estimates and historical assessment
- One-year-ahead (by mid-2026) distribution:
  - Baseline central estimate (median) around 4 percent.
  - 5th percentile (GaR 5%) about 1.75 percent.
  - 10th percentile about 2.75 percent.
  - Probability of negative growth in the next four quarters about 2 percent (noted as 1.96% in Figure 2).
  - Mode = 4.0; Realized Growth = 6.85 at quantile 59.57% (from Figure 2).
- Interpretation:
  - GaR 5% = 1.75 percent implies a 5 percent chance growth will fall below 1.75 percent in one year under prevailing conditions.
  - Near-term recession risk is low given strong starting point and momentum.
- Historical variation:
  - During 2015–19, one-year GaR in the 2–3 percent range.
  - COVID-19 shock: GaR plunged into negative territory in early 2020, consistent with the large contraction experienced.
  - By 2022–2023, GaR recovered.
  - Current GaR at 1.75 percent remains higher than during the euro crisis of 2012 or the 2008 financial crisis.
- Two-year-ahead horizon (through mid-2027):
  - Distribution is wider and flatter; left tail reaches notably negative growth rates.
  - Baseline two-year-ahead median might still be around 4 percent.
  - GaR 5% for two years ahead estimated at about –2.2 percent (noted as about –2 .2 percent in source).
  - GaR 10% for two years ahead about zero.
  - Implication: a 5 percent chance average annual growth over next two years could be -2 percent or worse.

### Scenario analysis: sensitivity to shocks and main drivers of downside risk
- Method: Shocking each composite factor in isolation (typically a 3 standard deviation adverse shock for scenarios).
- Domestic risk (credit and housing) shock:
  - A 3 standard deviation adverse shock to the “domestic risk” factor approximates a sharp house price fall plus substantial credit slowdown.
  - One-year-ahead GaR (5th percentile) deteriorates from 1.75 percent to around 0.5 percent.
  - Under this shock the entire growth distribution shifts left and the left tail becomes much thicker.
  - Transmission channels: contraction in construction activity, wealth effects lowering consumer spending, tighter credit availability, and higher loan delinquencies that could strain banks despite capital buffers.
- External shocks:
  - External factors from the Euro Area are likely to have a smaller direct impact on the growth rate distribution, transmitted through financial conditions in the bloc and Malta’s domestic FCI linkage.
- Additional sensitivity checks:
  - Using growth rate of tourist overnight stays for the Domestic Macro factor increases GaR to about 2.5 percent for the one-year ahead horizon but reduces it to about -4.6 percent for the two-year ahead horizon.
  - Adding tourist overnight stays and real exports to Domestic Macro variables results in higher GaR for the one-year horizon.

### Tightening of domestic financial conditions (Section 2)
- Modeled by imposing stress on the domestic FCI (e.g., sudden rise in interest rates or widening of spreads due to loss of confidence).
- Effect on GaR:
  - The 5th percentile declines by a few tenths of a percent.
  - Tighter domestic financial conditions reduce credit growth and raise financing costs, trimming both median and tail outcomes.
- Malta-specific considerations:
  - Strong bank buffers and the likelihood that domestic tightening might coincide with a strong economy mean the impact on tail risk is noticeable but not as large as the housing shock.
  - Maintaining market confidence and prudent policies would help keep domestic financial conditions benign, thereby containing downside risk.

### Large negative shock to domestic macro fundamentals (Section 2)
- Shock description:
  - Idiosyncratic shock to a major industry leading to lower growth and higher inflation, worsening Malta’s current macroeconomic fundamentals.
- Effect on GaR:
  - Lowers the entire growth distribution.
  - Malta’s one-year GaR drops closer to 1 percent.
- Policy implication:
  - Safeguarding the macro environment (through sound fiscal and financial policies) indirectly keeps GaR higher (better).

### Euro-area FCI shock (external financial tightening) (Section 2)
- Shock description:
  - Large euro-area-wide financial stress (e.g., sudden spike in global risk aversion; equity markets drop; credit spreads jump) causing the Euro Area FCI factor to deteriorate sharply.
- Transmission to Malta:
  - Credit to Maltese firms might slow as international lenders pull back.
  - Investor confidence could wane, and borrowing costs might rise for the sovereign and banks.
- Effect on GaR:
  - External financial tightening could reduce the one-year GaR close to or slightly less than that of the housing shock.
  - The GaR would fall to the 0.5–1   percent range in a severe case.
- Mitigating factor:
  - In practice, the ECB might respond to mitigate stress and soften the impact.
- Implication:
  - Malta’s outlook is sensitive to global financial conditions; even with sound domestic conditions, a global credit crunch can feed into higher downside risk.

### Negative external demand shock (Euro Area growth slowdown) (Section 2)
- Shock description:
  - Mild Euro area recession or significantly slower growth without major financial turmoil, weakening tourism and export demand for Malta.
- Effect on GaR:
  - Milder effect than the Euro Area FCI shock.
  - Model result: one-year GaR falls from 1.75 percent to 1.2 percent.
- Additional note:
  - External growth shock could affect baseline growth more than the extreme tail unless it triggers financial contagion.
  - Malta’s strong fundamentals and policy space could help cushion trade shocks, but prolonged external weakness would eventually feed into higher risks.

### Conclusion and policy recommendations (Section 2)
- Key baseline metric:
  - Malta’s baseline growth-at-risk is 1.75 percent, indicating a 5 percent chance that growth would fall below this threshold.
- Main risks ranked by impact on GaR:
  - Severe correction to credit and housing markets: could push the economy close to zero growth in a tail event with low probability.
  - External financial shocks (Euro-area FCI): material risks that can reduce GaR to the 0.5–1   percent range in severe cases.
  - Large negative domestic macro shock: relatively large impact, lowering GaR closer to 1 percent.
  - External growth slowdown and tightening of domestic conditions: more contained effects.
- Policy recommendations:
  - Domestic macroprudential policies should focus on the housing sector.
  - Vigilance is needed for global financial developments.
  - Maintaining strong policy buffers would support the resilience of Malta’s economy going forward.

*Source: Malta’s Growth-at-Risk: Exploring the Effects of Macro-Financial Factors on Growth, SIP/2026/022, prepared by Fuad Hasanov; completed January 20, 2026.*

### Section 1

### Malta’s Growth-at-Risk: Exploring the Effects of Macro-Financial Factors on Growth — Section 1

### Introduction: Purpose and GaR concept
- Growth-at-Risk (GaR) links current financial and economic conditions to a probability distribution of future real GDP growth over one- to two-year horizons.
- GaR focuses on tail risks: the lowest GDP growth rate with only a 5 percent chance of being lower (example: "If GaR is 2 percent, it means that there is a 5 percent probability that growth will fall below 2 percent over the specified horizon").
- GaR complements point forecasts by estimating the distribution and the likelihood of extreme negative growth scenarios.

### Malta’s macro-financial context: credit, housing, external openness, and buffers
- Growth and labor market
  - Real GDP growth averaged close to 7 percent per year from 2013 to 2019.
  - Real GDP growth remained above 5 percent in 2020-2024.
  - Growth in 2025 moderated to its estimated potential rate of about 4 percent.
  - Unemployment is at historic lows of about 2.9 percent.
  - Inflation has receded to around 2–3 percent.
  - Growth rate in 2024 was 6.85 percent (noted as at the 60th percentile of the historical distribution).
- Openness and external exposure
  - Total exports of goods and services at about 120 percent of GDP.
  - Current account surplus of around 6-7 percent of GDP.
  - Budget deficit declined to about 3.5 percent of GDP in 2024; public debt falling to below 50 percent of GDP (public debt noted at about 47 percent of GDP later).
- Credit and housing markets
  - Bank lending concentration in mortgages and construction loans: at end-2024 these accounted for 72 percent of banks’ private-sector loan portfolios, up from 60 percent a decade ago.
  - Household credit growth: household credit grew by 8–9 percent annually in recent years.
  - Mortgage interest rates around 3 percent.
  - Household debt approximately 60 percent of GDP, predominantly variable rate mortgages.
  - Residential property prices rose by 6.7 percent in 2024; price-to-income ratio stabilized at about 90 percent since the early 2020s.
  - Rental yields have edged up to about 6 percent.
- Financial conditions and buffers
  - Domestic financial conditions remained accommodative through 2024-25 (low mortgage interest rates, ample liquidity, moderate sovereign bond yields).
  - Public debt at about 47 percent of GDP and an A+ sovereign rating.
  - Central Bank stress tests: Tier 1 ratio of 21 percent; LCR more than 350 percent.
  - Domestic FCI correlated with Euro Area FCI; Euro Area FCI tightened in 2022-2023 with ECB rate hikes.

### GaR framework: variables, dimensionality reduction, and estimation
- Key composite factors included as predictors:
  - Domestic Financial Conditions: Malta-specific FCI (interest rates, spreads, equity performance, sovereign spreads, 10-year sovereign bond yields).
  - Domestic Risk Indicators: real house price growth, house price-to-income, house price-to-rent, real credit growth, credit to GDP.
  - Domestic Macroeconomic Fundamentals: recent trend (4-quarter moving average) real GDP growth and inflation.
  - External (Euro Area) Financial Conditions: Euro Area-wide FCI (credit spreads, volatility, investor sentiment, capital flows).
  - External (Euro Area) Macroeconomic Indicators: Euro Area GDP growth and inflation.
- Dimensionality reduction:
  - Principal component analysis (PCA) applied within each group.
  - The first principal component of each group (around 60 percent of group variance in the analysis) is used as the representative factor.
  - Final model uses five factors: domestic FCI, domestic risk, domestic macro, euro area FCI, euro area macro.
- Estimation approach:
  - Quantile regression in a local projections framework forecasting GDP growth h quarters ahead (h=4 for one-year, h=8 for two-year).
  - Separate regressions estimated for τ = 0.05 (5th percentile) and τ = 0.5 (median).
  - The one-year GaR regression form: g_{t+4, τ} = α_τ + β_τ ⋅ FCI_t + γ_τ ⋅ X_t + ε_{t+4, τ}, where coefficients vary by quantile.
  - A skewed T-distribution is fitted to the estimated quantiles to obtain the full forecast distribution.

### Baseline results: GaR estimates and historical assessment
- One-year-ahead (by mid-2026) distribution:
  - Baseline central estimate (median) around 4 percent.
  - 5th percentile (GaR 5%) about 1.75 percent.
  - 10th percentile about 2.75 percent.
  - Probability of negative growth in the next four quarters about 2 percent (noted as 1.96% in Figure 2).
  - Mode = 4.0; Realized Growth = 6.85 at quantile 59.57% (from Figure 2).
- Interpretation:
  - GaR 5% = 1.75 percent implies a 5 percent chance growth will fall below 1.75 percent in one year under prevailing conditions.
  - Near-term recession risk is low given strong starting point and momentum.
- Historical variation:
  - During 2015–19, one-year GaR in the 2–3 percent range.
  - COVID-19 shock: GaR plunged into negative territory in early 2020, consistent with the large contraction experienced.
  - By 2022–2023, GaR recovered.
  - Current GaR at 1.75 percent remains higher than during the euro crisis of 2012 or the 2008 financial crisis.
- Two-year-ahead horizon (through mid-2027):
  - Distribution is wider and flatter; left tail reaches notably negative growth rates.
  - Baseline two-year-ahead median might still be around 4 percent.
  - GaR 5% for two years ahead estimated at about –2.2 percent (noted as about –2 .2 percent in source).
  - GaR 10% for two years ahead about zero.
  - Implication: a 5 percent chance average annual growth over next two years could be -2 percent or worse.

### Scenario analysis: sensitivity to shocks and main drivers of downside risk
- Method: Shocking each composite factor in isolation (typically a 3 standard deviation adverse shock for scenarios).
- Domestic risk (credit and housing) shock:
  - A 3 standard deviation adverse shock to the “domestic risk” factor approximates a sharp house price fall plus substantial credit slowdown.
  - One-year-ahead GaR (5th percentile) deteriorates from 1.75 percent to around 0.5 percent.
  - Under this shock the entire growth distribution shifts left and the left tail becomes much thicker.
  - Transmission channels: contraction in construction activity, wealth effects lowering consumer spending, tighter credit availability, and higher loan delinquencies that could strain banks despite capital buffers.
- External shocks:
  - External factors from the Euro Area are likely to have a smaller direct impact on the growth rate distribution, transmitted through financial conditions in the bloc and Malta’s domestic FCI linkage.
- Additional notes from sensitivity checks:
  - Using growth rate of tourist overnight stays for the Domestic Macro factor increases GaR to about 2.5 percent for the one-year ahead horizon but reduces it to about -4.6 percent for the two-year ahead horizon.
  - Adding tourist overnight stays and real exports to Domestic Macro variables results in higher GaR for the one-year horizon.

*Source: Malta’s Growth-at-Risk: Exploring the Effects of Macro-Financial Factors on Growth, SIP/2026/022, prepared by Fuad Hasanov; completed January 20, 2026.*

### Section 2

### sipea2026022 - Section 2

### Tightening of domestic financial conditions
- Modeled by imposing stress on the domestic FCI (e.g., sudden rise in interest rates or widening of spreads due to loss of confidence).
- Effect on GaR:
  - The 5th percentile declines by a few tenths of a percent.
  - Tighter domestic financial conditions reduce credit growth and raise financing costs, trimming both median and tail outcomes.
- Malta-specific considerations:
  - Strong bank buffers and the likelihood that domestic tightening might coincide with a strong economy mean the impact on tail risk is noticeable but not as large as the housing shock.
  - Maintaining market confidence and prudent policies would help keep domestic financial conditions benign, thereby containing downside risk.

### Large negative shock to domestic macro fundamentals
- Shock description:
  - Idiosyncratic shock to a major industry leading to lower growth and higher inflation, worsening Malta’s current macroeconomic fundamentals.
- Effect on GaR:
  - Lowers the entire growth distribution.
  - Malta’s one-year GaR drops closer to 1 percent.
- Policy implication:
  - Safeguarding the macro environment (through sound fiscal and financial policies) indirectly keeps GaR higher (better).

### Euro-area FCI shock (external financial tightening)
- Shock description:
  - Large euro-area-wide financial stress (e.g., sudden spike in global risk aversion; equity markets drop; credit spreads jump) causing the Euro Area FCI factor to deteriorate sharply.
- Transmission to Malta:
  - Credit to Maltese firms might slow as international lenders pull back.
  - Investor confidence could wane, and borrowing costs might rise for the sovereign and banks.
- Effect on GaR:
  - External financial tightening could reduce the one-year GaR close to or slightly less than that of the housing shock.
  - The GaR would fall to the 0.5–1   percent range in a severe case.
- Mitigating factor:
  - In practice, the ECB might respond to mitigate stress and soften the impact.
- Implication:
  - Malta’s outlook is sensitive to global financial conditions; even with sound domestic conditions, a global credit crunch can feed into higher downside risk.

### Negative external demand shock (Euro Area growth slowdown)
- Shock description:
  - Mild Euro area recession or significantly slower growth without major financial turmoil, weakening tourism and export demand for Malta.
- Effect on GaR:
  - Milder effect than the Euro Area FCI shock.
  - Model result: one-year GaR falls from 1.75 percent to 1.2 percent.
- Additional note:
  - External growth shock could affect baseline growth more than the extreme tail unless it triggers financial contagion.
  - Malta’s strong fundamentals and policy space could help cushion trade shocks, but prolonged external weakness would eventually feed into higher risks.

### Conclusion and policy recommendations
- Key baseline metric:
  - Malta’s baseline growth-at-risk is 1.75 percent, indicating a 5 percent chance that growth would fall below this threshold.
- Main risks ranked by impact on GaR:
  - Severe correction to credit and housing markets: could push the economy close to zero growth in a tail event with low probability.
  - External financial shocks (Euro-area FCI): material risks that can reduce GaR to the 0.5–1   percent range in severe cases.
  - Large negative domestic macro shock: relatively large impact, lowering GaR closer to 1 percent.
  - External growth slowdown and tightening of domestic conditions: more contained effects.
- Policy recommendations:
  - Domestic macroprudential policies should focus on the housing sector.
  - Vigilance is needed for global financial developments.
  - Maintaining strong policy buffers would support the resilience of Malta’s economy going forward.

*Source: sipea2026022 - Section 2*

---


_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2026/english/sipea2026022.pdf_