Malta: Staff Concluding Statement of the 2022 Article IV Mission
IMF News, December 12, 2022
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- Published: December 12, 2022
Economic recovery and near-term performance
- Following the worst recession in decades due to the pandemic, Malta’s economy has recovered strongly.
- Output grew by 11¾ percent in 2021, the second-highest growth rate observed in the euro area.
- The economy continued to expand for the first three quarters of 2022, driven by strong net exports and private consumption.
- Staff expect real GDP to grow by 6½ percent in 2022.
- Inflation has picked up but has remained among the lowest in the euro area, reflecting the government’s policy to freeze retail electricity and fuel prices for all consumers.
- Foreign worker inflows have returned to pre-crisis levels; labor markets have tightened and the unemployment rate has stayed at historically low levels.
Outlook and risks
- Output growth is set to slow to 3¼ percent in 2023 as the confluence of global shocks weighs on the economy.
- Inflation is expected to gradually decline but remain elevated.
- Forecast assumptions: lower consumer purchasing power dampening domestic demand; weakening external demand from European partners overall, with tourism and gaming sector exports continuing to support growth.
- Risks to the outlook are tilted to the downside:
- External downside risks: a deeper-than-expected recession in Europe; possible de-anchoring of inflation expectations (raising Malta’s import prices and resulting in tighter monetary policy).
- Domestic downside risks: higher wage pressure (leading to higher and persistent inflation) and the realization of ML/TF risks.
- Upside scenario: lower-than-expected commodity prices would lead to stronger growth than forecast.
- Uncertainty is significant.
Tackling the global energy price shock
- The freezing of retail electricity and fuel prices has:
- Contained inflation.
- Imposed significant fiscal costs and blunted incentives to reduce energy demand and invest in green energy.
- Energy sector subsidies are expected to increase from 2½ percent of GDP in 2022 to 3½ percent of GDP in 2023, accounting for more than half of the overall deficit.
- With global energy prices likely to remain well above pre-war levels for a prolonged period, continuing the fixed price policy could strain fiscal policy and suppress price signals needed for energy conservation and green investment.
- Staff recommend preparing an exit strategy from the current fixed price policy while protecting vulnerable groups. Options include:
- Adjust fuel prices to better reflect their import prices in line with pre-crisis practices as a possible first step.
- For household electricity: allow a greater passthrough of market prices to consumers with targeted cash transfers to low-income and, to a lesser extent, middle-income households; alternatively, make the tariff structure more progressive to better reflect the level of electricity consumption and marginal cost, with the subsistence level of consumption priced at below marginal cost.
- For business electricity: allow a greater passthrough of market prices, with financial support for energy-intensive firms provided only on a temporary basis, conditional on efforts to increase energy efficiency.
- Consider the introduction of a peak demand electricity charge.
- Timing guidance: aim to start implementing exit options ahead of winter 2023/24, in a gradual fashion to contain inflation and economic risks.
Ensuring fiscal sustainability
- The moderate fiscal tightening planned for 2023 is appropriate.
- The 2023 Budget envisages a reduction in the overall deficit from 5¾ percent of GDP in 2022 to 5½ percent of GDP in 2023, implying a cut of about one percentage point of GDP of the primary structural balance.
- The increase in energy subsidies will be more than offset by the phasing out of COVID-19-related support measures and containment of non-energy spending, including capital projects.
- Staff welcome the authorities’ commitment to medium-term fiscal consolidation, but additional action is needed:
- Authorities plan to reduce the overall deficit to below 3 percent of GDP by 2025.
- Public debt is projected to hover just below 60 percent of GDP and could be put on an upward trajectory if growth underperforms.
- Additional measures are required to mobilize revenues and enhance spending efficiency.
- Revenue-side recommendations:
- In light of Pillar II of the global corporate tax reform agreement, reform the taxation of multinational firms and consider broader reforms to the tax system and to revenue administration to simplify and improve efficiency and reduce administration and compliance costs while protecting revenues.
- Spending-side recommendations:
- Launch a spending review to identify scope for rationalizing recurrent spending.
- Improve the efficiency of public investment, including in green investments.
- Closely monitor long-term demographic trends (including migration patterns) to properly plan pension-related reforms.
- Continue efforts to promote voluntary occupational pensions and personal pensions.
Distributional effects of inflation
- The distributional impact of high inflation warrants close monitoring.
- Higher inflation may be raising poverty and income inequality, particularly for low-income individuals and elders who receive a pension that falls below the poverty line.
- The 2023 Budget introduced additional support to these vulnerable groups.
- Given the risk of persistent inflation, authorities should continue to closely monitor its impact on inequality and evaluate the adequacy of the current tax and benefit system to prevent income inequality from increasing.
Safeguarding financial stability and AML/CFT reform
- The banking system is sound, with ample capital and liquidity buffers and adequate provisioning, but risks are emerging from high inflation and tightening global financial conditions.
- Authorities should remain vigilant and closely monitor banks’ risk management to ensure provisions are continuously updated as economic prospects change.
- Given the banking sector’s large exposure to the housing market, authorities could complement current macroprudential measures with a sectoral systemic capital risk buffer targeting mortgage loans.
- Cybersecurity risks have increased; authorities’ increased efforts to monitor cyber security risks are welcome.
- Climate-related stress testing:
- The Central Bank of Malta’s recent stress test indicates the banking sector is resilient to transitional climate risk.
- Authorities could develop a framework to assess resilience to physical climate risk and are developing a module that estimates second-round effects on non-financial corporates.
- AML/CFT progress:
- Prompt exit from the Financial Action Task Force’s grey list reflected high-level political commitment.
- Commendable progress in beneficial ownership information, application of sanctions for non-compliance, and use of financial intelligence.
- Resources for AML/CFT supervisors have been boosted.
- The national AML/CFT strategy for 2021–2023 enhances coordination and supervision.
- Close monitoring of high-risk sectors—especially virtual financial assets, gaming, and sectors associated with Malta’s Citizenship by Investment program—should continue.
Reinvigorating structural reforms and governance
- Continued efforts are necessary to address Malta’s long-term growth and climate challenges.
- The Recovery and Resilience Plan will address part of Malta’s structural challenges, but more efforts are needed.
- Digital and labor market challenges:
- Malta is placed well in the EU’s 2022 Digital Economy and Society Index compared to European peers, but weaknesses remain: low number of STEM graduates; low digital intensity of small and medium-sized enterprises; weak technical skills and human resources.
- The Smart Specializations Strategy for 2021-27 provides an opportunity to channel investments in priority areas and promote research and innovation.
- Authorities should continue to implement the plan for employment, including upskilling and reskilling the labor force.
- Foster labor force participation through incentives for workers to delay retirement and flexible working solutions to help address structural labor shortages.
- Climate policy:
- Concerted efforts involving all stakeholders are needed to implement the 2021 Low Carbon Development Strategy.
- Governance and justice system:
- Further strengthening of the governance framework is critical to attract investors.
- Progress has been made on justice system reforms, adopting new strategies to strengthen governance and allocating increased resources to investigative and prosecution bodies.
- Further efforts are needed to enhance the effectiveness and efficiency of the justice system.
Malta: Staff Concluding Statement of the 2022 Article IV Mission