Thu. Jul 18th, 2024

December 12, 2022

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

Washington, DC: Malta’s economic recovery from the pandemic has been remarkably strong. However, the indirect impact of the Russian war in Ukraine, including the anticipated slowdown in the European economy, high and volatile global energy prices, rising import costs, and weakened public finances following the pandemic are weighing on the outlook. In addition, boosting potential growth while achieving environmentally sustainable growth remains a key longer-term challenge. Against this backdrop, the policy priorities are:

  • Tackling the energy price shock in an efficient and cost-effective manner;
  • Continuing fiscal consolidation;
  • Maintaining financial stability and continuing efforts to strengthen the anti-money laundering and combatting the financing of terrorism (AML/CFT) framework; and
  • Reinvigorating structural reforms, including in green and digital transformation areas.

1. Following the worst recession in decades due to the pandemic, Malta’s economy has recovered strongly. With the easing of pandemic containment measures, output grew by 11¾ percent in 2021, the second-highest growth rate observed in the euro area. The economy has 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, but with strong labor demand, labor markets have tightened, and the unemployment rate has stayed at historically low levels.

2. 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. This growth forecast is based on the assumption of lower consumer purchasing power dampening domestic demand, and weakening external demand from European partners overall, even though tourism and gaming sector exports will continue to support growth. Uncertainty is significant, with risks to the outlook tilted to the downside. Externally, downside risks include a deeper-than-expected recession in Europe and a possible de-anchoring of inflation expectations (which would raise Malta’s import prices and result in tighter monetary policy than anticipated). Domestically, the key risk includes higher wage pressure (leading to higher and persistent inflation) and the realization of ML/TF risks. On the upside, lower-than-expected commodity prices would lead to stronger growth than forecast.

Tackling the global energy price shock

3. The freezing of retail electricity and fuel prices has contained inflation, but the price measures have also come with significant fiscal costs and blunted incentives to reduce energy demand and invest in green energy. The 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, the government’s strategy to continue the fixed price policy could place a strain on fiscal policy. Furthermore, suppressing the price signal does not help incentivize energy conservation and investment in energy-efficient products and green energy.

4. Staff recommend that the authorities prepare an exit strategy from the current fixed price policy while protecting vulnerable groups. Various options should be explored, including:

  • Adjust fuel prices to better reflect their import prices in line with pre-crisis practices as a possible first step.
  • Regarding electricity for household consumers, 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 consumers, 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.

The authorities should aim to start implementing exit options ahead of winter 2023/24, in a gradual fashion to contain inflation and economic risks.

Ensuring fiscal sustainability

5. 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 the 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. The expected size of the fiscal tightening is appropriate given the need to slow inflation and improve the public finances.

6. Staff welcomes the authorities’ commitment to medium-term fiscal consolidation, but additional action is needed. The authorities plan to reduce the overall deficit to below 3 percent of GDP by 2025. Public debt is, however, projected to hover just below 60 percent of GDP and could be put on an upward trajectory if growth underperforms. Accordingly, additional measures to mobilize revenues and enhance spending efficiency will be required.

· On the revenue side, in light of Pillar II of the global corporate tax reform agreement, the authorities need to reform the taxation of multinational firms and consider broader reforms to the tax system and to revenue administration, with the aim to simplify and improve the efficiency of the tax system and reduce administration and compliance costs while protecting revenues.

· On the spending side, staff supports the authorities’ plan to launch a spending review aimed at identifying the scope for rationalizing recurrent spending, while further efforts are needed to improve the efficiency of public investment, including in green investments. Long-term demographic trends (including migration patterns) should be closely monitored to properly plan pension-related reforms, and at the same time, efforts should continue to promote voluntary occupational pensions and personal pensions.

7. The distributional impact of the high inflation warrants close monitoring. Due to higher inflation, poverty and income inequality may be rising, particularly for low-income individuals and elders who receive a pension that falls below the poverty line. To mitigate the impact, the 2023 Budget introduced additional support to these vulnerable groups. Given the risk of persistent inflation, the 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 pursuing AML/CFT Reform

8. 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 . Since these risks could deteriorate the debt service capacity of borrowers, the authorities should remain vigilant and closely monitor banks’ risk management to ensure that provisions are continuously updated as economic prospects change. Given the banking sector’s large exposure to the housing market, the authorities could complement current macroprudential measures with a sectoral systemic capital risk buffer targeting mortgage loans. In addition, the risks of cyberattacks on critical infrastructure and institutions have increased, and the authorities’ increased efforts to monitor cyber security risks are welcome.

9. The Central Bank of Malta’s recent stress test indicates that the banking sector is resilient to transitional climate risk. Building upon this stress testing framework, the authorities could usefully develop a framework that assesses the banking sector’s resilience to physical climate risk. The authorities are also developing a module that estimates the second-round effects on non-financial corporates that will further improve the framework.

10. The prompt exit from the Financial Action Task Force’s grey list reflected the authorities’ high-level political commitment. Commendable progress has been achieved, including in the areas of beneficial ownership information, the application of sanctions for non-compliance, and the use of financial intelligence. Resources for AML/CFT supervisors have been boosted, which will help the long-term sustainability of reforms. In addition, the national AML/CFT strategy for 2021–2023 enhances coordination and supervision to mitigate existing and emerging risks. The close monitoring of high-risk sectors, especially virtual financial assets, gaming, and sectors associated with Malta’s Citizenship by Investment program, should also continue.

Reinvigorating Structural Reforms.

11. Continued efforts are necessary to address Malta’s long-term growth and climate challenges. Malta’s Recovery and Resilience Plan will address part of its structural challenges, but more efforts will be needed. While Malta’s digital transformation is placed well in the EU’s 2022 Digital Economy and Society Index compared to European peers, weaknesses remain related to the low number of STEM graduates, the low digital intensity of small and medium-sized enterprises, and weak technical skills and human resources. The Smart Specializations Strategy for 2021-27 provides an opportunity to address these weaknesses by channeling investments in priority areas and promoting research and innovation. In addition, the authorities should continue to implement the plan for employment, including upskilling and reskilling the labor force. Fostering labor force participation through incentives for workers to delay retirement and flexible working solutions could also help address structural labor shortages. On climate change policy, concerted efforts involving all stakeholders are needed to implement the 2021 Low Carbon Development Strategy.

12. Further strengthening of the governance framework is critical to attract investors. Over the past two years, the authorities have made some progress in reforming the Maltese justice system in line with the recommendation from international organizations, including 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.

The IMF team would like to thank the authorities and private sector counterparts for their generous availability and constructive dialogue.

Source – IMF

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