Difficulty in reducing Malta's public spending means that balancing the country's Budget is likely to result in a rise in the overall tax take, according to the latest Ernst & Young Eurozone Forecast for Malta.

The forecast points out that Malta's tax take has already risen substantially in the past 10 years but remains below the eurozone average at 36 per cent of GDP.

It also says Malta's economic growth is expected to reach a little over two per cent in both 2010 and 2011.

The forecast says the outlook for manufactured export growth is not as clear as tourism, as production and exports were set back by the eurozone downturn of 2008-09 despite their focus on new technology and software.

It says that although Malta's budget deficit is not as high as in some other countries, it may prove to be more protracted.

"Without further action to narrow the deficit, it is set to remain above four per cent of GDP until 2012, not returning below the three per cent eurozone ceiling until 2014," it says.

The report says this slow decline in the deficit is unacceptable to Brussels because Malta's public debt was already close to 70 per cent of GDP by the end of 2009 and will climb further unless the deficit falls faster.

The report says that Malta's eurozone entry has coincided with a shift from export-led to domestic expenditure-led growth, with the government an important source of this expenditure.

"The pattern will be relatively successful at generating growth with low inflation in 2010-14. But it leaves the upturn vulnerable to inward investment slowdown, which would force a reduction in the external deficit, and to EU pressure for faster fiscal deficit reduction," it says.

The forecast points out that Malta's rising wage costs compared with eurozone competitors will add to the difficulty of generating new manufactured exports, and may also begin to affect the tourist inflow.

"Malta's Central Bank will press for a review of current wage indexation arrangements, in pursuit of greater flexibility to tie pay rises to efficiency gains or demand and supply, in particular in labour markets," it says.

The report says financial services will benefit from the recovery of investment flows and fund values in 2010-11. However, Malta's efforts to expand as a base for hedge funds and other specialist investment vehicles will not be helped by new EU proposals for their regulation, approved by a majority of finance ministers in May despite Malta supporting the UK's opposition, it says.

"The new rules are primarily intended to improve supervision of funds to stop them causing systemic instability, a move that would ultimately support the industry's growth by letting it attract more mainstream investment. But the changes could also result in greater movement of specialist funds to larger eurozone financial centres, disadvantaging the smaller players," Ernst & Young says.

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