Malta must reduce deficit

To avoid further downgrades, the government must continue to reduce its deficit fast enough to persuade investors of public debt sustainability, according to Ernst and Young’s Autumn 2011 Eurozone Forecast for Malta, when referring to Moody’s downgrading of Maltese government bonds last September.

As countries implement austerity measures we expect a slowdown of tourist arrivals

“Current Budget plans show the fiscal deficit falling to 2.8 per cent of GDP in 2012 and 2.2 per cent in 2013. These projections are optimistic on the rate of public sector cost reduction. While unemployment is expected to fall from 6.9 per cent in 2010 to 6.5 per cent in 2011, helping to keep welfare costs down, public pension and health care costs remain a cause for concern,” the report says.

Ernst and Young, however, said the government has demonstrated that cutting the deficit is its main priority, and although it remains committed to income tax cuts, “it has yet to set a timetable for these, having indicated that rebalancing the budget is top priority during the present Parliament.”

The report forecasts the deficit will fall slightly from 3.1 per cent of GDP in 2011 to 2.8 per cent in 2013, while debt is expected to remain at 68 per cent of GDP in 2011 and decline gradually thereafter.

It adds: “While the government has promised to resist pressure for additional social spending, this will become harder to resist as elections approach in 2013. Trade union demands for pay and pension increases, to offset rising living costs, are likely to be backed by the opposition Labour Party, which has already attacked what it claims is a government plan to raise the retirement age to 68 from the current 65.

“But the ruling Nationalist Party’s likely alternative – increased private sector pension saving to relieve upward pressure on the state pension – will be difficult to pursue at a time when wage restraint and rising utility costs are already affecting real incomes.”

The forecast said the stability of Malta’s banking sector during the international financial problems that started in 2008 as well as the arrival of new investment fund and captive insurance business helped keep Malta’s sovereign credit rating stable, while those of other countries with large financial sectors, including the US, suffered downgrades.

“Standard and Poor’s, which downgraded the US in August 2011, affirmed Malta at A with stable outlook last October, but made this conditional on a return to economic growth, asset price recovery, budget deficit reduction and continued performance improvement at the banks and state-owned energy supplier Enemalta,” it said.

Since then, Ernst and Young says, the threat of contagion from neighbouring economies has worsened, with events in Cyprus – downgraded for its banks’ exposure to Greece, and energy supply problems – weighing especially heavily on Malta’s markets. It points out that the Central Bank of Malta has said banks’ collective exposure to Portugal is equivalent to 16 per cent of their capital. Spain (eight per cent) and Greece (five per cent) are the next biggest bilateral components.

The report warns: “But its calculation of exposure to all debt-troubled eurozone economies would inevitably rise sharply if credit concerns are established over Italy or any other large member country.”

The forecast says Malta’s GDP is expected to expand to 2.7 per cent this year and to 2.8 per cent in 2012, slightly down on last year’s growth of 3.4 per cent, adding that the financial market turmoil in the eurozone will affect Malta through lower demand for exports and weaker business confidence.

“Although tourist arrivals were up 12 per cent year on year in the first six months of 2011, the scope for further growth this year is limited by household income restraint in the eurozone and the impact of first-quarter fuel price increases on transport costs. As a result, we expect tourist arrivals to rise by less than 10 per cent in 2011 as a whole, after a strong rebound in 2010.

“Moreover, as most eurozone countries implement tough austerity measures during 2012-13, we expect a further slowdown of tourist arrivals in the next few years, before growth of revenues from the tourism sector regain momentum after 2014,” it says.

The report points out that “encouragingly” banking and alternative fund management services, on which the financial sector is concentrated, have been among the most resilient to 2011’s slowdown, and will help to offset the negative impact of eurozone and UK slowdown on tourism in the second half of this year.

“In contrast to the manufacturing slowdown, official data shows that the financial sector grew 22 per cent in 2010, its employment moving above 9,500,” it says.

The report says Malta’s success in attracting investment fund business is reflected in the latest foreign direct investment data which shows inflow up 46 per cent to €792 million in 2010. Almost 75 per cent of the net inflow consisted of equity capital and, in total, over 84 per cent was related to financial intermediation.

“Last year’s rise in market value of equity already invested meant that the officially recorded foreign direct investment stock virtually doubled, to €12.4 billion at the end of 2012,” it highlights.

Ernst and Young says the predominantly financial nature of foreign direct investment may make it potentially less stable than that with a greater fixed-investment component, “but the relatively large scale of inflows has helped to maintain stability, while the external deficit is gradually reduced”.

It says Microsoft’s decision to focus its first Maltese Innovation Centre on cloud computing can be interpreted as a vote of confidence in the effort to develop an information technology cluster on the island.

On Air Malta the report says the need for public subsidy reduction has already forced a painful rationalisation of the national airline, which is attempting to regain profitability, while keeping fares competitive with those of foreign budget airlines.

“Management has claimed progress toward cost-saving targets after initial union resistance; but it is unlikely to learn until the year-end whether the restructuring has gone far enough to satisfy the European Commission, enabling it to keep the €52 million one-off subsidy conditionally approved in 2010,” it says.