The European Commission’s recommendation to lift the excessive deficit procedure is evidence that Malta’s public finances are back on track. It also signifies that the requirements of the stability and growth pact are practically being met.
There are a number of reasons why the excessive deficit procedure is likely to be lifted. First, the Maltese economy is growing – and at a rate higher than our eurozone partners. In 2015, this growth is forecast to reach 3.5 per cent, driven by an increase in consumption and, to a lesser extent, investment. A growing economy generates higher levels of taxation, both direct and indirect, and, coupled with enhanced efficiency in tax collection, it is perhaps not surprising that the increase in government revenue is at present exceeding the increase in expenditure.
A second reason is government’s efforts to curb expenditure. Relative to gross domestic product, government spending has virtually remained at pre-2013 levels so the reduction in the general government deficit is to a larger extent due to increased revenue from direct and indirect taxation.
Sound financial management, especially in the timing of the maturity date of government stocks, has also proved important. Timing is crucial for managing expenditure on capital repayment and the Treasury has also done a very good job in seeking to optimise the government’s capital structure.
In my view, the above reasons go a long way towards explaining why public finances are on the mend. However, no analysis can be complete without considering the risks the Maltese economy is likely to face in the months and years ahead. The government is aiming to achieve a balanced budget by 2019. That seems to be ambitious, given the underlying risks as well as possible international developments that might derail economic growth and fiscal targets.
The risks associated with demographic change and population dynamics need to be factored in
In the first instance, our economy’s increasing reliance on tourism is becoming more obvious. Whereas tourism has boosted consumer spending and provided new jobs, the risks associated with planning of flights and hotel capacity cannot be overlooked. Risks are also likely to increase with tougher competition in southern Europe and the emergence of new market participants operating new business models, as well as the increasing relevance of web-based distribution of travel services.
Second, despite increasing global inventories, Brent crude oil prices are expected to rise from an average $61 a barrel in 2015 to $70 in 2016. Several factors are likely to contribute to this, including higher global oil demand, declining US tight oil production in the coming months, and the growing risk of unplanned supply outages in the Middle East and North Africa. The growing uncertainty in the Middle East, especially due to increasingly strained relations over a number of geopolitical issues between Iran and Saudi Arabia, is also likely to affect crude oil prices.
The outcome of the forthcoming EU referendum in Britain, and a positive impact of EU quantitative easing on eurozone economies could see the euro strengthening against a weaker pound, thereby make exports of tourism services to the UK more expensive.
And finally, the risks associated with demographic change and population dynamics need to be factored in. On a positive note, Eurostat’s revised population projections show that the Maltese population will continue to grow till 2060. This would reduce somewhat the dependency burden of retirees on the working age population. However, it is unlikely to offset further increases in pension expenditure. Further pension adjustment appears inevitable, but more far-reaching reform may be required if the economy does not grow as rapidly as expected, pressuring all incomes – including pensions. The risk that the distribution of income will change – to the detriment of retirees – would in these circumstances increase.
Despite an improved outlook for public finances, it would be foolhardy to ignore the risks that could negatively impact fiscal targets. I have tried to identify some of the more important risks but the list is not exhaustive by any means.
Philip von Brockdorff is the head of the economics department at the University of Malta.