Mission Concluding Statement 

Malta: Staff Concluding Statement of the 2023 Article IV Mission

November 23, 2023

Valletta, Malta: Malta has marked an impressive recovery from the pandemic and demonstrated substantial resilience to shocks resulting from Russia’s invasion of Ukraine. With weaker external demand and waning post-pandemic pent-up demand, growth is normalizing but is still expected to be among the highest in Europe. Persistent inflationary pressures are expected, while concern has risen about capacity constraints. Against this backdrop, the key policy priorities are:

• Initiate a front-loaded fiscal tightening to rebuild fiscal buffers at a faster pace and help contain demand pressures. Prepare an exit strategy from the current generous energy subsidy policy and gradually implement it, with a view to containing fiscal costs and risks and enhancing incentives for energy conservation and transition, while protecting vulnerable populations.
• Maintain vigilance in monitoring financial sector risks, particularly in the areas of borrower creditworthiness, cyber security, and money laundering/terrorist financing.
• Boost structural reform efforts in innovation, digitalization, labor markets, education, and green transformation to achieve high, socially- and environmentally-sustainable, and inclusive growth.

Robust growth with persistent inflationary pressure

1. Malta has experienced an impressive recovery from the pandemic. Output growth has rebounded sharply since the reopening of the economy in 2021. The recovery has been aided by fiscal support, increased labor participation, large inflows of foreign workers, and, more recently, limited passthrough from monetary policy interest rates to domestic retail lending rates. With weaker external demand and waning post-pandemic pent-up demand, staff expect real GDP to moderate but continue to expand by around 4 percent in 2023 and 3½ percent in 2024, among the highest growth rates in Europe. Labor markets remain tight, while the unemployment rate remains at historically low levels. Both headline and core inflation peaked a year ago and have since decelerated as global inflationary pressures have eased. Still, staff expect elevated inflation to remain persistent and above the 2 percent target until late 2025, in part reflecting tight labor markets and sustained demand pressure. The challenge for the medium term is to ensure a robust policy framework to foster strong, socially- and environmentally-sustainable, and inclusive growth.

2. Risks to the outlook are tilted to the downside. Externally, downside risks include spillover effects from a possible escalation of Russia’s war in Ukraine or of the Israel-Gaza conflict, especially with implications for global commodity prices, as well as a deeper-than-expected economic downturn in Europe. Domestically, wage and inflationary pressures could be higher and more persistent, while money laundering/terrorist financing risks could materialize. Uncertainties surrounding the effects of the EU’s Minimum Tax Directive (Pillar II) remain a risk. On the upside, lower-than-expected commodity prices would help decelerate inflation, ease fiscal pressures, and boost growth.

Building fiscal buffers faster and containing demand pressures

3. Fiscal deficits remain large. The 2024 Budget expects a small decline in the overall deficit from 5 percent of GDP in 2023 to 4.5 percent of GDP in 2024, with new discretionary spending measures, including to support pensioners and low-income earners, more than offset by the phasing out of costs related to Air Malta’s restructuring and remaining Covid-19 related support measures. The energy subsidies will remain large at 1¾ percent of GDP, accounting for about 40 percent of the overall deficit. The structural balance will remain at a deficit of 4.3 percent of GDP in 2024, compared to a surplus before the pandemic. Beyond 2024, the authorities plan to gradually reduce the overall deficit to the target of 3 percent of GDP by 2027, assuming sustained strong growth and lower energy prices. With sustained large deficits, general government debt will continue to rise from 52 percent of GDP in 2022 to 57 percent in 2026, compared with 40 percent in 2019.

4. Because of strong demand pressure, the authorities should consider a more sizable and front-loaded fiscal adjustment. The economy is at its full potential, marked by a tight labor market, strong domestic demand, and elevated inflation, and thus, a tighter fiscal stance will help contain demand pressure. In addition, the public debt trajectory is exposed to important downside risks because growth could underperform, and energy prices could stay high. Malta is a small, open, island economy particularly exposed to external shocks, with growing spending pressures to address climate change and infrastructure needs. Accordingly, building larger fiscal buffers—above current levels—is essential to strengthen the economy’s resilience. S taff recommend that the authorities undertake a more sizable and front-loaded fiscal adjustment, on the order of additional 1½ percentage points of GDP over 2024-2025.

5. The prevailing energy subsidy policy should be phased out.The ongoing energy price shock can no longer be viewed as temporary, and suppressing the price signal does not help incentivize energy conservation or green transition. In addition, the sheer size of the subsidies limits fiscal space in reallocating resources to productivity-enhancing reforms while consolidating the fiscal position. Accordingly, in line with staff’s recommendations in the 2022 Article IV Consultation, the authorities should prepare an exit from the fixed price policy, with the aim of containing fiscal costs and strengthening market price mechanisms to enhance conservation while protecting low-income and, to a lesser extent, middle-income households. The strategy should be implemented predictably and could move gradually, beginning with adjusting fuel prices to better reflect their import costs in line with past practices while also making the electricity tariff structure more progressive. A gradual move may ease pressures on consumers but would also delay the benefits of exit while leaving public finances vulnerable to further energy price increases.

6.Furthermore, broader efforts encompassing both revenue and spending measures should continue.On the revenue side, staff welcome a recently-launched comprehensive program to modernize the Commissioner for Revenue, aimed at improving the efficiency and effectiveness of tax collection. This should lead to higher revenue collections at lower costs of compliance for taxpayers. On the spending side, priorities include a review to identify the scope for rationalizing recurrent spending and reallocating more resources to boost productivity, improving the efficiency of public investment (including green), and strengthening public procurement by streamlining the vetting process, accelerating digitalization, and implementing a risk-based approach. Measures in these areas would contribute to the fiscal adjustment while supporting growth.

7. Corporate income tax (CIT) reform is increasingly urgent in light of the EU’s Directive on OECD Pillar II. Of utmost importance is developing a well-structured roadmap for a phased implementation of the CIT reform to provide both international and domestic taxpayers with certainty. Given the interaction of the personal income tax (PIT) and the CIT, the roadmap should also include PIT reform. The authorities should develop a road map in consultation with stakeholders and announce it by late 2024.

8. The authorities should continue to pay close attention to income inequality and poverty risk. The 2024 Budget introduced additional support for vulnerable groups, including pensioners. Given the risk of persistently high costs of living, the authorities should continue to closely monitor impacts of inflation and other economic developments on inequality and evaluate the adequacy of the current tax and benefit system.

Safeguarding financial stability and sustaining AML/CFT reform

9. Malta’s financial system remains sound and resilient to shocks. Banks maintain ample capital and liquidity buffers. Given heightened uncertainty, however, the authorities should ensure that banks continue to closely assess how developments in inflation and financial conditions affect the balance sheets of vulnerable and leveraged borrowers and update provisions for credit risks. In addition, the authorities should remain vigilant in monitoring price developments in the residential and commercial real estate sectors. Furthermore, while passthrough from monetary policy to retail lending and deposit interest rates has been limited, its differential effects on banks’ financial performance depending on their size and business model warrant close monitoring. Increased allocation of resources towards cyber security is welcome, especially given the growing threat of cyberattacks.

10. The authorities’ recent actions to tighten macroprudential policies are welcome. They introduced a sectoral systemic capital buffer targeting residential mortgage exposures, initially set at 1 percent from end-September 2023 and increasing to 1.5 percent from end-March 2024. This will strengthen banks’ resilience to a possible housing sector shock. As macro-financial conditions evolve, the authorities should continue to review the effectiveness and appropriateness of their borrower-based measures, including loan-to-value, debt-service-to-income, and maturity limits.

11. The authorities are committed to further improving the AML/CFT framework. Resources for AML/CFT supervisors and regulators have been significantly boosted, and collaboration mechanisms among them have been enhanced, which would support the long-term sustainability of the reforms. Other efforts include enhancing training programs for the private sector and for the risk-based approach. In light of a 2022 ruling of the EU Court of Justice on public accessibility of beneficial ownership (BO) information, Malta has suspended public access to the BO registry. Implications of this move for the robustness of the AML/CFT framework should be carefully assessed, and if warranted, risk mitigation measures should be developed. Malta’s updated AML/CFT National Risk Assessment should be published by the end of this year as planned.

Pursuing robust structural reforms

12. Boosting productivity will be imperative to achieve high, sustainable, and inclusive growth. Malta’s Recovery and Resilience Plan under the Next Generation EU initiative is starting to deliver much-needed reforms and investments in digitalization and green transition. The authorities have launched other initiatives, including the Smart Specializations Strategy for 2021-27 and the National Employment Policy for 2021-30. Beyond these, efforts should aim at promoting research and innovation, addressing skill gaps, and tackling the low take-up rate of adult learning for the low-skilled. In addition, education outcomes for students with non-EU backgrounds should be closely monitored. Progress has been made in strengthening Malta’s anti-corruption framework, but further efforts are needed to ensure investor confidence.

13. Accelerating decarbonization and boosting investments in renewables will help strengthen Malta’s resilience to energy shocks and its competitiveness. It is imperative to make steady progress in implementing the 2021 Low Carbon Development Strategy, to allow greater passthrough of market energy prices to consumers to enhance incentives for energy saving and efficiency, to complete the climate vulnerability risk assessment, and to update the climate change adaption plan.

14. In light of flagging productivity and looming structural capacity constraints, there is a need to refocus Malta’s economic development strategy. Key themes should include analyzing: (i) gaps in the needed labor force and skills to achieve sustainable long-term growth; (ii) immigration policies to ensure there is the right supply of skills needed to meet demand; and (iii) needs in physical and social infrastructure, including roads, housing, education, and health services. The existing national planning strategy, Strategic Plan for Environment and Development 2015, should be updated expeditiously to reflect the latest demographic projections, and sectoral policies (e.g., tourism) should be aligned.

The IMF team thanks the authorities and other counterparts for their generous availability and constructive dialogue.