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Outlook for Malta

Firm domestic activity lifts 2014 GDP growth forecast to 2.7%

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1EY Eurozone Forecast December 2014 | Malta

Highlights

• Malta was one of the fastest-growing countries in the Eurozone in H1 2014 and, as domestic activity has solid momentum, we have raised our forecast for 2014 GDP growth to 2.7% from the 2.2% seen in September. We expect consumer spending to remain reasonably strong, supported by the firm labor market and government spending.

• Malta’s unemployment rate in August fell to its lowest level since early 2008, helped by the introduction of polices to boost employment. In addition, fiscal policy has been expansionary and backed by higher revenues. Investment into the energy sector will help Malta reduce its dependence on fossil fuels and will boost its longer-term growth prospects, helping GDP growth to average more than 2% in 2015–18.

• The services sector continues to grow solidly, largely due to buoyant tourism. Over the medium term, we expect strong service exports to keep the current account in surplus, supporting robust GDP growth. Solid services activity should also protect Malta from the Eurozone-wide threat of deflation. Inflation was just 0.7% in October, but service price inflation is running at more than 2%.

• While we see the risk of deflation in Malta as low, lagging productivity is a bigger risk. As a small and very open economy, it is crucial that Malta’s service sector remains competitive. However, productivity has improved at a much slower pace than in some other European countries, such as Spain, in recent years. Wage rises are currently linked to inflation, but if they were linked to productivity this might be an incentive for it to improve.

GDP growth

2014

2.7% GDP growth

2015

2.5%

Unemployment

2014

5.9%

Consumer prices

2014

0.8%

2 EY Eurozone Forecast December 2014 | Malta

Firm domestic activity lifts 2014 GDP growth forecast to 2.7%

Domestic activity has solid momentum, outpacing the Eurozone

Malta’s GDP grew by 1.4% on the quarter in Q2, the fastest pace of growth in a year and 2.5% higher than 12 months earlier. Household spending remained firm, growing by 0.5% on the quarter and more than 2% on the year, and fixed investment rose sharply in the first half of 2014, driven by strong construction and machinery investment. Domestic activity should maintain this solid momentum into 2015. This will be helped by falling unemployment, which was down to 5.9% in August after ending 2013 at 6.4%, and strong tourist arrivals, which were up 8.4% on the year in January–August. Lower utility prices, which were cut earlier in the year, will also help.

We have upgraded our GDP forecast for 2014 to 2.7%, from the 2.2% seen in September. We expect the economy to grow by 2.5% in 2015 and 2.2% in 2016, remaining ahead of the Eurozone average.

Total government revenues rose by 16% on the year in the first eight months of 2014 (in nominal terms), helped by higher value-added tax revenues and higher receipts from rental incomes as a result of a revision to how rents are taxed. But nominal capital spending rose by 16.3% on the year in January–August, lifted by the construction of a new power plant that will provide Malta with 200 megawatts of energy capacity and liquefied natural gas once it is completed.

The Government is targeting a reduction in the fiscal deficit to 2.1% in 2014. However, given the strong spending in the year to date, we are more cautious and expect the deficit to be 2.3% of GDP. Over the medium term, we forecast that the deficit will shrink to close to 1% of GDP by 2018, driven down by higher revenue growth. The working age population is falling though, and the impact of this on pensions and health care is likely to limit any further improvement in the fiscal position. Within the next 10 years, Malta is expected to have 100,000 people over the age of 65, up from 72,000 in 2012, while over the same period the working age population is likely to have fallen by close to 5%.

Table 1

Malta (annual percentage changes unless specified)

2013 2014 2015 2016 2017 2018

GDP 2.5 2.7 2.5 2.2 2.0 1.8

Private consumption 1.7 2.0 2.3 2.2 2.0 1.9

Fixed investment 2.3 4.0 2.9 2.7 2.5 2.3

Stockbuilding (% of GDP) 1.0 –0.3 1.0 1.0 1.0 0.9

Government consumption 1.0 6.1 2.2 1.7 1.6 1.7

Exports of goods and services –1.7 –0.9 2.7 3.3 3.0 3.0

Imports of goods and services –1.8 –1.6 3.5 3.3 3.0 3.0

Consumer prices 1.0 0.8 1.3 1.7 2.3 2.3

Unemployment rate (level) 6.4 5.9 5.8 5.7 5.6 5.6

Current account balance (% of GDP) 0.9 2.4 1.2 0.9 0.4 0.0

Government budget (% of GDP) –2.7 –2.3 –1.9 –1.6 –1.4 –1.1

Government debt (% of GDP) 69.8 70.4 69.7 68.7 67.2 65.6

ECB main refinancing rate (%) 0.5 0.1 0.1 0.1 0.2 0.8

Euro effective exchange rate (1995 = 100) 120.8 123.4 119.2 117.2 116.6 116.2

Exchange rate (US$ per € ) 1.33 1.33 1.24 1.21 1.20 1.19

Source: Oxford Economics.

3EY Eurozone Forecast December 2014 | Malta

Table 2

Forecast for Malta by sector (annual percentage changes in gross added value) 2013 2014 2015 2016 2017 2018

GDP 2.5 2.7 2.5 2.2 2.0 1.8

Manufacturing –9.6 1.4 1.2 1.3 1.5 1.2

Agriculture –2.4 0.9 0.6 0.5 0.5 0.5

Construction –2.9 2.5 2.6 2.3 2.1 1.9

Utilities 240.3 3.0 2.4 1.9 1.6 1.3

Trade –0.4 2.3 1.9 1.3 0.8 0.5

Financial and business services 5.7 4.1 3.5 3.0 2.8 2.5

Communications 10.8 5.1 4.5 3.9 3.7 3.4

Non-market services 2.7 2.0 2.0 2.0 1.9 1.9

Source: Oxford Economics.

Investment is rising, driven by commitment to reducing energy costs

Fixed investment rose by 9.4% on the year in the first half of 2014, up from 2.3% for 2013 as a whole. And although we expect it to slow to a more sustainable pace, our forecast shows investment growth averaging more than 2.5% a year in 2015–18, outpacing GDP growth.

This will be underpinned by Malta’s commitment to reducing its dependence on fossil fuels. In addition to the new power plant, a high-voltage cable link to Sicily is being constructed, which will link Malta to the mainland European network.

Labor market continues to improve …

The unemployment rate fell to 5.9% in August from a recent peak of 6.6% in October 2013. This compares very favorably with the wider Eurozone, where the average jobless rate is still in double digits. Having risen by 3% in 2013, full-time employment (including both private and public sectors) rose by 3.6% on the year in the first five months of 2014.

This reflects the success of a number of policies introduced to boost the labor market. In particular, the rate of female participation in the labor force rose from 47.5% in 2012 to 50.2% in 2013. And youth unemployment fell from 13.5% in February to 12.7% in August, although this is still more than twice the rate of total unemployment. The modest decline was supported by measures introduced in the 2014 budget, including a new tax deduction scheme giving employers €600 for each work placement and €1,200 for each apprentice. The solid labor market should support robust growth in real wages over the medium term, underpinning average private spending growth of about 2% a year.

… and strong tourism is offsetting weaker financial activity

The banking sector has been largely unaffected by the problems in the rest of the Eurozone because its domestic role is mainly confined to intermediation (with loans largely financed by deposits). Banks’ total assets and liabilities are largely external, representing a fee-based service whose revenue is not viewed as vulnerable to shocks, such as a rise in interest rates. But the more subdued

Figure 1Real GDP growth

Source: Oxford Economics.

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Figure 2Inflation

Source: Oxford Economics; World Bank.

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4 EY Eurozone Forecast December 2014 | Malta

Firm domestic activity lifts 2014 GDP growth forecast to 2.7%

Figure 3Private consumption and total fixed investment

Source: Oxford Economics.

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Figure 4Unemployment rate

Source: Oxford Economics.

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Forecast

regional background does seem to have interrupted the growth of the financial sector in Malta. Indeed, national accounts data from Eurostat revealed that activity in the finance and insurance sector declined modestly in the first half of 2014, after growing at a double-digit annual pace in 2012. But this sector is volatile and activity seems to be picking up again recently, with lending to households growing by at least 6% in Q2 and in July and August, compared with around 5% in 2012 and 2013. In addition, Malta has built up a strong track record of attracting investment funds and over the medium term we expect banking, alternative investment funds and online gaming to remain important contributors to growth.

Offsetting the weakness seen in the first half of 2014 in financial services activity, tourism has remained strong. Visitor arrivals to Malta rose by 8.4% on the year in the first eight months of 2014, a similar pace to that seen in 2013. The strength reflects efforts in recent years to attract tourists outside the traditional summer peak season, in order to reduce congestion and boost employment, and to attract tourists from a wider range of countries. In the longer term, investment in other cultural and creative industries is expected to boost tourism, particularly as Valletta will be one of the two European Capitals of Culture in 2018.

Robust services to protect against deflation and support the current account

We expect robust services activity to protect Malta from deflation. While headline inflation eased to 0.6% on the year in September, before edging up to 0.7% in October, this is largely because prices for subsidized goods and services, such as electricity, were cut sharply earlier in the year. Indeed, prices of electricity, gas and other fuels were 22% lower than a year earlier in September. However, core prices (excluding food and energy) were 1.8% higher, whereas they were just 0.8% higher on the year for the Eurozone as a whole.

We expect strong exports of services to underpin the current account surplus over the medium term, particularly as the financial services sector has low import requirements. This ongoing improvement in Malta’s external position will help growth prospects by reducing reliance upon capital inflows to provide external financing.

Increasing competitiveness would boost longer-term prospects

The medium-term outlook for tourism and financial services is bright, but as a small and very open economy it is crucial that Malta maintains competitiveness in these sectors. According to Eurostat, Malta’s average hourly labor costs of €12.8 in 2013 are only around 60% of those in Spain (€21.1). But real labor productivity per person employed rose by just 1.2% between 2005 and Q2 2014, whereas real productivity in Spain rose by almost 14% over the same period. In the 2014 budget, wages were increased by €3.49 a week (commonly known as the cost of living adjustment) and in the 2015 budget, they will be increased by just €0.58 per week. However, an increasing number of employers believe wages rises should be linked to productivity rather than inflation, as this might encourage greater productivity.

The outlook is reasonably bright, but some risks remain

After rises of 2.5% or more in 2014–15, we expect Malta’s GDP to grow by an average of 2% a year in 2016–18, still underpinned by solid domestic activity and strong services exports. The strength of the services sector and the expansionary fiscal stance should mean that Malta is less at risk of deflation than other Eurozone members. However, higher productivity must be encouraged to ensure that Malta is not left behind by the rest of the Eurozone in terms of competitiveness. There is also a risk of delay to some investment projects, but, encouraged by the strength of investment in the first half of 2014, we see this risk as small.

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