The European Commission this week urged Malta to take steps to “unlock business potential” in its assessment of the country’s stability and convergence programme, in which the country’s progress to meet its 2011 deficit deadline was assessed.

Such steps, the Commission said, will be required by the challenge the country is facing in terms of strengthening its competitiveness and to improve its resilience to future external shocks.

Other steps along these lines outlined by the Commission include raising human capital as well as moving towards unlocking business and continuing efforts to move toward higher value added economic activities and “promoting an efficient wage setting process that allows a close link between wages and productivity developments”.

Malta, the Commission said, should also restore its sound fiscal position and improve the country’s long-term fiscal stability.

The global economic crisis, the Commission noted, has affected Malta chiefly through trade channels and the impact of the financial meltdown on the country’s financial sector remained contained.

Although much of Malta’s gross domestic product decline registered within the context of the crisis is cyclical in nature, the Commission also noted that growth in the country’s potential output would be resuming from a lower starting point.

Brussels also sounded a note of warning to the effect that “the crisis may also affect potential growth in the medium term through lower investment, constraints in credit availability and increasing structural unemployment”.

Also of concern is the Commission’s forecast that the impact of the crisis on Malta “will coincide with the negative effects of demographic ageing on potential output and the sustainability of public finances”.

As such, the Commission stresses the importance of undertaking further reforms in the areas of education and competition, adding that “it will be essential to accelerate the pace of structural reforms with the aim of supporting potential growth”.

Malta’s stability programme forecasts that gross domestic product growth will return to positive territory, at 1.1 per cent, this year after which it will level out at 2.6 per cent until 2012. The Commission agreed with this year’s GDP forecast, but labelled those for 2011 and 2012 as “favourable”.

Moreover, it said the country’s projected increase in domestic demand “seems to be on the high side” and that the programmes projections on inflation “appear to be on the low side”.

And while Malta has envisaged its deficit levels would fall below the three per cent of GDP threshold by 2011, it notes that “budgetary outcomes could turn out worse than projected”.

The Commission points out in its assessment: “In particular, the macroeconomic scenario underlying the budgetary projections appears favourable, especially after 2010. The expected contribution from tax buoyancy and enhanced tax compliance to the budgeted increase in the tax ratio in 2010 seems optimistic and represents a risk for the tax projections throughout the programme period.

“In addition, expenditure overruns cannot be excluded given recent slippages, the scale of the envisaged retrenchment and the lack of information on concrete measures underpinning the targeted cut in the spending ratio over the programme period. It is noted that, for 2010, the programme states that ‘close monitoring of emerging developments in revenue and expenditure components will be made and additional measures will be adopted as necessary’.”

The Commission also noted that there appears to be scope for improving the efficiency of public spending in Malta – especially in the areas of education, health, research and development, public infrastructure and general services.

The Commission noted that it will be “challenging” to achieve the expenditure cuts envisaged in Malta’s programme, particularly in the areas of employee compensation and intermediate consumption, which are generally intended to rationalise expenditure without affecting the level and quality of services provided.

In view of the recent situation in which companies facing liquidity problems were allowed to delay tax payments, the Commission stressed that “tax compliance and enforcement should be enhanced”, adding that the programme submitted by Malta “confirms the government’s commitment to intensify efforts to fight tax evasion and abuse in social transfer claims”.

2010 deficit projections

in line with EDP, doubts

for 2011 and 2012

Although, according to the Commission, the 2010 budgetary strategy is “broadly consistent with the Council recommendations” on the country’s ongoing Excessive Deficit Procedure, in 2011, taking into account the risks to the deficit targets, “the budgetary strategy may not be consistent with the Council recommendations”.

In particular, the Commission notes, while the planned structural improvement amounts to the recommended 0.75 per cent of GDP, the consolidation plans for 2011 “should be backed up by concrete measures while the authorities should stand ready to adopt further consolidation measures in case risks from less favourable GDP growth and revenue developments and from possible slippages on the expenditure side materialise.

“Provided these risks are adequately addressed and the consolidation plans fully implemented, the budgetary strategy seems to be sufficient to bring the government debt ratio back on a declining path in 2011-2012.”

It also underlines that for 2012 the programme envisages a move further away from the country’s medium term objectives, “rather than gradual progress towards its achievement, which is not in line with the requirements of the Stability and Growth Pact”.

It urges that, “A more ambitious pace of consolidation than foreseen in the programme would also be warranted in view of the high risks to the long-term sustainability of the public finances, while measures to strengthen the intra-year monitoring of public finances as well as the medium-term budgetary framework could help contain the risks to the deficit targets.

The Commission also requested Malta to fully spell out the implementation of the European Council’s recommendations and the broad measures behind the one per cent of GDP budgetary consolidation needed to correct the excessive deficit by 2011.

Overall, the Commission assessed that the deficit and debt ratios for the years up to 2012 forecast by Malta “could be higher than planned throughout the programme period”.

This, it noted, was mainly due to “assumed tax buoyancy and, especially after 2010, a favourable macroeconomic scenario and possible expenditure overruns given recent slippages, the scale of the envisaged retrenchment and the lack of information on concrete measures underpinning the targeted cut in the spending ratio over the programme period.

While the deficit target for 2010 set in the budget has been approved, the Commission said it will be important to address these risks “by spelling out the concrete measures underlying the strategy and adopting additional consolidation measures if economic growth or revenue increases turn out lower than projected”.

Overall, the Commission requested Malta to achieve the 2010 deficit target of 3.9 per cent of GDP, if necessary by adopting additional consolidation measures, and to back up the strategy to bring the deficit below three per cent of GDP in 2011 with concrete measures while standing ready to adopt further consolidation measures in case risks related to the fact that the macroeconomic scenario of the programme is less favourable than forecast.

The country should also “considerably strengthen” its strategy for 2012 to ensure an adjustment towards the medium term objectives in line with the requirements of the Stability and Growth Pact, and seize any further opportunities to accelerate the reduction of the gross debt ratio towards the 60 per cent of GDP reference value.

The Commission also invited Malta, in view of the significant projected increase in age-related expenditure, to improve the long-term sustainability of its public finances by implementing further reforms of the social security system.

Malta was also requested to strengthen the binding nature of the medium-term budgetary framework, improve the monitoring of budget execution throughout the year, and enhance the efficiency of public spending, especially in the area of health.