The writing has been on the wall for a long time, but now it has been underscored in bold: Malta direly needs to address the fiscal problems associated with its ageing population or the country will face some very serious challenges in the long term.

The government very clearly has some painful and unpopular decisions to make.

The European Commission delivered the verdict this week in its annual report on the state of public finances in the Economic and Monetary Union. The finding was reinforced by another report, this one drawn up by the European Policy Centre think tank.

While the Commission has repeated what it has been repeating for years now – that Malta must urgently address the sustainability of its pension and healthcare system if it is to cater for its ageing population in the decades to come.

Malta is one of a good number of European Union countries facing the most significant challenges, challenges characterised by a very significant age-related long-term expenditure.

In Malta and the rest of this group of EU countries, the Commission said, it will be necessary to address both the long-term costs of ageing through reforms to pension systems and the weakness of their budgetary positions.

In particular, reforms to the pension and healthcare system will not adversely affect the current economic recovery as they typically take effect over the medium to long-term, and, according to the Commission’s warning, should be implemented as a matter of urgency.

This may include measures to raise potential growth and employment over the medium term, but, overall, Malta’s prospect for the short-term goals of reducing the deficit to more manageable levels were positive, but not so for the long-term objectives.

Even so, the Commission this week warned once again that current deficit and debt ratios could turn out to be higher than forecast due to a degree of post 2010 government optimism when it comes to tax buoyancy and a projected favourable macroeconomic scenario.

While confirming the 2010 budget deficit target, the Commission echoed the European Council’s recommendation that Malta spells out concrete measures underlying its strategy and adopting additional consolidation measures if economic growth or revenue increases turn out lower than what is being projected, or if the risk of expenditure slippages materialises.

And, in addition to achieving a sound budgetary position and improving long-term sustainability through further reforms to curb the projected rise in age related expenditure, Malta, according to the Commission, faces the additional challenge of strengthening competitiveness to improve the economy’s resilience to future external shocks.

This, according to the Commission, will require implementing productivity-enhancing measures and promoting an efficient wage setting process that allows a close link between wage and productivity developments.

But the recommendation for a wage setting process linking wages and productivity sounds very much like the advice the International Monetary Fund has been delivering for at least two years now.

In 2009, the IMF had called on Malta to scrap the COLA, noting, “As inflation remains high, the mandatory inflation indexation of wages (COLA) risks hampering necessary cost adjustments, especially in manufacturing industries hit by the global downturn, and in low-skilled employment intensive sectors.”

The IMF observed that negotiations on the public sector collective agreement should set a “conservative benchmark” for the private sector, but fell short of advising how such a benchmark would be ensured.

It advised, “… introducing productivity-linked wage increases at enterprise level instead [of the COLA]”.

The issue of the COLA is a tightrope between the toll of inflation on workers’ wages and wider competitiveness issues, where the IMF found that “wage developments will also need to play their role in strengthening Malta’s competitive position”.

This particular issue will be a dicey one for the government if it intends going down that politically treacherous path, while it will need to be seen how the government acts on another recommendation to enhance the efficiency of public spending, “especially in the area of health”.

On the recommendation to urgently address the pension system, the Prime Minister made it clear to the press just after the Commission’s report, when he said this week that the government is in the process of studying the implementation of the second pillar of the pension reform – that entailing private retirement schemes funded by employers and employees to supplement the present state pension. The move is to follow in the footsteps of the first pillar announced in 2006.

This week’s European Economic Sustainability Index by European Policy Centre, developed with a view to assessing the economic sustainability of Europe’s economies, simultaneously assessing the short, medium and long term sustainability of the EU’s member states.

The index, which combines six factors – deficits, national debt, growth, competitiveness, governance/corruption, and the cost of ageing, places Malta’s sustainability ‘in danger’, but not as ‘unsustainable’ as in the case of the EU’s PIGS – Portugal, Italy, Greece and Spain.

And while Malta has improved in the index from a 21st position out of the EU27 in 2007, its 20th position ranking leaves a lot to be desired when considering the pitiable state of many of the EU’s economies.

Rankings aside, if the country is to provide for posterity, it simply cannot continue with the state pension scheme it has had for so long; it will need to address competitiveness, perhaps with similarly unfriendly policies such as doing away with the cost of living adjustment once and for all, and with figuring out new ways to fund state health care in a scenario in which it has pledged to keep public health care free of charge – all tall orders, taller still now that the administration has moved into the second half of the current legislature and an election now on the albeit still distant horizon.