Economic activity in Malta continued to outperform the weak growth in the EU in the first half of 2014.

A strong rebound in investment is projected to boost growth to 3% in 2014, before moderating  somewhat over the forecast horizon. The budget deficit is projected to gradually decline over the  forecast horizon, while the government debt is forecast to remain stable.

Growth in first half of 2014 higher than  anticipated...

The Maltese economy continued expanding at a  robust rate in the first half of 2014. Annual real  GDP growth surprised positively and reached  3.2%, up from 2.5% for 2013 as a whole. Growth  was driven by buoyant domestic demand,  particularly thanks to investment and public  spending. Net exports also contributed positively  as a drop in exports, driven by a further contraction  in the electrical machinery industry, was more than  offset by a decline in imports.

...and is expected to remain strong over the  forecast horizon.

Overall, real GDP growth is projected to reach 3%  in 2014 and moderate gradually to 2.9% in 2015  and 2.7% in 2016. Large scale energy projects,  including the construction of a power plant in  2014-15 are expected to be a major driver of  growth over the forecast horizon. Improving  business sentiment and the absorption of EU funds,  as projects funded under the 2007-13 financial  framework are coming to an end, are expected to  provide a further boost. Private investment in  equipment and machinery is set to benefit from  improving financing conditions, reflected in a  gradual decline in interest rates, but bank credit  standards for the construction sector are not  expected to loosen notably.

The strong investment profile is expected to  impact Malta's external trade figures over the  forecast horizon due to the high import content of  investment. Net exports are forecast to contribute  negatively to growth in 2014, as the growth in  imports is seen to pick up and outpace the  relatively weak exports in the second half of the  year. The expiration of the major energy-related  projects in 2015 should result in a moderation of  imports, while the upturn in global demand and  especially the recovery of the electronics industry  is projected to boost exports.

Favourable labour market developments and  growing disposable income, also related to the  lowering of electricity tariffs in 2014, are forecast  to spur private consumption over the forecast  horizon. At the same time, after peaking in 2014,  the contribution of public consumption to growth  is projected to moderate.

Risks are mainly concentrated around the investment outlook. Slippages in the energy  projects would shift the growth profile forward,  while the improvement in investor sentiment and  the foreign investment in the energy sector could  provide a further boost in 2015-16. The  depreciation of the euro could boost demand for  Maltese exports from outside the EU.

Price inflation is projected to pick-up

HICP inflation was low in the first nine months of  2014 because of the reduction in electricity tariffs  for households in April and very moderate  increases in food prices. Overall, HICP is  projected to average 0.7% in 2014 as a whole  before gradually picking up to 2% in 2016. This  increase is expected to come mainly from a  stabilisation in energy prices and a normalisation  in food prices inflation. The expected lowering of electricity tariffs for industry in 2015 is projected  to keep input costs contained and, in turn, services inflation stable, thereby offsetting upward pressure  from households' growing disposable income.

Deficit under control despite growing spending

The general government deficit is expected to  improve marginally in 2014 to 2.5% of GDP, from  2.7% in the previous year. Current revenues are  projected to increase thanks to the favourable  macroeconomic outlook as well as to the revenue  increasing measures included in the 2014 budget,  namely increases in indirect taxation, a new  programme to grant Maltese citizenship to foreign  individuals and families and the introduction of a  new tax regime for rental income. In addition, in  July, a new scheme intended to enable taxpayers to  adjust past irregular declarations of income was  launched. Despite the restrictions on recruitment  envisaged by the 2014 budget, employment in the  public sector has increased due to the temporary  nationalization of the transport system as well as  higher recruitments mainly in the health and  education sectors. Therefore current expenditure is  expected to increase, also due to higher than  expected subsidies to the transport sector as well as  intermediate consumption. Net capital expenditure  is expected to fall due to a lower capital injection into Air Malta, compared to the one in 2013.

In 2015, under the no-policy-change assumption,  as the 2015 budget was not presented before the  cut-off date of the forecast, the deficit is expected  to increase marginally to 2.6% of GDP, also due to  a further capital injection into Air Malta, higher  than the previous year one (0.5% of GDP).

In 2016, using the no-policy-change assumption,  the deficit is expected to decline to 2.0% of GDP,  thanks to a favourable growth outlook and to the  expiration of the public support for Air Malta.  After having decreased by more than 1 pp. of GDP  in 2013, the structural deficit is projected to  stabilise in 2014 and to deteriorate marginally in  2015. In 2016, the structural deficit is expected to  improve by ½ pp. of GDP.

The general government debt-to-GDP ratio  increased to 69.8% in 2013, also on account of a  debt-increasing stock-flow adjustment. Despite the  expected repayment of some tax arrears from  Enemalta (the public energy utility corporation),  the debt ratio is projected to continue increasing in  2014 thanks also to a higher cash buffer at the end  of the year, before moderating somewhat by 2016.