Malta's public debt continues to climb. It reached almost €11 billion in February - a rise of €859m on the previous year's level. This prompted the PN Opposition to claim that "the alarming rise in national debt certainly does nothing to provide stability or peace of mind." Do we really have a big problem?
To put this in context, Europe's public debt outlook has worsened sharply over the last six years. In the EU, the public-debt-to-GDP ratio is now 3.6 percentage points higher than before the COVID pandemic. Governments have found it hard to reverse the extensive fiscal support they provided to mitigate the pandemic's impact and the subsequent energy shock.
Though the Maltese government phased out most of its Covid measures, it signally failed to roll back expensive energy subsidies. On the contrary, it boasts that it has resisted pressure from the European Commission and the IMF to do so. As a result, our ratio has risen by 8.1 p.p. over the same period. This would seem to give credence to the PN's criticism, until one compares the absolute level of the ratio, where Malta's ratio of 47.4 per cent contrasts positively with the EU's 81.0 per cent and even more so with the Eurozone's 87.4 per cent. There is no doubt as to the meaning of this comparison. Malta is far better placed than most EU economies in its ability to absorb shocks to its economy, even more so than in the pre-2013 period, when the ratio averaged over 65 per cent.
Reducing public debt has several significant benefits. First, a lower public debt results in reduced interest payments, which can lead to a healthier primary budget balance, assuming that interest rates and growth rates remain constant. The savings from lower interest payments can then be redirected towards other expenditures or used to reduce taxes. Second, a lower public debt ratio is conducive to lower interest rates on public debt, which further decreases interest payments. Third, lower debt-to-GDP ratios are typically associated with higher economic growth. This growth benefits households by increasing incomes and can also help reduce the fiscal balance needed to maintain a stable debt ratio. Finally, maintaining a lower public debt can provide a cushion against future economic shocks, especially during periods when revenue declines combined with higher expenditures on unemployment benefits and other social transfers.
On the other hand, these benefits can be offset by the immediate costs of fiscal austerity, including more limited public services and higher taxes. In a democracy, where elections of some sort or other occur biennially, the societal discount rate (the value placed on future benefits versus present sacrifices) would be very high since voters don't care as much about their future financial position as they do about their present one.
By the end of the day, the gross financing needs in the EU are expected to remain high due to significant fiscal deficits and steadily rising interest costs. Although the longer average maturity of new debt in the euro area has minimized short-term liquidity risks, it has increased future debt service obligations. This situation is made worse by a shift in sovereign bondholders, moving away from central banks, which exposes countries with high debt to a risk of sudden market downturns.
Going forward, there are significant medium- to long-term spending pressures on government finances in the EU, ranging from defence, through climate transition, to population ageing. Excluding defence, the other two pressures will apply in Malta as well. Against this backdrop, the risk that debts will not stabilize in the medium term has increased. Facing these elevated risks, policymakers are being challenged to implement carefully-primed fiscal adjustments which ensure debt sustainability while supporting growth.
Debt Sustainability Analysis (DSA) now. plays a key role in reformed EU fiscal rules, which came into force last year. For countries with a fiscal deficit above 3% of GDP or a public debt ratio above 60%, the European Commission has put forward a DSA-based "reference trajectory". This is aimed to ensure that, by the end of a multi-year fiscal adjustment period, the public debt ratio "is on a plausibly downward trajectory or stays at prudent levels, even under adverse scenarios."
Debt sustainability is a complex and contested concept. In this context, one welcomes an analysis on the sustainability of Maltese Government debt prepared by the staff of the Central Bank of Malta and published in the 2024 Annual Report. In their article, Ian Debattista and John Farrugia, respectively senior economist and manager, carried out a DSA of public debt during the periods 2019-2023 using different methodologies and then derived a forecast fiscal path between 2024 and 2034.
Without going into the esoteric technical details, the authors used both deterministic and stochastic debt sustainability analysis as well as so-called heat map indicators, to assess the risks of unfavourable changes in the macro-economy, composition of the debt, interest-rate shocks, changes in the liabilities of the public sector, and adverse turns in non-performing loans, among others.
The main conclusions drawn by the authors in the deterministic analysis were: most short-term and long-term risks to sustainability in 2023 were medium; a small likelihood that the debt-to-GDP ratio would surpass 60% in the medium term; a peaking of the debt ratio at just over 50% in 2028 before declining to just over 46% by 2034; a less favourable interest-growth differential and higher interest rates would increase the debt ratio by some 4-7 p.p. but still below the threshold 60%.
Because deterministic analysis does not fully capture uncertainty, the authors used a stochastic analysis which generated 10,000 different paths for the government debt. The median path of these trajectories is illustrated in the chart, where the median path is broadly in line with the deterministic scenario but with considerable variation depending on the level of uncertainty (see the fan). The main conclusion is that the probability that the debt will exceed its initial level reduces from 69.2% in 2025 to 29.1% in 2034, while the probability that the debt will exceed 60% of the GDP increases from 0.0% in 2025 to 7.9% in 2034.
As far as the heat map for 2019-2023 is concerned, risks associated with the composition of debt and availability of liquidity was assessed to be relatively low; risks associated with gross and net financing needs diminished; the main risks to debt sustainability arise predominantly from the historically high share of non-performing loans borne by core domestic banks, though this has improved; an increase in population-ageing expenditure which will increase by 8.7 p.p. but remain below the eurozone average; and some risk relating to government-guaranteed debt, particularly in the energy sector.
In conclusion, Malta certainly does not have a public debt problem. Though one might quibble about the speed at which we are moving towards a neutral balance in the fiscal deficit, we are well-positioned to meet future challenges provided we maintain a reasonable economic growth path.
Frans Camilleri is an economist. He studied at Oxford and University of East Anglia, is a former corporate head at Air Malta, and has served on various public and private boards.