The European Economic Forecast for Winter 2014 has just been released, overall it forecasts thatvEurope’s economic recovery, which began in the second quarter of 2013, is expected to continue spreading across countries and gaining strength while at the same time becoming more balanced across growth drivers. As it is typical following deep financial crises, however, the recovery remains fragile.

The forecast for Malta expects private consumption to drive growth in Malta, price inflation to gradually pick up and the budget defecit to stabilise, has outlined in full detail below:

Private consumption to drive growth in Malta

Real GDP growth is estimated to have reached 2% in 2013 and projected to maintain the same pace in 2014-15. Domestic demand is seen becoming the main driver of growth, largely on the back of recovering household consumption. The general government deficit is projected to stabilise below 3% of GDP.

Economic growth is projected to remain stable Real GDP growth was relatively strong in the first three quarters of 2013, largely on the back of the change in inventories component, which is used as a residual item in national accounts. Gains in household consumption were offset by a further decline in investment activity, which is estimated to have contracted for the third consecutive year.

Trade volumes surprised on the downside, but the decline in exports was milder than that in imports and thus external trade are seen to have had a slightly positive contribution to growth. Real GDP is estimated to have increased by 2% in 2013 as a whole, up from a mild 0.9% growth in 2012.

Real GDP growth is projected to remain largely unchanged, averaging 2.1% in 2014-15. Labour market participation is set to remain on an upward path, largely reflecting higher activity by women and older workers. The job market is expected to be able to fully absorb this inflow and the unemployment rate is set to decline slightly.

Favourable labour market conditions and the positive impact of the announced reduction of electricity tariffs are projected to support a further improvement in household consumption. With capacity utilisation exceeding its long-term average, investment is projected to improve. The recovery, however, is set to be rather cautious in an environment of low credit growth and higher interest rates, compared to the euro area.

Improving domestic demand is expected to boost import growth, but overall net exports are projected to continue to contribute positively to real GDP growth and the current account is forecast to remain in surplus over the forecast horizon.

Risks to the macroeconomic scenario are broadly balanced. The forecast assumes a stabilisation of the investment-to-GDP ratio and thus a continuation of the downward trend observed in recent years would present a downside risk. At the same time, the structural reforms that the government has committed to enact in the energy sector could lower costs for the economy and boost domestic demand, thus constituting an upside risk, particularly in 2015. No significant change in financing conditions is projected to occur over the forecast period.

Price inflation gradually picks up

HICP inflation came in slightly below expectations at 1% for the year as a whole in 2013, slowing down from 3.2% in 2012. Deceleration came on the back of lower prices of services offered in restaurants and hotels. This explains why the local measure of inflation, the Retail Price Index, which puts less emphasis on tourist services, decelerated less than HICP inflation. Energy prices also declined slightly, in line with developments on international markets.

In 2014, the reduction in electricity tariffs is projected to offset a rebound in services inflation and keep overall price inflation at a relatively moderate by Malta’s historical standards 1.2%. With the output gap estimated to have closed in 2014, the HICP is forecast to accelerate further to 1.9% in 2015, above the euro-area average.

Budget deficit to stabilise

From 3.3% of GDP in 2012, the budget deficit is expected to decrease to 3.0% of GDP in 2013. Current primary expenditure relative to GDP is forecast to increase by 0.5 pp. despite the spending review at ministry level that started in July 2013. On the capital side, net expenditure, including the planned additional equity injection into Air Malta (0.6% of GDP), is expected to stabilise. Indirect taxes relative to GDP are projected to increase by 0.3 pp., driven also by the recovery in consumption in the second half of the year. Corporate profitability as well as a favourable labour market outlook is expected to drive income taxes, despite measures to gradually reduce the overall income tax levels.

The 2014 budget includes mostly revenue- increasing measures, among which increases in indirect taxation (mainly excise duties), a new programme to grant Maltese citizenship to foreign individuals and families (against the payment of a fee and investments in the country) and the introduction of a new tax regime for rental income. On the expenditure side, the budget envisages some restrictions on recruitment. Overall, the current revenue ratio is projected to increase by 0.2 pp. of GDP, while primary current expenditure is forecast to stabilise. The deficit is expected to narrow to 2.7% of GDP. In 2015, on a no-policy- change assumption, the deficit is projected to remain at 2.7% of GDP.

After having worsened by ½ pp. of GDP in 2012, the structural deficit is estimated to have improved by 0.7 pp. of GDP in 2013, despite the limited size of the consolidation measures. Thereafter, the structural deficit is projected to improve slightly by 0.2 pp. of GDP in 2014 before deteriorating by 0.3 pp. of GDP in 2015. The debt-to-GDP ratio is projected to reach 72.4% in 2014 and decrease to 71.5% in 2015, following the due repayment of part of a loan from Air Malta.

Downside risks relate to the financial situation of Enemalta (the public energy utility corporation) as well as higher than budgeted disbursement related to the car VAT refund scheme.

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