On the same day as Malta’s 2009 budget, the EU has issued an economic forecast for Malta which predicts that the general government deficit will increase to 3.8% this year, two percentage points higher than was projected earlier this year. The full economic forecast is shown below:

GDP growth slows down in 2008 – Following a strong outturn for 2007, economic activity decelerated in the first half of 2008. The downward trend is set to persist, bringing GDP growth for 2008 to 2.4%. Private consumption is foreseen to grow by 2.2%. Purchasing power benefitted from income tax cuts and higher transfer payments but was dented by increases in food and utility prices as well as softer employment growth. Growth in gross fixed capital formation is expected to decelerate in 2008 mainly due to a decline in public investment following the completion of the Mater Dei hospital. The pace of private investment is expected to slow from the highs of the previous two years on the back of lower housing starts and investment by the manufacturing sector. Growth in exports is projected to be mainly driven by services, specifically remote gaming and ICT. Following a strong result in 2007, the performance of tourism is projected to be modest this year.

Subdued consumption but investment picks up in 2009-10 – Going forward, real GDP growth is expected to weaken further in 2009 and remain practically unchanged in 2010. Until now the financial crisis had a modest effect on Malta but economic activity, especially the external sector, is expected to suffer from the ensuing global slowdown. Domestic demand will remain the main driver of growth.

Though benefitting from lower inflation, private consumption growth is anticipated to slow in 2009 on the back of weaker labour market conditions. For 2010, consumption is foreseen to increase at a similar pace with somewhat better employment growth.

Investment is foreseen to pick up in 2009 mainly on account of public capital spending. Private construction will be supported by the commencement of construction on a major ICT business park but in general the weak international economic scenario is likely to adversely impact investment decisions. For 2010, investment is anticipated to accelerate further.

Net exports affected by the global slowdown – The external sector will remain fragile in the face of worsening global conditions. Tourism is anticipated to weaken over the forecast horizon as a result of sluggish demand especially from the price-sensitive British market, which is Malta’s single most important source market. On the other hand the business services sector, specifically ICT and remote gaming, is anticipated to show resilience to the global slowdown and will continue to be the main contributor to growth in export of services. Foreign sales of goods, dominated by semi-conductors, will remain sluggish, albeit supported by the further expansion of the emerging pharmaceutical industry. Imports are projected to remain moderate in line with the slowdown in both private consumption and the import-intensive exports.

The current account deficit is projected to worsen over the forecast horizon. In view of the projected weak external demand, the deficit of trade in goods (in percent of GDP) is set to widen until 2009 to 19.5% of GDP, and to broadly stabilise thereafter. The surplus on the services account, which peaked at 15.5% of GDP in 2007, is projected to decrease over the forecast horizon, mainly on account of weaker tourism earnings.

Inflation to recede amid a softer jobs market – Inflation continued to rise rapidly in the first half of 2008 driven by an acceleration in food and tourist accommodation prices, the latter representing around 20% of the index, and reinforced by unfavourable base effects. The authorities’ decision to reverse the freeze on water and electricity prices in mid-year added impulse to inflation. For 2008, inflation is expected to average 4.4%, reflecting the assumed reduced price pressures from unprocessed food and the lower tourist accommodation prices in the wake of softer demand.

For 2009 and 2010, inflation is anticipated to decelerate on the back of lower commodity prices and the anticipated weak prospects for tourism which will ease accommodation prices. Wage increases may feed into inflation but this would be more a reflection of already negotiated salary rises and automatic wage indexation rather than prevailing labour market conditions. Indeed, the strong pace of employment creation in the first half of 2008 is expected to slow down. The labour market is projected to remain soft over the forecast period reflecting subdued activity in manufacturing as well as in tourism and wholesale and retail.

Budgetary position weakens – The downward trend in the general government deficit, which had started in 2005, is projected to experience a marked setback. In 2008, the deficit ratio is estimated to increase to 3.8% of GDP from 1.8% of GDP in the previous year. The deterioration results primarily from the expenditure side: (i) a higher increase in the wage bill on account of additional recruitment and higher wages in particular in the health sector; (ii) higher subsidies given the decision to freeze water and electricity prices and the sharp rise in the oil price; and (iii) early retirement schemes in preparation for the privatisation of the Malta Shipyards with an estimated one-off cost of 1% of GDP.

On a pre-budget basis and with the one-off cost of the early retirement schemes vanishing, the deficit is projected to decline to 2¾% of GDP in 2009. Tax revenue and social contributions are projected to be less buoyant reflecting the sluggish economic activity. Under the customary no-policy-change assumption, the deficit ratio in 2010 is projected to decline to 2½% of GDP.

In line with weaker nominal GDP growth and a return to a deficit on the primary balance, government debt is estimated to increase from 62.2% of GDP in 2007 to 63.1% in 2008. Thereafter the ratio is expected to remain practically unchanged.

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