EN Official Journal of the European Union C 74/28

COUNCIL OPINION

of 4 March 2008

on the stability programme of Malta, 2007-2010

(2008/C 74/07)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies (1), and in particular Article 5(2) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1) On 4 March 2008, the Council examined the first stability programme of Malta, which covers the period 2007 to 2010.

(2) On 1 January 2008, Malta joined the euro area with GDP growth on a recovery path since 2004. During the early 2000s, weak economic performance was partly a result of external factors, to which Malta is particularly exposed, being a small open economy and relying on sectors such as tourism and the electronics industry, which have proven to be volatile. Domestic structural weaknesses also explain the sluggish GDP growth. Productivity contracted by an annual average of around 1 % between 2001 and 2003. In addition, significant wage growth led to a sharp rise in unit labour cost and, as a result, to a loss in external competitiveness. Since 2004, economic performance improved primarily due to favourable cyclical conditions but also owing to wage moderation and a recovery in productivity. On the fiscal side, euro area entry followed a period of considerable consolidation — with debt as a percent of GDP on a declining path since 2005 — as well as progress towards lower inflation. In this new context, enhancing the room for manoeuvre of fiscal policy, which could be achieved by pursuing further budgetary consolidation and via expenditure reforms, namely in the fast-increasing healthcare spending, represents a challenge for Malta's adjustment capacity to asymmetric disturbances. Moreover, such spending reforms would improve the long-term sustainability of public finances, as well as allow a re-direction of expenditure to growth-enhancing categories, thereby help boost productivity. Higher productivity, together with a continuation of wage moderation would bolster competitiveness — another challenge facing the Maltese economy, particularly within a euro area context.

(3) The macroeconomic scenario underlying the programme envisages real GDP to grow by 3,5 % in 2007, slow down in 2008 and accelerate thereafter to reach 3,4 % by the end of the programme period. Assessed against currently available information (2), this scenario appears to be based on plausible growth assumptions for 2007. For the period 2008-2010, GDP growth projections seem favourable, mainly due to strong contribution of net exports projected in the outer years of the programme period. The resulting improvement in the external balance of goods and services of 3,3 percentage points of GDP by 2010 projected in the programme seems optimistic. The programme's projections for inflation appear realistic and are in line with the Commission services' autumn 2007 forecast. However, the possibility of further increases in public sector wages, which could lead to overall wages rising far in excess of productivity gains, may entail a less favourable development in Malta's competitiveness than implied by the stability programme.

(4) For 2007, the general government deficit is estimated at 1,8 % of GDP in the Commission services' autumn 2007 forecast and at 1,6 % in the stability programme, against a target of 2,3 % of GDP set in the last update of the convergence programme. Net of one-off transactions (consisting mainly of sale of land, which are conventionally recorded as negative expenditure), however, the 2007 deficit outturn is broadly in line with the target in the 2006 convergence programme in spite of a favourable base effect from 2006. Revenue as a ratio of GDP is significantly below expectations largely owing to lower-than-expected absorption of EU funds. As a consequence, the expenditure ratio for 2007 is also lower than planned in the 2006 convergence programme. As the structural adjustment in 2007 now seems below 0,5 percentage point of GDP, compared to around 1 percentage point as planned in the last update of the convergence programme, budgetary implementation is not in line with the invitation in the Council opinion of 27 February 2007 on the previous programme (3) to ‘pursue adequate progress towards the MTO as foreseen in the programme’.

(5) As in the last update of the convergence programme, the main budgetary goal outlined in the stability programme is to pursue further fiscal consolidation over the programme period, with the overarching objective of achieving the MTO of a balanced position in structural terms (i.e. cyclically-adjusted net of one-off and other temporary measures) by 2010. The general government balance is planned to improve from a deficit of 1,6 % of GDP in 2007 to a surplus of 0,9 % of GDP by 2010. With a projected decline in the interest burden, the primary surplus is expected to increase to 3,8 % of GDP by 2010. The structural balance is projected to improve by 2 percentage points of GDP in the period 2007-2010. The nominal adjustment is to be achieved through a decline in the primary expenditure ratio of over 3,5 percentage points of GDP, which more than offsets a fall in the revenue ratio of 1,5 percentage points of GDP. Lower recourse will be made to deficit-reducing one-off measures than in the recent past. Expenditure restraint is relatively broad-based with particular emphasis on compensation of employees. The marked fall in indirect taxes as a share of GDP in the outer years is not explained in the programme, while the cost of the 2008 changes to the personal tax reform system is assumed to be more than covered by higher revenue from other direct taxes. Against the background of a broadly unchanged macroeconomic scenario, the budgetary targets for 2008 and 2009 in the stability programme are less ambitious than in the 2006 update, by around 0,25 of a percentage point of GDP, reflecting a lower adjustment effort in 2008. Government gross debt, estimated to fall to around 63 % of GDP in 2007, still above the 60 % of GDP Treaty reference value, is projected to further decline by almost 10 percentage points over the programme period.

(6) The budgetary outcomes could be worse than projected in the programme. For 2008, the assumption that the changes to the personal income tax system will be covered by other, typically volatile revenue items, such as capital gains tax and profit taxes, constitutes a risk. There is also a possibility of expenditure slippages linked for instance to the decision to subsidise utility prices without compensating measures. Additionally, generous wage increases granted to health sector employees could lead to similar claims within the rest of the public sector. For 2009 and 2010, outcomes could be worse than targeted due to the favourable macroeconomic scenario underlying the programme's projections (although tax projections for these years seem cautious assuming that no discretionary tax reductions are envisaged) and also due to the lack of information on measures underpinning the consolidation process, in particular as regards the envisaged continued restraint in the public wage bill. In view of these negative risks to the budgetary targets, the evolution of the debt ratio is likely to be less favourable than projected in the programme, especially after 2008. On the positive side, the outturn of expenditure as a ratio of GDP in the past years has consistently been lower than planned in successive programmes. Furthermore, Malta's track record of achieving its targets for the general government deficit has been good, as outcomes have usually been better than planned.

(7) In view of this risk assessment, the budgetary stance in the programme may not be sufficient to ensure that the MTO is achieved by 2010, as envisaged in the programme. However, a sufficient safety margin against breaching the 3 % of GDP deficit threshold with normal macroeconomic fluctuations would be provided from 2008. The planned consolidation is in line with the Stability and Growth Pact, which prescribes an annual improvement in the structural balance of 0,5 % of GDP as a benchmark and a larger effort provided that Malta remains in good economic times. However, given the risks above, the pace of adjustment towards the MTO implied by the programme should be backed up with measures, especially in the years 2009 and 2010. Finally, taking into account the risks to the debt projections mentioned above, the debt ratio seems to be sufficiently diminishing towards the reference value over the programme period and would fall below it in 2009.

(8) Malta appears to be at medium risk with regard to the sustainability of public finances. The long-term budgetary impact of ageing is significantly lower than the EU average, with pension expenditure decreasing as a share of GDP over the long term. Yet, the 2006 pension reform, which aims both at increasing the retirement age and improving the level of pension, is likely to imply higher spending over the long run. In addition, the current level of gross debt is still above the Treaty reference value. The budgetary position in 2007 as estimated in the programme, which is better than the starting position of the previous programme, contributes to offsetting the projected long-term budgetary impact of ageing populations. Improving the budgetary position, including by enhancing the efficiency and flexibility of public spending, such as in the fast-increasing healthcare expenditure that is also subject to the impact of ageing, would contribute to reducing the risks to the sustainability of public finances.

(9) The stability programme seems to be to some extent consistent with the October 2007 implementation report of the national reform programme. In particular, the programme's budgetary projections take into account the public finance implications of the measures identified in the national reform programme. The measures in the area of public finances envisaged in the stability programme seem consistent with those foreseen in the national reform programme. In particular, the main policy measure presented in the stability programme, i.e. a further revision of the personal income tax regime, is in line with the national reform programme. However, healthcare reform — a key area in public finance identified in the national reform programme — is not dealt with in the stability programme. Also, the programme does not clearly spell out the way in which expenditure will be channelled to growth-enhancing categories, especially in the outer years.

(10) The budgetary strategy in the programme is partly consistent with the country-specific broad economic policy guidelines included in the integrated guidelines and with the guidelines for the euro area in the area of budgetary policies issued in the context of the Lisbon strategy. In particular, the programme does not envisage significant progress in healthcare reform, as encouraged by the Council in its recommendation.

(11) As regards the data requirements specified in the code of conduct for stability and convergence programmes, the programme has some gaps in both the compulsory and optional data (4).

The overall conclusion is that the stability programme envisages continued progress towards reaching the MTO, which is planned to be achieved by 2010, brought about by expenditure restraint in a context of sustained economic growth. The reduction of the general government gross debt is planned to proceed at a satisfactory pace and is expected to fall below the 60 % of GDP reference value by 2009. However, there are risks to the achievement of the budgetary targets linked to a reliance on volatile tax revenue items in 2008, the envisaged degree of spending restraint, the favourable macroeconomic outlook after 2008 and the lack of information of the underlying measures, in particular as regards the envisaged continued restraint in the public wage bill. These may hinder the achievement of the MTO by the target year 2010. In addition, Malta's competitiveness within the euro area may be at risk in the event of a departure from wage moderation in the public sector, which may spill over to the private sector. In terms of the long-term sustainability of public finances, Malta is at medium risk.

In view of the above assessment, Malta is invited to:

(i) pursue further fiscal consolidation as envisaged in the programme so as to reach the MTO by 2010 and ensure that the debt-to-GDP ratio is reduced accordingly, by spelling out the measures supporting the planned consolidation, especially on the expenditure side;

(ii) enhance the efficiency and flexibility of public spending, including by accelerating the design and implementation of a comprehensive healthcare reform.

Comparison of key macroeconomic and budgetary projections

2006 2007 2008 2009 2010 Real GDP (% change) SP Nov 2007 3,2 3,5 3,1 3,2 3,4 COM Nov 2007 3,2 3,1 2,8 2,9 n.a. CP Dec 2006 2,9 3,0 3,1 3,1 n.a. HICP inflation (%) SP Nov 2007 2,6 0,9 2,5 2,3 2,1 COM Nov 2007 2,6 0,8 2,5 2,2 n.a. CP Dec 2006 3,1 2,2 2,1 2,0 n.a. Output gap (5) (% of potential GDP) SP Nov 2007 – 1,9 – 0,8 – 0,1 0,5 1,9 COM Nov 2007 (6) – 1,5 – 0,6 – 0,1 0,5 n.a. CP Dec 2006 – 2,1 – 1,3 – 0,3 0,9 n.a. Net lending/borrowing vis-à-vis the rest of the world (% of GDP) SP Nov 2007 – 3,7 – 0,5 0,2 3,2 5,5 COM Nov 2007 – 3,7 – 0,9 – 0,6 0,0 n.a. CP Dec 2006 n.a. n.a. n.a. n.a. n.a. General government balance (% of GDP) SP Nov 2007 – 2,5 – 1,6 – 1,2 – 0,1 0,9 COM Nov 2007 – 2,5 – 1,8 – 1,6 – 1,0 n.a. CP Dec 2006 – 2,6 – 2,3 – 0,9 0,1 n.a. Primary balance (% of GDP) SP Nov 2007 1,0 1,7 2,0 2,9 3,8 COM Nov 2007 1,0 1,5 1,6 2,1 n.a. CP Dec 2006 1,1 1,1 2,5 3,2 n.a. Cyclically-adjusted balance (5) (% of GDP) SP Nov 2007 – 1,8 – 1,3 – 1,2 – 0,3 0,3 COM Nov 2007 – 2,0 – 1,6 – 1,5 – 1,2 n.a. CP Dec 2006 – 1,8 – 1,8 – 0,8 – 0,2 n.a. Structural balance (7) (% of GDP) SP Nov 2007 – 2,5 – 2,1 – 1,4 – 0,5 0,1 COM Nov 2007 – 2,7 – 2,3 – 1,7 – 1,2 n.a. CP Dec 2006 – 2,9 – 2,0 – 1,0 – 0,4 n.a. Government gross debt (% of GDP) SP Nov 2007 64,7 62,9 60,0 57,2 53,3 COM Nov 2007 64,7 63,1 61,3 59,2 n.a. CP Dec 2006 68,3 66,7 63,2 59,4 n.a. Stability programme (SP); Convergence programmes (CP); Commission services' autumn 2007 economic forecasts (COM); Commission services' calculations.

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The documents referred to in this text can be found at the following website:

http://ec.europa.eu/economy_finance/about/activities/sgp/main_en.htm

(2) The assessment takes into account notably the Commission services' autumn forecast and the Commission assessment of the October 2007 implementation report of the national reform programme.

(3) OJ C 72, 29.3.2007, p. 9.

(4) The missing data include the contribution of labour, capital and total factor productivity to potential GDP growth, the breakdown of stock-flow adjustments for the general government and some items in the projections for the long-term sustainability of public finances.

(5) Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission services on the basis of the information in the programmes.

(6) Based on estimated potential growth of 2,3 %, 2,2 %, 2,3 % and 2,3 % respectively in the period 2006-2009.

(7) Cyclically-adjusted balance excluding one-off and other temporary measures. One-off and other temporary measures are 0,7 % of GDP in 2006, 0,8 % in 2007, 0,2 % in 2008, 0,2 % in 2009 and 0,1 % in 2010; all deficit-reducing according to the 2007 stability programme and 0,7 % of GDP in 2006, 0,8 % in 2007, 0,2 % in 2008 and 0 % in 2009; all deficit-reducing in the Commission services' autumn forecast.

Sources:

Stability programme (SP); Convergence programmes (CP); Commission services' autumn 2007 economic forecasts (COM); Commission services' calculations.