EUROPEAN COMMISSION Brussels, 26.2.2020 SWD(2020) 517 final COMMISSION STAFF WORKING DOCUMENT Country Report Malta 2020 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2020 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {SWD(2020) 150 final}



Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Reform priorities 3.1.Public finances and taxation 3.2.Financial sector 3.3.Labour market, education and social policies 3.4. Competitiveness, reforms and investments 3.5. Environmental sustainability Annex A: Overview Table Annex B: Commission debt sustainability analysis and fiscal risks Annex C: Standard Tables Annex D: Investment guidance on Just Transition Fund 2021-2027 for Malta Annex E: Progress towards the Sustainable Development Goals (SDGs) References LIST OF Tables Table 1.1:Key economic and financial indicators - Malta

Table 2.1:Annual assessment of the 2019 CSRs (*) Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth Table E.1:Indicators measuring Malta’s progress towards the SDGs LIST OF Graphs Graph 1.1: Gross Added Value by sector, 2009-2018 Graph 1.2: Real GDP and components, 2012-2021 Graph 1.3: Key employment indicators Graph 1.4: Total Factor Productivity trends, Malta and selected countries Graph 1.5: Trade balance and import content of export trends, 2005-2018 Graph 1.6: Current account decomposition, 2005-2018 Graph 1.7: Private sector debt and benchmarks Graph 2.1: Overall multiannual implementation of 2011-2019 CSRs to date Graph 3.1.1: Total outgoing dividend payments from EU Member States and share going to offshore financial centres*** Graph 3.2.1: House price misalignment

Graph 3.2.2: Building permits and housing investment Graph 3.3.1: Labour shortages: job finding and separation rates Graph 3.3.2: Women employment rates by age cohort Graph 3.3.3: At-risk-of-poverty-or-social-exclusion rate (AROPE), age groups Graph 3.4.1: Malta investment trends, excluding machinery Graph 3.4.2: Labour productivity by sector, 2008-2018 Graph 3.4.3: Productivity per person employed by sector and firm-size, 2016 Graph 3.4.4: Inbound tourism, January 2018-October 2019 Graph 3.5.1: Total greenhouse gas emissions (excluding international aviation), EU and Malta Graph 3.5.2: Trends in population growth and road transport sector LIST OF Boxes Box 2.1: EU funds and programmes contribute to addressing structural challenges and to foster growth and competitiveness in Malta Box 3.3.2: Monitoring performance in light of the European Pillar of Social Rights Box 3.4.3: Investment challenges and reforms in Malta Box 3.5.4: Social and environmental sustainability implications of Malta’s housing sector Executive summary Malta’s fast-growing economy is confronted with long-term sustainability challenges. The Maltese economy has been experiencing fast growth and sustained employment creation for several years. Recent reform efforts have helped to encourage investment in a number of important areas. However, several long-term structural challenges remain, including (i) the fiscal sustainability implications of ageing; (ii)_ low skills levels and (iii) governance vulnerabilities. In addition, demographic and economic growth are expected to put further pressure on Malta’s infrastructure and natural resources. It is therefore key to (i) strengthen long-term resilience through innovation; (ii) improve infrastructure quality and (iii) take further steps towards a climate-neutral and environmentally sustainable economy. ( )

Economic growth is expected to slow down. Malta’s economic performance continues to be among the strongest in the EU, supported by strong domestic demand and a vibrant, export-oriented services sector. Real GDP growth is expected to gradually moderate, from 4.5% in 2019 to 4% in 2020 and 3.7% in 2021. Inflation is expected to stabilise at 1.5%. As a small open economy, Malta is subject to risks in the external environment. The government is running fiscal surpluses although at lower levels than in previous years. The headline surplus has declined gradually from an exceptionally high level in 2017 to an estimated surplus of about 1% of GDP in 2019, where it is expected to stabilise in the coming years. A large rise in tax revenues driven by favourable economic conditions was used to increase expenditure growth. Expenditure composition is expected to shift in favour of public investment, while social and healthcare spending as a percentage of GDP is set to stabilise below the figures observed in the past. The decline in the public debt-to-GDP ratio, which reached some 46% in 2018, is expected to continue. The banking sector remains in good health, due to conservative lending practices but is exposed to risks. Banks have remained profitable while strengthening their capital base and maintaining sufficient liquidity owing to customer deposits. Non-performing loans have declined as well. However, tight lending standards limit borrowing opportunities for companies. In addition, continued weaknesses in the anti-money laundering framework has put strains on relationships with correspondent banks. Investing in innovation, natural resource management, skills and infrastructure are critical to sustaining Malta’s economic growth. In the longer term, investment in areas other than residential construction will be crucial to alleviate growing bottlenecks. Investment is also needed in adequate infrastructure, skills and innovation. Given spatial and resources constraints, continued economic development will require even more focus to be placed on environmental sustainability. This environmental sustainability can be promoted by (i) continuous improvement in resource management and (ii) increasing the economy’s energy efficiency. Malta has made limited ( ) progress in addressing the 2019 country-specific recommendations. There has been some progress in the following areas: ·strengthening the anti-money laundering framework; ·focussing investment-related economic policy on research and innovation; ·improving the management of natural resources and improving resource and energy efficiency; ·improving inclusive education and training. There has been limited progress in the following area: ·ensuring sustainable transport and reducing traffic congestion; ·strengthening the judicial independence, through the establishment of a separate prosecution service. ·strengthening the overall governance framework, including by continuing efforts to detect and prosecute corruption. There has been no progress in the following areas: ·ensuring long-term sustainability of public finances by addressing shortcomings of the pension and healthcare systems; ·addressing features of the tax system that may facilitate aggressive tax planning; The Social Scoreboard supporting the European Pillar of Social Rights points to a relatively good performance of Malta, despite remaining challenges. The robust expansion in recent years contributed to: (i) one of the highest employment growth in the EU and (ii) a drop in both, the overall and long-term unemployment rates over recent years. Income inequality is stable, although, some population groups face a higher risk of poverty than others. High level of early school leaving and poor education outcomes, (both of which are greatly determined by the type of school a pupil attends), limit equal opportunities. Progress in reaching the national targets under the Europe 2020 strategy is mixed. Malta has met its targets on employment and tertiary education attainment. However, it is expected that Malta will narrowly miss its 2020 renewable energy target. Other areas require further efforts to achieve the set targets. These areas include R&D expenditure, early school leaving, poverty reduction, the reduction of greenhouse gas emissions and energy efficiency. Malta has made some progress on the United Nations’ Sustainable Development Goals (SDGs). It made significant progress on SDG 8 (decent work and economic growth), with especially fast growth in employment. However, Malta still faces significant challenges on SDG 9 (industry, innovation and infrastructure). In particular, gross domestic R&D expenditure as a share of GDP has been declining ( ).

Key structural issues analysed in this report, which point to particular challenges for Malta’s economy, are set out in the following paragraphs: The composition of Government revenues may dent the fiscal position in the medium term. Corporate taxes, which constitute a significant share of tax revenues, may prove volatile given the slowing economy and international initiatives in the area of corporate taxation. Moreover, recent fiscal surpluses have relied to a large extent on proceeds from the Individual Investor Programme (citizenship scheme). These proceeds are difficult to predict and may decline over the medium term. Preserving a sound fiscal position will therefore become increasingly dependent on expenditure adjustments. Public finances will come under increasing pressures from the costs of ageing. In the long term, Malta’s increase in public pension and healthcare spending is projected to be one of the largest in the EU, albeit from a level much below the EU average. Recent measures have aimed at diversifying pension income and increasing pension adequacy. Pension indexation at levels above increases in the cost of living contributed to better adequacy, but this will weaken public finances in the long term. Measures are ongoing to improve healthcare efficiency and to ensure the provision of long-term care services. Economic evidence suggests that Malta’s tax rules are used for aggressive tax planning purposes. Although Malta has implemented previously agreed European and international initiatives to address some ATP concerns, rules such as the absence of withholding taxes and the design of Malta’s investor-citizenship and investor-residence schemes remain a cause for concern. The Maltese economy remains vulnerable to money laundering risks. The supervision of financial markets is improving gradually. Three aspects of the Maltese economy are particularly susceptible to money-laundering risks: (i) its specialisation in remote gaming; (ii) its specialisation in virtual assets and (iii) its citizenship and residence schemes. Steps have been taken to strengthen the role of the anti-money laundering supervisor by investing in human resources and IT, strengthening risk assessment tools and improving risk-based processes. However, the practice of the Malta Financial Services Authority to use a private consultancy for supervisory tasks raises concerns. Shortcomings in the investigation and prosecution of money laundering remain a challenge. Reforms to strengthen law enforcement in the fight against money laundering are under way but still need to be assessed for effectiveness. The unabated growth of residential house prices needs close monitoring. Demand pressures have led to a surge in residential investments. These demand pressures have, in turn, been driven by job-rich growth, low interest rates, inward migration and booming tourism. There are now signs of overheating in the residential real estate market and surging house prices have also raised concerns about affordability, especially in the rental sector. Moreover, although the capital bases of banks are solid, the continued concentration of their portfolios in real estate deserves attention. This is an especially pressing issue given lengthy insolvencies procedures and the relatively high ratio of household debt to gross disposable income. The labour market is tightening, resulting in labour shortages and a greater reliance on foreign workers. Employment rates continue to increase for both men and women. The participation of young women in the labour market has significantly increased, facilitated by free childcare. However, the gender employment gap in Malta remains the highest in the EU. Unemployment rates, including long-term unemployment and youth unemployment, are well below the EU average. Malta relies heavily on foreign workers from within and outside the EU to fill labour shortages. There is no strategy in place to keep these workers in Malta for longer periods even though companies report difficulties in recruiting and retaining skilled workers. The share of low-skilled adults is comparatively high, but the take-up of measures to promote adult learning and upskilling remains low. Poor educational outcomes are set to impede future growth. Persistently high student underachievement and early school leaving make it difficult to meet the need for skilled labour. This also has long-term implications for social inclusion, because children from socially disadvantaged families are less likely to benefit from the best education opportunities and are more likely to lag behind their more advantaged peers. Measures have been taken to make education more inclusive. The average performance of Maltese pupils remains below the EU average and an increasingly diverse student population poses challenges for the Maltese education system. Increased coordination and more use of evidence-based approaches may make reforms and investment in education more effective. Inequalities and poverty have stabilised after declining in recent years, but certain groups face higher risks of poverty. Child poverty has decreased, but children whose parents are single, foreign or with low income are at higher risk of poverty. The social integration of non-Maltese people, despite their high participation in the labour market, is limited. The rapid population growth (+17% in the past 10 years), mainly due to economic migration from both EU and non-EU countries may exacerbate existing social and environmental challenges. The need to cater to a larger and more diverse population presents particular pressures for the housing market, social services, health services, and the education system. The services sector continues to grow rapidly, but companies face increasing difficulties in access to finance. The services sector continues to enjoy solid growth. Tourism continues to grow all year-round, albeit at a slower pace than in recent years. The gaming industry is a key contributor to Malta’s economic performance, although it entails governance risks, with potential cross-border implications, given the international significance of the sector. Malta is also set to play an increasing role in blockchain solutions and virtual financial assets, and has adopted a national strategy on artificial intelligence. In addition to ongoing labour-shortages, difficulties in access to bank services and bank credit are a growing business concern, particularly for small businesses. It remains a challenge to strengthen the institutional capacity Different indicators point to a perceived weakness in Malta’s governance framework, with negative effects on the business environment. The government announced its intention to strengthen the independence of the judiciary and took steps to establish a separate prosecution service. This will require concrete follow-up and adequate implementation. Institutional shortcomings hinder the effective detection of corruption, while investigations by the police seem to remain fragmentary. There is room for improvement in (i) the prosecution of crimes related to corruption, abuse of power and money laundering, and (ii) transparency in public procurement. Conflicts of interest are perceived to be widespread, including in public procurement. Productivity has significantly improved, but research and innovation still play a limited role in the economy. Malta has experienced significant growth in investment and productivity experienced a sizeable growth in the past decade. Small and medium-sized enterprises are the main contributors to economic growth and employment. However, research and innovation activity by Maltese firms remains limited. Although Malta’s scientific output is improving, academic research does not seem to translate easily into innovation. Malta’s efforts to cut greenhouse gas emissions, promote sustainable mobility and increase energy efficiency do not seem to match the scale of the challenges it faces. With current policies, emissions are projected to continue increasing, putting Malta far off track in relation to its 2020 and 2030 targets. If Malta is to reach these targets it will be necessary to break the current trend of increasing emissions from transport as well as from the heating and cooling of buildings. Malta’s transition to greener and more sustainable growth requires a long-term, comprehensive strategy. To deliver on its climate and energy objectives, Malta will need to: (i) identify investment needs in green technologies and sustainable solutions and (ii) secure adequate funding. Malta is the most urbanised and most densely populated country in the EU and remains particularly vulnerable to climate risks. Sectors such as water management; infrastructure and land use; natural ecosystems; agriculture and fisheries; health and tourism would benefit from targeted investments to further climate neutrality. These sectors would also benefit from measures in disaster risk management and disaster risk response. Malta´s level of resource productivity is below the EU average. Economic growth and the increasing population and economic activity are expected to further exacerbate environmental concerns and put pressure on scarce natural resources. Malta has not yet capitalised on turning waste into a resource or on turning low recycling rates into business opportunities. The booming housing and construction sector is generating social and environmental concerns as new projects exert further pressure on the already-high levels of land use. Actions to address infrastructure bottlenecks emphasise road construction. The Commission’s proposal for a Just Transition Mechanism under the next multi-annual financial framework for the period 2021-2017, includes a Just Transition Fund, a dedicated just transition scheme under InvestEU, and a new public sector loan facility with the EIB. It is designed to ensure that the transition towards EU climate neutrality is fair by helping Member States to address the social and economic consequences. Key priorities for support by the Just Transition Fund, set up as part of the Just Transition Mechanism under the next multi-annual financial framework for the period 2021-2027, are identified in Annex D, building on the analysis of the transition challenges outlined in this report. EU funds and programmes contribute to addressing structural challenges in the Maltese economy. Support from the EU programmes focussed especially on sustainable and inclusive growth and sustainable transport. Research facilities have been built and business infrastructure has been strengthened. EU programmes have also helped to promote inclusion in education and vocational training. Given the positive experience with EU funds in the past, EU funds can also help to overcome the identified challenges in the future. 1. Economic situation and outlook Growth performance Malta’s economy keeps growing faster than the EU average, supported by a thriving services sector. Malta’s annual growth in real gross domestic product (GDP) averaged 7.8% between 2014 and 2018, making it one of the fastest growing economies in the EU. In particular, the gross value added generated by the services sector grew on average by 12% per year in the same period, accounting for 68.5% of Malta’s total gross value added in 2018 ( ) (see Graph 1.1). Economic growth started to moderate in 2019, and annual real GDP growth is expected to come in at 4.5% for the full year of 2019. Domestic demand has been underpinned by increasing public expenditure and strong investment growth, which helped to boost growth in goods imports. However, private consumption growth was less than the very high rate recorded in 2018. While rebounding in the third quarter of 2019, export growth remained rather subdued compared to the strong increases of recent years, partly reflecting a slowdown in the growth of tourism. Graph 1.1:Gross Added Value by sector, 2009-2018 Source: Eurostat Growth is expected to slow in the short term, amid external risks. Growth is set to continue, but the pace of expansion is expected to gradually ease to 4% in 2020 and 3.7% in 2021 (see Graph 1.2). Private consumption growth is set to weaken, while remaining above its historical average, due to favourable labour-market conditions. Investment growth is forecast to remain high into 2020, supported by large-scale projects in the aviation, health and tourism sectors. However, it is set to slow down thereafter, as a number of infrastructure projects reach completion. Export growth is expected to remain relatively modest in the short term, reflecting less robust growth in Malta’s main export markets and elevated global uncertainty. As domestic demand continues to remain high, imports are set to grow somewhat faster than exports in 2020, before decelerating in 2021. As a small, open economy, Malta’s economic outlook is subject to the risks of a weak external environment and the economic performance of its trading partners.

Graph 1.2:Real GDP and components, 2012-2021 Source: European Commission The long-term sustainability of Malta’s growth potential remains the main concern. Malta’s strong economic performance has been driven by the shift towards fast-growing export-oriented services, such as remote gaming, finance and tourism. The large inflow of foreign workers has helped to boost labour supply and enabled strong jobs growth. However, the Maltese economy faces a number of structural challenges, notably an ageing population, low skills levels, governance vulnerabilities, infrastructure bottlenecks, and limited innovation potential (see also Section 3). In this context, reconciling the increasing economic activity with Malta’s physical and institutional constraints (e.g. land and other natural resources; the labour force; and institutional capacity) remains crucial to ensure the long-term economic, social and environmental sustainability of the country’s growth model. Inflation Inflation remains moderate and is expected to increase only gradually. Headline inflation in 2019 registered a slight deceleration compared to the previous year, from 1.7% to 1.5%. Starting in April 2019, inflation in Malta was in line with inflation in the euro area. This followed a period in 2017 and 2018 when inflation in Malta was lower than the euro-area average. Prices of unprocessed food increased particularly swiftly in the first half of 2019. By contrast, prices for non-energy industrial goods remained low, due to weak inflationary pressures in Malta’s trading partners, helping to keep core inflation below headline inflation. In the future, labour-market tightness is expected to gradually translate into higher wages, particularly in the services sector. This is expected to lift the price of services in the coming years. Labour market The labour market is tightening due to sustained job creation and low unemployment. Robust economic growth has gone hand in hand with sustained employment growth (5.7% in 2018). The employment rate reached 75.5% in 2018 and has increased for both men and women. The unemployment rate dropped to 3.4% in the second quarter of 2019 (see Graph 1.3). Long-term unemployment is very low, at 1.1% in 2018. Youth unemployment has also been falling, and decreased to 9.1% in 2018, well below the EU average. As economic growth slows down, employment growth is expected to moderate slightly, but the unemployment rate is projected to remain below 4% in the short term. Wage growth started accelerating in 2018 and is expected to remain strong in 2019 and 2020. The increases in labour supply due to significant inflows of foreign workers, and the rising labour-market participation of women, have both helped to limit wage growth in recent years. In 2018, nominal compensation per employee increased by 2.3%, while real (GDP-deflated) wages turned positive (increasing by 0.2%). Nominal wages are expected to continue their gradual increase in 2020. Unit labour costs increased by 1% in 2018. However, wage growth remains both: (i) below the rate consistent with a stable evolution of cost competitiveness; and (ii) below the rate consistent with internal labour-market conditions ( ). Graph 1.3:Key employment indicators Source: Eurostat Despite the overall favourable labour-market conditions, structural challenges risk hampering inclusive and sustainable growth. The population is rapidly ageing and labour shortages continue to remain a challenge. At the same time, the labour-market participation of certain groups remains low. Although the employment rate of women has increased significantly in recent years, the gender employment gap was 21.9 pps in 2018, one of the highest in the EU. The labour-market participation of older people (between 55 and 64) and people with disabilities remains below the EU average. In addition, Malta continues to face challenges in the area of education and skills, which impede inclusive and sustainable growth. Both the share of low-skilled people and the early school-leaving rate remain high, despite improvements in recent years. Basic skills attainment is also still weak (see also Section 3.3). Social developments and inequality After a strong decline, the risk of poverty or social exclusion is stabilising, but some groups are still at high risk. Strong economic growth and job creation helped to reduce the risk of poverty or social exclusion in recent years. However, this risk remains high for specific population groups, such as single earner households, the low-skilled, older people, and non-EU nationals. Inequality is stable, but some disparities remain. Malta has relatively moderate inequality of income compared to EU averages (the income quintile ratio stood at 4.28 in 2018 against 5.17 in EU, and is stable), despite the fact that equal opportunities remain limited for some groups. The unmet need for medical care is low with little variation between income groups. Disparities in education outcomes are strong and linked to socioeconomic background, disability status and type of school (see also Section 3.3). Regional disparities A regional gap can be observed between the island of Malta and the island of Gozo. Regional disparities in Malta can be observed only at NUTS3 level ( ), dividing the country into the island of Malta (around 93% of total population) and the islands of Gozo and Comino. The population density of Gozo in 2018 was roughly one fourth of the density on the island of Malta, while Comino is mostly uninhabited. The share of working age population (age 15-64) for the island of Malta is generally 2 pps higher than in the island of Gozo. More than 20% of the Gozo resident workforce works on the island of Malta. In 2017, GDP per capita in Gozo, in purchasing power standards, corresponded to 60% of the EU average. The gap between the two islands significantly widened from 2004 to 2017, from 31 to 41 pps (European Commission, 2019i). Productivity Total factor productivity growth increased, in contrast to labour productivity per hour in 2018. Over the last decade, several factors, including the shift to high-added-value sectors, have helped to boost productivity growth in Malta. After peaking at over 4% in 2017, labour productivity growth slowed in 2018 to 1.3%. In turn, total factor productivity growth peaked at 2.2% in 2018 (see Graph 1.4), suggesting that investment did not keep up with the increase in labour utilisation (see also Section 3.4). Graph 1.4:Total Factor Productivity trends, Malta and selected countries Source: European Commission The inflows of skilled foreign workers helped lift productivity, but these inflows also create challenges. The Maltese economy experienced substantial inflows of foreign workers in the past decade, including many high-skilled individuals (see also Section 3.3). The increased availability of skilled labour helped to address skills shortages and mitigate skills mismatches, which previously acted as a drag on productivity growth. At the same time, research shows that EU-national foreign workers in Malta are generally young and tend to spend a relatively short time in the country. In most cases, these workers do not change job while in Malta, nor do they improve their employment occupation while there (Borg, 2019). The lack of mobility within the Maltese labour market may weigh on future productivity growth, as ﬁrms must routinely hire new workers, with limited productivity gains from ‘learning-by-doing’. Competitiveness There are some signs of a moderate deterioration in Malta’s external competitiveness. The real effective exchange rate continued to appreciate above that of major EU economies in 2018, while the export market share stabilised in 2018, after increases in 2014 and 2015. As a result, with a decline in export growth and an increase in import growth fuelled by growth in internal demand, the trade surplus shrank slightly, but it remains largely positive.

A steady decline in the import content of services exports has supported the trade surplus. The import content of services exports is deﬁned as the share of services imports to services exports (in real terms). Since 2012, the services import content has been on a declining path, which has helped to reduce total import intensity (i.e. the ratio of total imports to total demand) and so increase the trade surplus. In 2018, services imports were equivalent to 72% of services exports, signiﬁcantly lower than the 2009-2018 average, which was above 80% (see Graph 1.5). The decline in the import content of exports reflects the shift in value added creation towards service-oriented firms that use information technology and skilled labour as their main inputs. These firms operate in sectors such as computer programming and remote gaming (Central Bank of Malta, 2019a). Graph 1.5:Trade balance and import content of export trends, 2005-2018 Source: European Commission External position Malta’s current account surplus is among the highest in the EU. The current account balance turned from negative to positive in 2013 and has remained in surplus since then, peaking at 10.5% of GDP in 2017, among the highest figures in the EU for both years. The current account surplus reflects a large surplus in the balance of services, which averaged 32.4% of GDP in the four quarters ending in the third quarter of 2019. In the same period, exports of services represented 115.7% of Malta’s GDP, an indicator of the Maltese economy’s services specialisation and trade openness (see Graph 1.6). Amid a weakening external environment, which was reflected in the slowdown in export growth, the current account balance narrowed, averaging 10.1% of GDP in the four quarters ending in the third quarter of 2019. Graph 1.6:Current account decomposition, 2005-2018 Source: Eurostat The large current account surplus is not in line with fundamentals. The cyclically adjusted current account surplus was estimated at 13.1% of GDP in 2018. The current account balance remains above the current account norm calculated by the European Commission according to fundamentals (i.e. demographics, reserve currency status and manufacturing intensity) (Coutinho, Turrini and Zeugner, 2018), which for Malta indicates a current account close to balance, taking into account the financial centre status of Malta, which is estimated to inflate the current account balance by 2 pps.”. A large residual, which is not explained by fundamentals, is the most important factor behind this difference, reflecting the presence of large internationally oriented businesses. In small finance centres like Malta, the cross-border flows associated with multinational companies may also result in measurement errors ( ). The net international investment position shows that Malta is a creditor to the rest of the world. Malta’s net assets, measured by the net international investment position, amounted to 63% of GDP in June 2019. The net international investment position excluding ‘non-defaultable’ debt, which focuses on the net international investment position components that may be subject to default or partly used as collateral, constituted 255% of GDP in June 2019. This points to vulnerabilities due to changes in debtor economies. In particular, claims of UK banks on Maltese residents amount to around 46% of Maltese GDP. The level of Malta’s total foreign assets abroad amounted to €251 billion, with roughly 47% of foreign assets represented by portfolio investment, in particular equity and investment fund shares. Net foreign liabilities accounted for €244 billion, of which €198 billion was direct investment (around 81%). In total, gross external assets and liabilities are equivalent to around 40 times the country’s GDP. Private sector debt Private debt levels highlight the need for further deleveraging. Deleveraging is still needed, despite the reduction in private sector borrowing due to the high nominal growth in GDP. Private sector consolidated debt amounted to 130% of GDP in 2018, above the European Commission’s fundamental-based and prudential benchmarks ( ), while non-consolidated debt was close to 190% of GDP ( ) (see Graph 1.7). A significant share of total private debt is owed by non-financial corporations (80% of GDP consolidated, and just below 139% of GDP non-consolidated). The significant difference between consolidated and non-consolidated non-financial corporate debt is explained by the extensive use of intragroup lending, related to the presence of multinational companies. The high level of private debt combined with a weak insolvency framework (see Section 3.2.1) amplifies the economy’s vulnerability to possible adverse shocks. Household indebtedness has been declining but remains relatively high. Household indebtedness as a share of GDP decreased from 61% to 49% between 2012 and 2018, mostly reflecting the fast pace of GDP growth. However, the analysis of mortgage trends reveals specific vulnerabilities (see Section 3.2.3). While the household debt-to-GDP ratio is below its prudential benchmark (at 58% of GDP), it is still somewhat higher than the fundamentals-based benchmark estimated by the European Commission (42% of GDP). Furthermore, the ratio of household debt to gross disposable income is close to 100%, suggesting the need to contain the increase in nominal debt to ensure more sustainable household balance sheets. Graph 1.7:Private sector debt and benchmarks Source: European Commission Financial sector Conservative lending practices keep the financial sector in good health, but make lending difficult. The median loan-to-value at origination of around 77%, and a loan-service-to income ratio of 21%, point to a continuation of conservative practices by local banks despite favourable macroeconomic conditions. The overall ratio of non-performing loans improved further to 3.4% in 2018, down from 4.1% in 2017. This is just above the EU bank average of 3.2%. The non-performing loans ratio for mortgages also declined to 2.5% in 2018. Core domestic banks continue to be largely funded through customer deposits (which account for 80% of all assets), and more specifically by residents (90% of total customer deposits), thus maintaining ample liquidity. Comprehensive stress tests by the Central Bank of Malta confirm that the overall capital and liquidity positions of banks would remain sound and within the regulatory requirements even in the event of severe shocks. Nevertheless, Maltese surveyed banks have maintained their tight credit standards on loans to enterprises (Central Bank of Malta, 2019b). The banking sector is also facing: (i) the retraction of correspondent banks from the Maltese market in recent months; and (ii) ongoing weaknesses in the supervisory framework to counter money laundering (see Section 3.2). The exposure of domestic banks to the real-estate market has further increased. Total assets of core domestic banks ( ) grew by 5.1% in 2018, amounting to some 195% of GDP. Growth was almost entirely driven by customer loans to residents, especially to finance mortgages, which increased by almost 9%. The share of resident mortgages in total resident loans increased to 49.5% in 2018. Loans granted to the construction and real-estate sector also increased. Collectively, the share of property-related loans in the total loan portfolio of domestic banks increased to 63% in 2018 compared to just above 52% in 2008. Such sectoral concentration poses a growing risk for the local financial system (Central Bank of Malta, 2019b). Public finances Public finances are expected to remain in good shape in the coming years. After an exceptionally high surplus of 3.4% of GDP recorded in 2017, the fiscal balance declined in 2018. The fiscal balance is expected to ease further to about 1% of GDP in 2019 and the following years. Positive fiscal outcomes are largely sustained by revenue from the Individual Investor Programme (citizenship scheme) ( ), whose future development is difficult to predict. As of 2019, the composition of expenditures is expected to have shifted in favour of public investment, which is expected to have exceed 4% of GDP, well above the long-term average. In contrast, the ratio of social and healthcare spending to GDP, which amounted to 9.8% in 2018 (EU average 20.4%), is set to stabilise below the levels observed in the past. Fiscal challenges are more pronounced in the longer term. The ratio of public debt to GDP fell by more than 17 pps between 2014 and 2018 to about 45%, and is expected to decline further in the coming years. A relatively low level of public debt combined with fiscal surpluses makes Maltese public finances resilient in the short term. However, in the medium term, Malta’s reliance on corporate taxes makes the country vulnerable to international initiatives on the fight against tax avoidance, which could reduce fiscal revenues. In the long term, an increase in ageing-related outlays on pensions and healthcare is expected to put an additional strain on Malta’s public finances (see Section 3.1). Progress towards sustainable development Malta’s performance in relation to the United Nations’ Sustainable Development Goals (SDG) is mixed. Malta is above the EU average in most of the indicators pertaining to decent work and economic growth (SDG 8), which contributed to advancing on reducing poverty (SDG 1). Good health and well-being are also areas where Malta performs relatively well (SDG 3). Despite some recent improvements, Malta lags behind EU average on a number of indicators related to quality of education (SGD 4) and gender equality (SDG 5). A declining trend in terms of R&D expenditure and R&D personnel points to a particularly weak performance on SDG 9. In addition, a number of environmental challenges remains, for example in relation to final energy consumption (contributing to SDG 7 on affordable and clean energy, SDG 12 on responsible consumption and production, and SDG 13 on climate action) and waste recycling (SDG 11, sustainable cities and communities). The corruption perception index (SDG 16, peace, justice and strong institutions) has also deteriorated over the past years. Table 1.1:Key economic and financial indicators - Malta Source: Source: Eurostat and ECB as of 4-2-2020, where available; European Commission for forecast figures (Winter forecast 2020 for real GDP and HICP, Autumn forecast 2019 otherwise)

2. Progress with country-specific recommendations Since the start of the European Semester in 2011, 68% of all country-specific recommendations (CSRs) addressed to Malta have recorded at least ‘some progress” ( ). 32% of these CSRs recorded 'limited' or 'no progress' since 2011 (see Figure 72.1). Substantial progress or full implementation have been achieved in the area of fiscal policy and fiscal governance, as well as in certain areas of the labour market and energy sector. Graph 2.1:Overall multiannual implementation of 2011-2019 CSRs to date Source: European Commission Although the short-term fiscal position has improved, long-term challenges have not yet been sufficiently addressed. The budget has been in surplus since 2016. In addition, the structural balance remained above the medium-term objective over the past years and the debt-to-GDP ratio fell below the 60% threshold in 2015, and has continued falling since then. The fiscal framework has been strengthened through the implementation of binding multiannual targets and the introduction of spending reviews. The further incorporation in the budgetary process of these targets and reviews is ongoing. In contrast, limited action has been taken to improve the long-term sustainability of public finances, and the projected increase in ageing costs in Malta remains one of the highest in the EU, although from a level much below the EU average. There remains room to mitigate the risks from money laundering. Malta’s supervisory bodies have been strengthened by: (i) investing in human resources and IT; (ii) revising policies and procedures aimed at improving risk-based processes; and (iii) introducing better monitoring of money laundering/terrorist financing risks. However, there has been insufficient action to tackle flaws in the frameworks for investigating and prosecuting money laundering. Weaknesses in the governance framework persist, particularly in the judicial independence. Although police resources are being increased, efforts to detect and prosecute corruption remain insufficient. Reforms to improve the criminal justice system have not yet been implemented. Limited progress was made to strengthen the independence of the judiciary. The government announced its intention to tackle the issue but concrete measures on the appointment and dismissal of judges have been announced but have not been taken yet. On the prosecution services, the government took steps to create an autonomous prosecution service, with the adoption of the State Advocate Act in July 2019. This measure aims at ending the Attorney General’s dual role as both the primary public prosecutor and the primary government consultant in legal matters. However, the reform appears insufficient to meet existing concerns about the independent functioning, effectiveness, and accountability of the prosecution services. Concerns remain over checks and balances in the appointment procedure for the Attorney General, which in practice remains under the exclusive power of the Government. Energy reforms have been implemented, but environmental sustainability challenges remain. In recent years, Malta has made substantial progress in diversifying its energy mix, in particular through infrastructure investment. The growing population makes it all the more important to further strengthen environmental sustainability, especially by improving the energy performance of buildings. In addition, greenhouse gas emissions are increasing, and Malta is expected to miss its 2030 emissions targets. A number of policy measures to promote sustainable mobility are in the pipeline. It is crucial to strengthen and implement these measures, as traffic congestion generates significant economic and environmental costs. Measures to strengthen human capital are now under way, and previous reforms have helped to broaden the labour supply. Labour-market reforms have helped to increase the labour supply in recent years. Some progress has also been made in making education more inclusive for all. A policy on inclusive education in schools and a national inclusive education framework were published in 2019. It is now important to ensure full implementation of the new policy in all schools. The early-school-leaving rate has been declining in recent years, but it remains one of the highest in the EU. The government recently invested in research infrastructures, aiming to improve the teaching and research capacity of the public sector. Malta has made limited progress in addressing the 2019 CSRs (see Table 22.1). No progress has been made in addressing the 2019 CSR on the long-term sustainability of public finances. This is because no new measures were adopted to: (i) restrict early retirement; or (ii) reflect gains in life expectancy in the statutory retirement age. The steps that have been taken to address the adequacy of pensions are likely to require additional government outlays, and therefore do not improve the fiscal position in the long term. Although implementation continues of measures introduced in the past to improve the efficiency of the healthcare system, no new measures have been announced to further improve the system. On the governance framework, some progress has been made to improve the regulatory and supervisory framework for combating money laundering. Additional resources were allocated to supervision and cooperation among supervisory authorities was strengthened. However, the practice of Malta Financial Services Authority to use a private consultancy for supervisory tasks is of concern. A reform of the Financial Investigation Department within the police is underway. Investigations, prosecutions and convictions for money laundering and related offences remain limited. However, no progress has been made in altering features of the tax system that may facilitate aggressive tax planning. In addition, only limited progress was made on tackling corruption. Limited progress was also made on strengthening the independence of the judiciary. Some progress has been made in focusing investment-related economic policy on: (i) research and innovation; (ii) natural-resource management; (iii) resource and energy efficiency; and (iv) inclusive education and training. Limited progress was made on investing in sustainable transport and reducing traffic congestion. Upon request from a Member State, the Commission can provide tailor-made expertise via the Structural Reform Support Programme to help design and implement growth-enhancing reforms. Since 2017, such support has been provided to Malta for 30 projects. In 2019, several projects were delivered on the ground. The Commission, for example, helped the Maltese authorities to improve the framework for detecting and supporting students at risk of early school leaving and to strengthen the administrative capacity of the Planning Authority. Furthermore, the Commission facilitated the training of public officials working in the area of e-government. In 2019, support continued in promoting spending reviews with a particular focus on the implementation of recommendations and in introducing a performance-based budgeting framework, while work has started in supporting Malta’s participation in InvestEU. Table 2.1:Annual assessment of the 2019 CSRs (*) Source: European Commission (*)The assessment of CSR 3 does not take into account the contribution of the EU 2021-2027 cohesion policy funds. The regulatory framework underpinning the programming of the 2021-2027 EU cohesion policy funds has not yet been adopted by the co-legislators, pending inter alia an agreement on the multiannual financial framework (MFF). Box 2.1: EU funds and programmes to address structural challenges and to foster growth and competitiveness in Malta. Malta significantly benefits from EU cohesion policy funding. The financial allocation from the EU Cohesion policy funds ( I ) for Malta amounts to €863 million in the current Multiannual Financial Framework, representing around 1.1% of GDP. As of end 2019, Malta allocated to specific projects €888 million (more than the total amount planned) and spent €345 million ( II ), showing a level of implementation above the EU average. In particular, the cohesion policy programmes have allocated EU funding of €146 million for smart growth, €361 million for sustainable growth and sustainable transport, and €181 million for inclusive growth. In 2019, following a performance review ( III ), Malta received additional funding for €52 million. EU cohesion policy is contributing to the transformation of the Maltese economy. By 2019, investments driven by the European Regional Development Fund (ERDF) have led to two significant research facilities implemented by the University of Malta: one enabling and supporting technology transfer, entrepreneurship and knowledge exchange with industry (the “Trake project”, the other one being a laboratory to monitor resource efficient technologies in real life (the “Sustainable Living Complex”). With the aim of promoting innovation, Malta also approved the ‘Sintegram’ project in 2018 to develop a national spatial data infrastructure, and to enhance the capacity of geo-spatial technology expertise. Malta also decided to support business infrastructure for SMEs through three projects: the Internationalisation Knowledge Platform (231 enterprises have registered), the redevelopment of Ta’ Qali Crafts Villa, and the ongoing extension of Xewkija Industrial Park. In the field of environment, a major project aiming at ensuring an integrated water resources management is set to be implemented by January 2022. The European Social Fund (ESF) notably promotes inclusive training opportunities. By the end 2018, 16,342 people received training or other support through the ESF, which aims among others, at providing inclusive and quality vocational education and training (VET) and making VET more attractive. 1 272 people with disabilities participated in an ESF funded activity. 9,431 people gained a qualification and 1,645 people found a job. Agricultural and fisheries funds and other EU programmes also contribute to addressing the investment needs. The European Agricultural Fund for Rural Development (EAFRD) fund makes available in total €130 million, whereas the European Maritime and Fisheries Fund (EMFF) a total of €29 million, including national co-funding. Malta benefits also from other EU programs, such as the Connecting Europe Facility, which allocated EU funding of €49 million to specific projects on strategic transport networks and Horizon 2020 which allocated EU funding of €24 million (including €6 million support for 20 SMEs). EU funding contributes to mobilise private investment. The SME initiative allocates €22 million in the form of loans, guarantees and equity, an increase by €7 million compared to 2018 due to the success of the initiative. This is expected to leverage additional private investment amounting to €88 million. At end September 2019, 655 SMEs from 60 different economic sectors have benefitted from the initiative, 48% of which being start-ups. EU funds already invest substantial amounts on actions in line with the Sustainable Development Goals (SDGs). In Malta the European Structural and Investment Funds support 12 out the 17 SDGs and up to 94% of the expenditure is contributing to those. 3. Reform priorities 3.1.Public finances and taxation 3.1.1.Taxation Corporate income taxes continue to be a crucial source of government revenues, but their volatility remains a concern. With a tax-to-GDP ratio of 31.8% ( ) in 2018, Malta has one of the lowest tax burdens in the EU. Although consumption and labour-income taxes were the largest sources of tax revenue, the share of corporate income tax in total tax revenue (17.4%) remained among the highest in the EU ( ), partly reflecting a surge in registered businesses. Between 2010 and 2018, the number of corporations in Malta doubled to over 55,000. Most of these corporations have at most 10 employees. This growth is likely due to international companies that are attracted by the Malta’s tax system, which allows companies to reduce their effective tax rate to between 0% and 10% through a series of tax credits and refunds even though the statutory corporate income tax rate stands at 35% (Deloitte, 2019). High reliance on corporate tax revenues, combined with hard-to-predict revenues from its Individual Investor Programme that amount to some 1% of GDP, make Malta’s fiscal position sensitive to economic shocks and developments in the corporate and personal tax framework, both in the EU and beyond. The economic data suggests that companies and individuals are using Malta’s tax rules to engage in aggressive tax Planning. Persistently high inward and outward foreign direct investment stock (which is almost exclusively held by special purpose entities) coupled with a high level of dividend (see Graph 3.1.1) and royalty payments as a percentage of GDP suggests that companies use Malta’s tax rules to engage in aggressive tax planning (European Commission, 2020b). Measures identified as being of particular concern: the absence of withholding taxes on outbound payments, the country’s investor citizenship and residence schemes (the Individual Investor Programme and Residence and Visa Programme); and the notional interest deduction ( ) (European Commission, 2019b). The Maltese treatment of resident non-domiciled companies can also lead to situations of double non-taxation between Malta and most countries with which Malta has concluded a bilateral tax treaty (the ‘Single Malt’ structure ( )). In August 2019, Malta introduced a new ‘patent box’ regime in line with EU and international standards. However, the economic evidence for the effectiveness of patent boxes in encouraging R&D remains limited (CPB, 2014), and they could be used in aggressive tax planning schemes (Alstadsæter et al., 2018). Finally, the lack of a robust transfer-pricing framework may also allow multinational groups to use Malta for aggressive tax planning. Malta is implementing European and internationally agreed initiatives to curb aggressive tax planning. Malta has implemented the second anti-tax avoidance Directive (ATAD 2), which should neutralise certain hybrid mismatch arrangements that would otherwise result in double non-taxation, and the sixth amendment of the Directive on Administrative Cooperation (DAC 6), which provides for new transparency rules for intermediaries involved in tax planning. Further, Malta has ratified the OECD Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, which entered into force on 1 April 2019. Although Malta applies this convention to the vast majority of its treaty partners, it has put reservations on numerous articles, significantly limiting the effectiveness of this multilateral instrument. A Competent Authority Agreement between Malta and Ireland came into force in November 2019 to make sure that the bilateral tax treaty between those countries is not used for aggressive tax planning practices through the ‘Single Malt’ structure ( ). The extent to which these initiatives limit the scope for aggressive tax planning remains to be assessed. No additional reforms have been introduced to address specific tax rules used by multinationals engaged in aggressive tax planning structures. Graph 3.1.1:Total outgoing dividend payments from EU Member States and share going to offshore financial centres*** Source: European Commission

Significant tax revenue is lost due to international tax evasion by individuals. Offshore wealth held by Maltese citizens is estimated to have reached 48% of GDP in 2016, 17 pps more than the 2001-2016 average. This is very high compared to an EU average of 9.7% (ECOPA and CASE, 2019). The corresponding estimated level of international tax evasion of 2.4% of GDP was the highest in the EU (against an EU average of 0.3%). As shown in a recent study, after the introduction of the Individual Investor Programme, deposits of Maltese citizens held in low-tax jurisdictions reporting to the Bank of International Settlements increased by about 70% (Langenmayr and Zyska, 2019). The OECD ( ) has said that Malta’s investor citizenship and residence schemes have a potentially high risk of being misused to circumvent the automatic exchange of financial account information. This is because such schemes facilitate the concealment of the real jurisdictions of residence. When used as tools to hide assets held abroad from reporting, they can be used to evade tax. Some efforts are ongoing to limit international tax evasion by individuals. The Maltese government exchanges information with other governments about people that have obtained residence/citizenship through Malta’s investor citizenship and residence schemes. In addition, the country’s common reporting standard guidelines have been amended to give more detailed explanations to financial institutions about these schemes and their potential to circumvent reporting guidelines. Tax compliance has improved and further measures have been implemented. In 2017, the VAT gap ( ) declined by an additional 0.7 pps to 2%. This is well below the EU average of 10.9% (CASE, 2019) and suggests there have been improvements in compliance. Nevertheless, due to VAT exemptions and the application of lower VAT rates to selected products, Malta is one of the EU countries with the highest rate gap suggesting revenue losses due to the existence (and level) of reduced rates. To tackle tax evasion, cash transactions exceeding €10,000 were banned for purchases such as properties, vehicles, art, precious stones and yachts. Given a sharp increase in tourist demand for private accommodation, in 2019 the authorities made an agreement with major providers of online booking portals to promote properties licensed by the Malta Tourist Authority. This will improve the monitoring of private rental income and improve collection of the 15% tax that is due on this type of income. Real-estate-related tax revenue comes exclusively from transaction taxes. Real estate taxes, which exclusively come from transaction taxes, totalled 1.3% of GDP in 2018, compared to an EU average of 2.5%. They represented 4.2% of total tax revenues in Malta compared with 6.4% in the EU, since Malta does not apply recurrent taxation on immovable property. Shifting from transaction to recurrent property taxes could foster a more efficient use of building space, which is particularly relevant for Malta. However, as Malta does not have a property register, this would entail certain set-up costs. Recurrent property taxes could also help in dampen potential boom-and-bust cycles, especially given the considerable recent increases in Malta’s property prices (see Section 3.2). There is scope to improve the design of environmental taxes. Environmental taxation both in terms of GDP and total tax revenue exceed the EU average. This is mainly due to the category of non-fuel-related transport taxes, which ranks among the highest in the EU. Vehicle taxes depend on the carbon dioxide emissions of the vehicle, and hence encourage fuel efficiency. However, they do not affect decisions on the number of kilometres driven. Fuel taxes, on the other hand, affect the marginal cost of using a vehicle and tend to have the greatest effect in reducing carbon dioxide emissions from car use. Fuel taxes are part of energy taxes which is the largest category of environmental taxation. Malta’s energy taxes are below the EU average, both as a percentage of GDP and as a share of total tax revenues. In addition, two major tax distortions diminish the effectiveness of fuel taxes, namely the reduced 5% VAT rate on electricity and the diesel excise duty rate (which is 14% lower than the petrol rate) (see also Section 3.5). Compensatory measures may help to mitigate the potential adverse impacts of fuel taxes for low-income groups (European Commission, 2019n). It is also noteworthy that Malta is one of the few Member States that does not appear to have a landfill tax nor an incineration tax (Confederation of European Waste-to-Energy Plants, 2017). 3.1.2.Fiscal Framework Malta’s sound fiscal framework could be improved further. The Maltese fiscal framework is well guided by numerical fiscal rules and medium-term budgetary plans with clear policy objectives. In addition, fiscal policies are monitored by an independent fiscal council. In line with the recommendations of the IMF fiscal transparency report (IMF, 2018), the government expanded the coverage of fiscal reports and improved reporting for extra-budgetary units and pension entitlements. However, the transparency of the framework would further benefit from: reporting tax expenditures; ensuring consistency between different fiscal reports; reviewing the performance of different public budget entities; and reviewing the performance of the public corporation sector (IMF, 2018). Initiatives continue in the area of spending reviews. In 2019, the spending review focused on the Malta Police Force. The review concluded that the ongoing move towards hubs with inter-disciplinary teams should enable police officers to be better redeployed in new priority areas (i.e. to address the changing nature of crime). 3.1.3.Debt Sustainability analysis and fiscal risks Malta faces fiscal sustainability risks in the long term. A relatively low — and declining — public-debt-to-GDP ratio (43% in 2019), combined with headline fiscal surpluses, make Malta one of the countries with low fiscal risks ( ) in the short-to-medium term in the EU. However, in the long term the sustainability gap indicator S2 ( ) (3.0 pps of GDP) suggests medium risks to fiscal sustainability. This is driven by a projected increase in ageing costs of 6.8 pps of GDP until 2070, which are due to: (i) increasing pension costs (2.9 pps of GDP); and expenditure on healthcare and long-term care expenditure (4.1 pps of GDP). Pension system The effects of an ageing population will weigh on the sustainability of the pension system. At 8% of GDP in 2016, pension spending in Malta was among the lowest in the EU. According to the European Commission (2018b), Maltese pension spending is projected to increase to 10.9% of GDP in 2070. Although this would be close to the EU average, the rate of growth over this time would be among the highest in the EU. The largest contribution to this increase in spending is projected to come from the dependency ratio, reflecting a relative increase in the number of pensioners compared to those of working age. However, the indexation rules in place will go some way to containing pension outlays ( ). Migration is likely to dampen pension outlays. The intermediate 2019 Eurostat population projections envisage faster population growth for Malta than previous projections due to higher projected migration flows. If these migration forecasts are confirmed in April 2020 ( ), the projected increase in pension expenditure would be 0.8 pps lower by 2070 than previously estimated. However, Malta would still remain a ‘medium-risk’ country with respect to the long-term sustainability of its public finances. If sustained, short-term stays of migrant workers may ease the pressures on pension outlays. About half of foreign workers leave again after 1-2 years, and almost 70% leave the country by the sixth year (Borg, 2019). Given their relatively short stays, not many foreign workers meet the minimum period of contributions (10 years) to qualify for pension entitlements ( ). This is especially true for migrants from non-EU countries, whose share in total migration has been increasing. Recent measures aim at diversifying pension income and increasing pension adequacy. In 2019, the government launched the home equity release scheme, which allows homeowner pensioners to raise their standard of living by allowing them to convert a part of their home’s value into income. The fiscal incentives for private pension savings and voluntary occupational pensions were also strengthened by increasing the maximum tax credit granted. To address the adequacy of pensions, the government increased pensions beyond the regular cost-of-living adjustment index. This led to a hike of more than 20% in the average public pension in 2020, the largest increase since 1980. A broader review of the pension system is expected in 2020 when the Pension Strategy Group set up in 2018 is expected to publish its report. Healthcare and long-term care system Public expenditure on healthcare is projected to increase considerably due to ageing. Malta spends 9.3% of GDP on health, only marginally below the EU average of 9.8% of GDP. However, out-of-pocket outlays of Maltese patients cover over a third of healthcare expenditure, more than double the amount of their average EU counterparts. Government expenditure on healthcare (excluding outlays on long-term care) is therefore relatively low at 5.9% of GDP (EU: 6.8% of GDP in 2016). However, given the ageing population, public spending on healthcare is projected to surge by 2.7 pps of GDP between now and 2070. An additional increase of 1.4 pps of GDP is expected for long-term care expenditure over the same period. The health system appears to be effective and well accessible. Malta has one of the highest life expectancies (82.4 years) in the EU, and in recent years has recorded substantial falls in treatable and preventable mortality. Nevertheless, behavioural risk factors persist. The obesity rate remains high and requires further prevention measures. A high rate (70%) of family doctor visits carried out in private clinics (OECD/European Observatory on Health Systems and Policies, 2019) is the main reason for high out-of-pocket outlays. Despite this, healthcare appears well accessible, as self-reported unmet needs for medical care are very low. Overuse of hospital emergency care persists, while long waiting times for specialists declined. In the absence of after-office-hours services of private doctors, patients tend to use emergency care in hospitals, despite the increased after-office hours in the National Health Service outpatient care, coupled with enhanced supply of diagnostics and specialist care. The government has run an information campaign to encourage patients in such cases to revert to public primary health centres. However, these measures seem to be insufficient to yield the full efficiency potential of reducing this costly practice. The public-private arrangements in outpatient care (e.g. for dentists and medical imaging) have reportedly reduced waiting times and are expected to be revisited once the backlog of cases declines to a reasonable level. Although the number of physicians and nurses has increased in recent years and converged to EU averages, shortages persist for nursing staff in hospitals and long-term care. Various measures aim to increase healthcare efficiency. Two primary-care hubs expected to be operational in 2022 will offer emergency outpatient care and increase the number of specialists. Efficiency gains may materialise if unjustified use of hospital emergency care is limited. Given a lack of details on service fees for the public-private partnership in hospital care, monitoring is warranted to ensure costs are contained. As the Valletta Declaration ( ) initiative is still under development, Malta continues to face challenges from the high prices of innovative medicines and treatments due to the small size of its market. Further policy measures are therefore needed in this area to address the growing pressure on public finances. The electronic patient record system is well advanced. The implementation of a broader national e-health system, which has the potential to improve the efficiency of the healthcare sector, is still ongoing.

Long-term care capacity has expanded in recent years. Although public capacity for institutional care (i.e. residential homes) is around the EU average, it is insufficient to meet demand. The government therefore contracted long-term care beds from the private sector. Home-based services have also expanded in recent years. The provision of these services is tested for needs, but not means, and the existing co-payments asked of patients are relatively low. The demand for long-term care services is expected to grow due to the ageing population and the growing labour-market participation of women who traditionally provided this type of care. 3.2. Financial sector 3.2.1.Financial stability Core domestic banks continue to strengthen their capital positions and leverage ratios. Capital ratios remained high in 2018 after declining mildly in previous years, which can be explained by balance sheet expansion (leading to the growth of risk-weighted assets) and valuation losses caused by higher yields. The total capital ratio stands at 23.4%, and the leverage ratio at 12.3%, for the sector ( ). The profitability of core domestic banks remains slightly above their euro-area peers, with a return on assets of 0.4% and a return on equity of 3.7% (0.2% and 3.2% in the euro area respectively). In the first half of 2019, net interest income declined to 73.6% of gross income. The operational-cost-to-income ratio plunged in the second quarter of 2019, reaching 48.5%, well below the euro-area average of 66.2%. However, fintech companies, which tap primarily business for electronic money, have become significant competitors to local banks in this service area. Although the impact of this new source of competition on banks’ interest rate margins is not yet relevant, the new digital players have increased their market share by taking on customers that do not fit the risk profile of a traditional bank. Aggregate figures on mortgages hide pockets of vulnerability. A shift from the construction and real-estate sector towards mortgages has reduced concentration risk, as lending is spread among a larger number of small borrowers. In addition, although household indebtedness grew, it was accompanied by household accumulation of net financial wealth. However, there has been an increase in both: (i) the shares of mortgages with a value equivalent to 5-6 times the client’s gross income; and (ii) the share of mortgages to people with a loan-service-to-income ratio within the 20%-25% interval (Central Bank of Malta, 2019b). This suggests that borrowers are increasingly required to borrow more compared to their income, and must therefore pay higher monthly instalments. Mortgages are also largely granted at variable rates, indirectly linked to the European Central Bank’s main refinancing operations rate (IMF, 2019), creating vulnerabilities in the event of a downturn or interest-rate hikes. Nevertheless, sensitivity tests carried out by the Central Bank of Malta on a potential increase in the interest rates by 150 basis points on new mortgages show that only 5% of new loans would have a debt-service-to-income ratio that exceeds 40%. In response to the momentum in the residential real-estate sector, supervisory rules were strengthened. The Central Bank of Malta issued Directive 16 on the Regulation on Borrower-Based Measures, which came into force on 1 July 2019, and applies to all domestic lenders granting domestic, residential real-estate loans. For two categories of borrower, the measures set limits on: (i) the size of loans relative to the value of property; (ii) the size of debt service relative to income; and (iii) the maturity of the loan ( ). Under the new rules, first-time buyers benefit from higher loan-to-value ratios and longer maturities relative to category II buyers. They are also exempt from loan-to-value and debt-service-to-income restrictions if the collateral market value of the acquired property is below €175,000. With both borrower categories, the banks have ‘speed limits’, which allow banks to deviate from the maximum loan-to-value ratios for a specified number of loans, differing by borrower category. These borrower-based measures are expected to: (i) strengthen the resilience of lenders and borrowers to any potential shocks; and (ii) preserve the current sound and prudent lending standards. Malta is also further developing its capital market for small and medium-sized enterprises. The number of non-bank companies quoted on the Malta Stock Exchange surged between 2013 and 2019. There was also a corresponding increase in the amount of debt issued on financial markets by non-bank companies, which almost tripled over the same period. This trend exacerbated the disintermediation process (companies being able to raise money in debt markets instead of having to go to banks), and is expected to improve financial stability by diversifying credit risk among a range of market participants. Moreover, as a result of the national capital-markets strategic plan that was launched in 2016, small and medium-sized enterprises were able to issue bonds or equity via the Prospects Multilateral Trading Facility, thus increasing access to the capital markets for small players. By 2019, the Prospect Multilateral Trading Facility market, which consisted predominantly of bonds, constituted almost 2.5% of outstanding corporate bond issuance and amounted to some 0.4% of GDP. It is important to ensure that buyers of different financing instruments are aware of the associated risks. The domestic insurance sector remains profitable and has retained a strong solvency position. Out of 70 insurance companies, only 8 firms underwrite risks in Malta as their main line of business. Notwithstanding the prevailing uncertainty in yields on international markets, the systemically relevant domestic insurance sector has remained profitable, with a return on assets and return on equity respectively standing at 1.3% and 12% (EU insurers: 0.6% and 12.7%) in June 2019. Over the same period, the sector also met regulatory Solvency II requirements with all domestic insurers having solvency capital requirement ratios ( ) and minimum capital requirement ( ) ratios well above 100%. The withdrawal of correspondent banks still needs to be addressed. Correspondent banks, which help domestic banks conduct transactions in other currencies, especially US dollars, have become increasingly more risk averse in recent years. This has led them to exit or de-risk this service in small jurisdictions and those with a concentration of high-risk clients. US regulators perceive payments involving online gaming and payment gateways that are outside the Visa and MasterCard systems as high risk. To address such concerns, several banks implemented requirements set by correspondent banks, such as refraining from: (i) processing payments in the gaming and crypto-currencies sectors; and (ii) dealing with clients who availed of any of Malta’s citizenship or residency schemes (MONEYVAL, 2019). Deutsche Bank stopped providing such services to local banks in 2019, while ING promised to extend them until March 2020. To improve their international reputation and prevent the further loss of correspondent banks, additional measures to tackle money-laundering issues may be required (see Section 3.2.2). Lengthy procedures do not provide an adequate remedy against insolvency. In the World Bank’s Doing Business 2020 report, Malta ranked among the last of all EU Member States for resolving insolvency. This is because of a relatively low recovery rate and long proceedings (which last about 3 years on average). Moreover, the insolvency framework index ( ) points to overall weakness in the whole insolvency framework. An assessment of the insolvency system by the Central Bank of Malta in early 2019 took a sample of 204 non-performing loans. The assessment showed that 27 obligors (13% of the total) were resolved in court and settled within a median timeframe of 0.7 years, while longer-lasting cases took some 4 years to settle. To remedy the system, the banking association proposed that banks with commercial loans could be allowed to sell the commercial property themselves to accelerate the process and achieve an easy disposal of assets. The government has not yet discussed the measure. 3.2.2.Combating money laundering The Maltese economy remains vulnerable to money-laundering risks. Money-laundering cases have affected Maltese credit institutions in recent years (European Commission, 2019k). Following the findings of the European Banking Authority of a breach of EU law by Malta’s Financial Intelligence Analysis Unit (FIAU) in July 2018, and the subsequent opinion from the European Commission, Malta’s anti-money laundering system has been strengthened with regard to supervision. However, the Mutual Evaluation Report of Malta, published by MONEYVAL in July 2019, identified shortcomings in the investigation and prosecution of money laundering, due to limited resources within the police and a lack of sufficient prioritisation. Deficiencies were also found in asset-tracing and the confiscation regime for criminal proceeds. Malta’s specialisation in gaming and plans to specialise in virtual assets, which have inherent money laundering risks, highlights the need for commensurate mitigating measures. Remote gaming is one of the key sectors in the Maltese economy and is expected to contribute to Malta’s economic growth in the coming years (EY, 2019). At the same time, as highlighted in the country’s national risk assessment (Ministry for Finance, 2018), remote gaming is inherently vulnerable to money laundering. This requires effective implementation of appropriate mitigating checks, both at the initial stage (when a customer first signs up) and on an ongoing basis. Cooperation between the FIAU and the Malta Gaming Authority has been strengthened. Furthermore, as an emerging international hub in the area of virtual assets, Malta has begun an analysis aimed at assessing the risks posed by the sector and related services. The findings of the analysis will be crucial to ensure effective application of the appropriate mitigating measures to address vulnerabilities and money-laundering risks emerging from this sector. Potential money-laundering risks are associated with Malta’s citizenship and residence schemes. In 2013, Malta introduced an investor citizenship scheme, the Individual Investor Programme, and a residence by investment scheme, the Malta Residence and Visa Programme. The Individual Investor Programme is being administered by an independent government entity. In the country’s national risk assessment, the potential risks of money laundering linked to the citizenship and residence schemes were not analysed, although these schemes inherently raise money-laundering concerns (European Commission, 2019j). Ensuring an adequate understanding of the risks posed by this type of scheme and the adoption of appropriate mitigating measures remain a challenge. Malta has stepped up efforts to enhance its anti-money-laundering regulatory and supervisory framework. The FIAU, as the anti-money-laundering supervisor, has adopted a 2019-2021 development plan. The plan aims at significant growth in all the FIAU’s areas, such as investment in human resources and IT solutions to improve data gathering and risk-assessment tools. The FIAU also continues to revise policies and procedures aimed at improving risk-based processes. In parallel, the Malta Financial Services Authority (MFSA) has: (i) begun to increase staff levels to support its supervisory role (European Commission, 2019b); and (ii) reviewed its structure and anti-money-laundering oversight. In February 2019, the MFSA published an anti-money-laundering/counter-financing-of-terrorism strategy. The strategy includes the monitoring of money-laundering/terrorist-financing risks associated with the firms overseen by the MFSA. On the basis of a memorandum of understanding, the MFSA conducts anti-money-laundering supervision jointly with the FIAU, or on its behalf, on the basis of this FIAU’s manual and procedures. The response given by the Maltese authorities in the Satabank case (European Commission, 2019b) is an example of the stronger cooperation between the FIAU and MFSA in the anti-money-laundering supervision of credit institutions. It also shows improvements in Malta’s application of effective sanctions for breaches of anti-money-laundering obligations. However, the MFSA practice of using a private consultancy for supervisory tasks is of concern. On the law enforcement side, additional reforms are in the pipeline, although their effectiveness has yet to be assessed and yield results. In June 2019, Malta announced a number of reforms aimed at strengthening the role of law enforcement authorities in the fight against money laundering and financial crime more generally (doi.mt.gov, 2019). These reforms include: (i) the creation of a new Financial Organised Crime Agency to investigate and prosecute the most serious cases of money laundering and financial crime; and (ii) increased powers for the Asset Recovery Bureau. It remains to be assessed how these reforms will be implemented in practice. Until the end of October 2019, the Police intended setting up their own Prosecutions Unit but eventually this was superseded by a decision taken ahead of the date of the fact-finding mission in November. At the time, it was agreed that there would be one prosecution service led by the Attorney General, with the police retaining cases up to two years imprisonment. 3.2.3.Housing market There has been a sustained increase in residential house prices with some signs of overvaluation. Following the peaks reached between 2005 and 2008, property price growth was sluggish until 2014. Since then, house prices — as measured by the official transactions-based index published by the National Statistical Office — gained momentum, growing by 5.8% per year between 2014 and 2018. The property price index published by the Central Bank of Malta, which is based on advertised prices, suggests even faster annual average growth of 9.3%. Neither of these two indices reflects the floor area of sold properties. The price per square metre may therefore have surged by even more. Housing demand has been supported by: (i) the low-interest-rate environment; and (ii) budgetary measures incentivising property purchases for first-time buyers (and, more recently, also for second-time buyers). The job-rich economic growth, coupled with higher female participation, has also contributed to an increase in household incomes, supporting borrowers’ ability to apply for a mortgage. Higher demand for properties was also driven by inward migration and booming tourism (tourists are increasingly renting private accommodation for their stays). Ratios of house price to income and to rent point to a positive deviation from their long-term averages, suggesting some degree of overheating (Graph 3.2.1). This evidence is muted by the model overvaluation gap, based on econometric analysis, which suggests instead some undervaluation. Combining all indicators, the overall valuation gap points to an overvaluation of about 6% (Philiponnet and Turrini, 2017) ( ). Supply responded strongly to the swelling demand for residential property. Between 2014 and 2018, residential investment almost tripled in real terms, reaching 5.2% of GDP. In 2018, real investment in dwellings surpassed even the peak reached in 2007 (Graph 3.2.2) and accounted for more than half of total construction investment. The Planning Authority issued the highest-ever number of building permits (for 12,885 dwelling units) in 2018, an increase of 338% compared to 2014. The construction spree is thus likely to continue. Building permits are also increasingly issued for construction on virgin land. The government is seeking to tame high rental prices amid affordability concerns. The rapid growth of house prices appears to have made it more difficult for middle-income households to enter the property market (MDA, 2019). More importantly, rental prices have surged, driven by growing demand, mainly from foreign employees and tourists looking for temporary and short-term stays (see Box 3.5.1). High levels of rent inflation may crowd out vulnerable groups from what used to be affordable property. To address this issue, the government approved a reform to regulate the rental housing market starting in 2020 without imposing upper limits on rent levels in new rental contracts. The main elements of the reform include: (i) annual rental increases capped at 5%; (ii) residential leases of a minimum of 1 year; (iii) tax credits for landlords for long-term contracts; and (iv) an obligation for all rental contracts to be registered online using blockchain technology.

Graph 3.2.1:House price misalignment Source: European Commission services calculations Graph 3.2.2:Building permits and housing investment Source: Malta Planning Authority, Eurostat 3.3. Labour market, education and social policies 3.3.1.Labour market Malta is experiencing high levels of employment and a tightening of the labour market. In 2018, the employment rate in Malta reached 75.5%. At 5.7%, its employment growth is the highest in the EU. The unemployment rate is at a record low (3.7%), including for young people aged 15-24 (9.1%). Long-term unemployment (1.1%) is also at a record low. The share of young people (aged 15-24) not in employment, education or training is 7.3%, far below the EU average (10.5%). The activity rate rose to 74.7% and is now above the EU average (73.7%). However, the labour-market participation of certain groups remains low. In 2018, the employment rate of older people aged 55-64 was 50.2%, well below the EU average (58.7%). Graph 3.3.1:Labour shortages: job finding and separation rates Source: European Commission Labour shortages affect all skills levels. The share of companies reporting labour shortages as a major factor constraining their activity is among the highest in the EU, and increased from 4.2% in 2013 to 38.1% in 2018. Difficulties in finding and retaining specialised skilled workers remain one of the main challenges expressed by employers (Jobsplus survey) (see Graph 3.3.1). The authorities plan to address the shortage of employees through incentives for overtime work, and further promoting upskilling opportunities. Skills mismatches remain an issue. The share of low-qualified adults is decreasing but remains one of the highest in the EU (46.7% in 2018 against 21.9% in the EU). The employment rate of low-skilled adults increased from 59.2% in 2017 to 62.2% in 2018, but they tend to be employed in jobs for which they are underqualified (the second highest under-qualification rate in the EU). The uptake of upskilling and re-skilling schemes remains low, notably by SMEs and low-skilled adults. Adult participation in education and training stood at 10.8% in 2018, almost reaching the EU average (11.1%). However, only 4.1% of low-skilled adults participated in training in 2018, despite their greater need for upskilling. Incentives for employers’ involvement, and the improved labour-market relevance of training programmes, may have helped increase the number of SMEs providing training to their employees in recent years. 249 SMEs provided training to their employees under the European Social Fund co-financed scheme, Investing in Skills, in 2018 and 2019. However, the level of SME participation in training is below the EU average, and the uptake of existing support schemes remains low. Most employees surveyed by Malta’s Public Employment Service report a lack of interest in in-work training, mainly because they claim they already have the right skills for the job. Employers, on the other hand, report a lack of incentive to invest in the training of their employees due to the high turnover of workers. Foreign labour strongly contributed to Malta’s economic dynamism, but the population growth can also exacerbate existing challenges. Malta relies strongly on foreign workers to address labour shortages and skills gaps. In 2019, foreign workers represented 23.8% of the labour force in Malta, of which more than 60% were from other EU countries (Jobsplus). According to Eurostat, the population residing in Malta increased by 17% between 2008 and 2018, mainly due to large economic migration flows from both EU and non-EU countries. This increased demand for public services (schools, healthcare, etc.) and housing, resulting in an integration challenge. The high turnover of foreign workers also undermines investments in training ( ). The share of non-Maltese workers varies across sectors, and their skills level is higher than the native average. The share of foreign workers is especially high in the arts, entertainment and recreation (including gaming) sector (39.9%), and in accommodation and food-service activities (32.1%). Foreigners aged 25-54 are represented at all skill levels. Almost half of foreign people are high-skilled (4.1% of EU nationals and 45.6% of non-EU nationals), against 26.9% of Maltese workers. They are more often employed in occupations below their skill level (41% of non-EU born workers in 2018, against 13% of those born in Malta (Eurostat, Labour Force Survey). Malta also attracts foreign workers for medium- and low-skilled jobs. It has developed bilateral agreements with specific non-EU countries to meet the growing demand in specific sectors. Foreign workers tend not to settle in Malta. The average length of stay is 3.5 years, relatively unchanged since 2012 (Borg, 2019). Due to the shortness of their stays, it is likely that their social integration is low. However, Malta has not yet adopted incentives for the retention of foreign workers, for example by facilitating their socioeconomic integration through labour mobility and opportunities to improve their skills or job quality and better access to services. Despite significant improvements, the activity rate of women still lags behind that of men. Malta has implemented various policy initiatives aimed at attracting more women to the labour market, such as: back-to-work fiscal incentives; new income-tax arrangements; increases in maternity and adoption leave; tax credits for self-employed people; and exemptions from means-testing for income earned by women working part-time. Despite these efforts, the activity gap is still high with 64% of women aged 15‑64 in Malta being active, against 85% of men. At 21.9 pps, the gender employment gap is also one of the highest in the EU. The employment rate of younger women has increased significantly in recent years (up 15.5 pps between 2008 and 2018 for women aged 25-29 and 18.2 pps for those aged 30-34), facilitated by the free childcare scheme and the ‘making work pay’ strategy (European Commission, 2019b). Work-life balance is still a concern in Malta, and the employment rate of women still drops after the age of 40 (Graph 3.3.2). One out of five women aged 46-55 provides unpaid care services and the employment rate of female informal carers of this age group is below 50% ( ). More labour-market support for informal carers, either from outside the labour force or unemployed, could further address the gender employment gap. The gender pay gap is below the EU average, but slightly widening. The gender pay gap stood at 12.2% as a percentage of men’s average gross hourly earnings in 2017. This is partly due to women being more likely to: (i) engage in the labour market on a part-time basis (in 2018, 6.5% of men worked part-time as against 23.0% of women); (ii) fill medium- and low-skilled positions; and (iii) occupy fewer managerial positions (men held 70% of managerial positions in 2018). As for the gender pension gap ( ), although improving, it remains at 46%, one of the highest in the EU. Graph 3.3.2:Women employment rates by age cohort Source: European Commission The employment rate of people with disabilities remains low. The employment rate of people with disabilities in Malta (37% in 2017) increased by 8 pps in 1 year, and has more than doubled over 10 years, but remains one of the lowest in the EU (EU average: 51%). The activity rate of people with disabilities is also very low. The weak labour-market outcomes of people with disabilities may be explained by a low level of qualifications and educational attainment (despite recent improvements) combined with a lack of accessibility or reasonable accommodation in the workplace. Current measures to address this situation include a quota requiring that in companies employing 20 or more employees at least 2% of the workforce are persons with a disability, and schemes supporting the transition of people with disabilities from unemployment to employment (including subsidies to employers and exemptions from social security contributions). Other initiatives include pre-employment training, job coaching, and sheltered employment training (ANED, 2018). Malta has a high number of information and communication technology (ICT) specialists and graduates, but shortages in ICT remain. Malta is one of the EU’s leaders in training ICT specialists (7.9% of all graduates), and they account for a relatively high share of the workforce (4.8% against 3.9% in the EU). However, mismatches remain. In 2019, 67.3% of enterprises that tried to recruit ICT specialists had difficulties recruiting employees with appropriate skills. While the share of female ICT specialists is slightly above the EU average, it is important to further increase the participation of women in this field, given the focus of the country on the ICT sector. Steps have been taken to address skills mismatches and the gender gap in the digital sector with the collaboration of all stakeholders. Malta’s strategy for artificial intelligence promotes training, including a specific re-skilling programme to help vulnerable workers acquire digital skills. The collective bargaining system functions well, and social partners’ involvement in policy-making remains frequent and meaningful. Examples of a functioning social dialogue include discussions on the minimum wage or pension reforms. However, the technical capacity of social partners could still be improved, and the density in trade-union membership (38% of workers were trade-union members in 2018, Eurofound ( )) is not keeping up with the increase in employment. This is partly a reflection of the low trade-union-membership rates of foreign workers, who represent an increasing share of the labour force. Undeclared work is an issue, but there is a lack of definition of this phenomenon and no appropriate monitoring mechanisms. In 2018, Malta’s National Statistical Office estimated that the non-observed economy constituted 2.9% of Maltese GDP. Malta recently increased the number of inspections and penalties for employers that do not comply with labour and social security requirements. Income tax rates have also decreased to encourage the uptake of formal employment. The introduction of itemised payslips in 2019 aims at reducing fraud and abuse, in particular for social security contributions. However, coordination across key bodies responsible for tackling undeclared work remains an issue.

3.3.2.Education and skills A large percentage of pupils do not possess an adequate level of basic skills. The latest results of the OECD Programme for International Student Assessment (PISA) 2018 show that, in all three subjects tested, Malta’s mean performance is below the EU average ( ). These results also show that the proportion of underachieving pupils is above the EU average and remains practically unchanged since 2015 ( ) (OECD, 2019a; European Commission, 2019h). Underachievement is prevalent across the entire socioeconomic distribution. This suggests that educational factors such as curricula, student assessment practices, and teaching quality are also important determinants of poor student outcomes. Successful implementation of the curriculum and reform of student assessment are crucial in this context. Socioeconomic background and type of school strongly influence student outcomes. PISA 2018 also shows that underachievement is widespread among disadvantaged students. Around 51% of pupils from the bottom socioeconomic quartile fail to achieve a minimum level of skills in reading (compared to 34.8% at EU level). This is more than twice the rate of underachievement within the top quartile — even if the underachievement rate for the top quartile is also high by international standards (24.3% against an EU average for this top quartile of 9.3%). The difference between the top and the bottom quartile in average reading score has decreased by 17 points since 2009, suggesting that equity has improved, but this improvement is still insufficient. Performance remains strongly related to the type of school a pupil attends, with private school pupils performing best (they have a mean reading score of 516) compared to peers in church schools (a score of 473) and public schools (a score of 419) (Ministry for Education and Employment, 2019). This suggests a persistent fragmentation of the education system, whereby children from socially disadvantaged families, including some of those with a migrant background, do not have access to the best performing schools. Relatively high investment in the education system is not leading to better education outcomes. In 2017, Malta spent 4.9% of its GDP (vs 4.6% of GDP at EU level) and 13.9% of its total public expenditure (vs 10.2% at EU level) on education. Comparatively high levels of investment, high rates of underachievement in basic skills, and a high share of early school leavers suggest there is a need for more effective and efficient allocation of resources. They also suggest there is a need for comprehensive long-term strategies to tackle the skills challenge and accommodate a growing and more diverse pupil population. Difficulties in recruiting and retaining teachers may affect teaching quality and student outcomes. Teacher shortages tend to be a recurrent problem. Limited salary progression throughout the career and a lack of appraisal and feedback on performance (European Commission/EACEA/ Eurydice, 2019; European Commission 2019c) may make it more difficult to attract and retain better candidates into the profession. It may be all the more difficult given the high demand for skilled workers in the private sector. High turnover may also have adverse effects on teacher collaboration and student outcomes (OECD, 2019c). This highlights the need to make the profession more attractive, and take measures that go beyond improving teachers’ education and their access to continuous professional development. Efforts are underway to make education more inclusive but challenges remain. The number of foreign-born pupils aged under 15 increased by 67% between 2014 and 2017. In some schools, there are more than 50 nationalities represented among the pupils, and this has an impact on the working environment for teachers (OECD, 2019c). According to the 2018 OECD Teaching and Learning International Survey (TALIS), 20.4% (vs 13.4% at EU level) of teachers report a high need for training to teach in multicultural settings. Malta adopted a strategic plan on inclusive education in schools in 2019. It aims to guide public schools on how to adapt pedagogical approaches and redesign their practices to meet the needs of a more diverse student population. Induction programmes have been set up for newly arrived pupils who cannot yet communicate in Maltese or English. This may help reduce the average difference in reading performance between foreign pupils who speak English at home and those who do not (a difference in P