Limited progress made in addressing the 2016 country-specific recommendations

This report assesses Malta’s economy in the light of the European Commission’s Annual Growth Survey published on 16 November 2016.

In the survey, the Commission calls on the EU Member States to redouble their efforts on the three elements of the virtuous triangle of economic policy — boosting investment, pursuing structural reforms and ensuring responsible fiscal policies.

In so doing, EU Member States should focus on improving social fairness in order to deliver more inclusive growth.

Economic activity has eased somewhat, but remains buoyant. Real GDP growth was among the highest in the EU in 2014-15, reaching 7.9%, driven by strong net service exports, robust private consumption and a surge in investment, partly due to one-off factors.

Growth eased somewhat in 2016, but is forecast to have remained strong at 4%. Positive developments have also been observed in competitiveness, the sustainability of the external position and private indebtedness.

Moreover, employment growth is among the highest in the EU, in particular due to the services sector. The unemployment rate has dropped to a record low of below 5%. Net immigration flows helped to offset emerging skill gaps and labour shortages.

Public finances have also improved. Strong economic growth boosted tax revenues, in particular direct taxes. Some efforts on the expenditure side have also helped to reduce the structural budget deficit.

The gross government debt is estimated to have dropped below 60% of GDP for the first time since 1998. Despite some progress, challenges concerning tax compliance remain.

Overall, limited progress has been made in addressing the 2016 country-specific recommendations. Measures have been taken to improve the sustainability of public finances, particularly regarding age-related budgetary costs. The full impact of these measures on public expenditure, however, is not yet certain.

Some progress has also been made in strengthening labour supply by improving access to and participation in lifelong learning, with a focus on the lowskilled. Regarding the progress in reaching the national targets under the Europe 2020 strategy, Malta has made progress towards its target on employment.

However, there appears to remain a gap with respect to the targets for reducing greenhouse gases, raising R&D expenditure, increasing renewable energy provision, improving energy efficiency, reducing early school leaving, increasing the tertiary education attainment, and reducing poverty.

The main findings of the analysis in this report and the related policy challenges are as follows: • Despite the improvement in public finances, some risks to long-term sustainability remain. The fiscal position has benefited from the strengthening of revenues. Corporate income taxes have a higher weight in tax revenues than in the rest of the EU, implying higher vulnerability to economic shocks In addition, in the • • • medium to long-term horizon, international initiatives in the fight against tax avoidance could have an impact on tax revenues and the fiscal position of the country. On expenditure, sustainability challenges remain due to the projected increase in age-related budgetary costs, in particular in the healthcare and pension systems. The financial system continues to face some structural challenges. The system is characterised by a large number of foreign institutions attracted to Malta also by a favourable tax environment. The effective supervision of internationallyoriented business, however, creates some challenges. In the banking sector, asset quality and the flow of non-resident deposits may pose additional risks for profitability and liquidity management. Positive labour market developments continue. Employment growth is high, helping to reach the national Europe 2020 employment target, and pushing down unemployment to a record low level. Employment rates among women are increasing steadily, albeit from a low level. They remain low for older and lowskilled women, who constitute a substantial proportion of the labour force, but the employment rate for young women has risen above the EU average. Poverty and social exclusion risks are declining but they remain substantial for children, the elderly and the low-skilled. • Malta is addressing the social challenges and strengthening policies for active inclusion. Income inequalities are rather stable and below the EU average thanks to low market inequalities and the possible redistributive impact of the tax and benefits system. The latter has improved as a result of recent reforms. he skills supply does not yet adequately match labour market needs. Access and participation in lifelong learning have generally improved, but labour market participation by the • low-skilled remains low. While educational attainment is increasing, the rate of early school leaving remains high and basic skills attainment among young people is still weak. In response to tightness in the labour market, the reliance on foreign workers is increasing. This points to labour shortages across a broad spectrum of sectors and skills, possibly hindering investment. Sustainability of productivity growth calls for a higher investment in both knowledge and intangible assets. Major steps have been taken to strengthen the research and innovation system. Nevertheless, room for progress in filling knowledge and skill gaps is significant. In addition, infrastructure in general still faces challenges. Financing conditions have improved, but access to appropriate financing instruments is needed to promote new investment. The authorities have made available a broad range of mechanisms for alternative financing. Financing innovations in services and new business models require more diversified financing instruments and venture capital in particular. The Malta Development Bank is being set up to address these needs as well as long term investment projects. Despite improvements, some inefficiencies in public administration remain. The rolling out of e-government facilities and the reform of the planning authorisation process are expected to enable investment. Nevertheless, significant entry barriers for new firms remain. The regulatory environment for bankruptcy and a second chance for entrepreneurs in financial difficulties is still underdeveloped. Despite registering improvements in judicial system efficiency, there remains substantial room for improvement. In view of natural resource constraints, current policies do not appear sufficient to achieve the goals related to green growth and a circular economy. There are signs that the existing physical infrastructure may be insufficient to cope with the current pace of development. Despite improvements, the quality of road infrastructure remains a concern, leading to heavy congestion. This generates considerable costs to citizens' welfare, operating costs for businesses and environmental costs. The adoption of the National Transport Strategy with a 2050 horizon and the Operational Transport Master Plan 2025 is a welcome step to tackle the issues in transport.

Similarly, in energy, the policy strategy has focused on securing supply and removing the dependence on imported oil, but the achievement of the national energy efficiency target remains a challenge. The promotion of renewable energy provides an opportunity to exploit domestic energy sources. Improving resource efficiency will be key for sustainable growth given the very limited available resources. •