Political uncertainty risks impacting public finances, Central Bank warns

The Central Bank of Malta expects economic growth over the coming years to remain strong, averaging 4.1% between 2019 and 2022. Growth in private consumption and government expenditure is expected to remain robust, while investment is expected to recover from the contraction recorded in 2018.

Compared with the bank’s previous projections, gross domestic product growth has been revised downwards in 2019, due to weaker than expected outturn in private consumption data in the first half of the year.

Over the projection horizon, GDP growth will be supported by domestic demand, mainly reflecting robust growth in private consumption and investment. Conversely, the net export contribution to growth is expected to be negative in 2019, reflecting the weak international environment and a pick-up in import growth as a result of strong domestic demand. The contribution of net exports should turn positive in 2020, reflecting acceleration in export growth and lower imports of capital machinery as investment.

The pace of job creation is set to moderate, but remain strong. The labour market is expected to remain tight, with the unemployment rate projected at 3.8% by 2022.

Annual inflation, based on the

Harmonised Index of Consumer Prices, is projected to ease slightly in 2019, before edging up to 1.9% by 2022, reflecting a pick-up in services and non-energy industrial goods inflation.

Moreover, the government balance is expected to remain in surplus over the coming years, such that the debt-to-GDP ratio is projected to decline to just over 35% in 2022. These forecasts incorporate the measures announced in the Budget for 2020. The latter also envisions higher public investment that is more than offset by increased inflows of EU funds.

Looking ahead, the external environment poses downside risks to the projections of economic activity and inflation. In the light of recent events, the bank has updated its estimates of the potential impact of Brexit on the Maltese economy.

Looking at two scenarios, one where the UK would have access to a free-trade or customs-union-like agreement with the EU and another where following unsuccessful negotiations trade would default to WTO rules, the bank estimates Malta’s GDP would decline by between 0.19% and 0.39% between 2019 and 2021.

While this impact is lower than the 0.5% found from a previous study conducted by the bank in 2017, it is important to treat these results with caution given the high degree of uncertainty that still surrounds the terms of the UK’s exit from the EU.

At the same time, the recent escalation of domestic political uncertainty is likely to compound the downside risks emanating from the external environment, especially in the short-term, through the possible postponement of both private consumption and investment.

The risks to public finances are tilted on the upside in 2019, but thereafter, especially in 2020, are tilted to the downside should the risks emanating from lower domestic demand materialise and if political uncertainty is prolonged.