Electricity and water rate cuts to translate into 0.65% GDP growth by 2019

€45m in resulting GDP growth largely depends on businesses passing savings on to consumers.

The 25 per cent cut in electricity rates and the five per cent cut in water rates will result in a total gross domestic product growth of 0.65 per cent by 2019, according to estimates drawn up by the Central Bank of Malta’s Modelling and Research Office that were tabled in Parliament by Labour MP Silvio Schembri.

Based on today’s GDP level of roughly €7 billion a year, the resulting increase to the country’s overall GDP would stand at approximately €45 million.

The rates cuts for domestic users were introduced in March of this year, while the same cuts will be applied to commercial consumers next March.

The overall GDP increase from the reductions for domestic users was estimated at 0.08 per cent per year until 2020, and was calculated using the weight of water and electricity prices in the Harmonised Index of Consumer Prices (HICP).

The rate cuts for commercial users will in the first year add 0.28 per cent to GDP as from next year, rising incrementally until 2020 when the impact of the rate cuts will raise GDP by 0.57 per cent.

The GDP effect of the commercial rate cuts was calculated by adding the implied share in total production costs of water and electricity costs, and by assuming that firms would pass the reduction on to their consumers in full and immediately. This, according to the CBM, would have a double impact: export prices would decline while consumer price inflation would be reduced by businesses passing on the lower costs to local consumers – assuming that Maltese consumers purchase half their goods from the local market.

The lion’s share, roughly 88 per cent, of the projected growth in GDP from the rate cuts, however, will be wholly dependent on whether businesses choose to pass on their cost savings to consumers, in the form of lower prices, or whether they would simply choose to pocket the savings themselves. In fact, the rate cuts themselves will result in a GDP increase of less than 0.1 per cent (approximately €7 million), with the full effect occurring in 2015 when commercial rates are reduced.

As the Central Bank noted in its study: “By far the largest impact would result if the decline in operating costs is passed on in full to export prices. This would boost GDP nearly 0.25 percentage points in the first year [out of a total commercial impact of 0.28 per cent], rising to 0.4 percentage points in 2016 [out of a total of 0.45 per cent], and then rising to 0.5 percentage points in subsequent years” [out of a total commercial impact of 0.51, 0.55, and 0.57 until 2019].

But, the bank adds: “…the projections embed the assumption that in some sectors, namely those less exposed to competitive pressures and those where in recent years profits have fallen, the reduction in commercial tariffs will not be passed on to consumers but will rather boost profitability. While the multiplier effect of this is less strong than if one assumes that price reductions are effected, there are still significant positive impacts on investment and employment if firms’ profit levels improve”.

In fact, the Central Bank has estimated that, as a result of the rate cuts, unemployment levels could be reduced by 0.08 per cent.