EIU warns of ‘tough fiscal measures’ after elections

Tough fiscal measures will be required by whoever wins the next general elections, as important, politically sensitive reforms, such as pensions and healthcare, are unlikely to be tackled until after the election.

The clear warning was spelt out by the Economist Intelligence Unit in its report for June, which refers to Prime Minister Lawrence Gonzi's 'fragile one-seat majority' and who faces a 'deepening political crisis which has resulted in an almost complete legislative paralysis'.

The EIU report warns of fiscal slippage in 2012 in view of the electoral cycle and weaker economic environment, adding that a huge improvement in public finances will be needed in the coming months if government is to get back on track with its Stability Programme.

"So far, investors have remained fairly sanguine as 10-year government bond yields have averaged around 4.25% since the beginning of 2012 - substantially below yields for the financially distressed countries of the eurozone - however, as has happened elsewhere in recent months, notably in Italy, Spain and Cyprus, sentiment can shift quite rapidly," the EIU warns.

The sharp deterioration in public finances during the first quarter of 2012 and pressure for fiscal consolidation from the European Union could persuade Prime Minister Lawrence Gonzi to opt for an election after parliament's summer recess, before it has to present the 2013 Budget.

The observation comes from the Economist Intelligence Unit in its June report on Malta, which explains how divisions within the ruling PN parliamentary group have escalated to the point that government can no longer be sure of the outcome of a parliamentary vote.

This uncertainty has prevented government from undertaking much-needed reforms, especially in healthcare and a mandatory second pillar in the pension system.

The EIU spelt a clear warning however, that "whichever party wins the election will probably be required to take tough fiscal measures".

While referring to Gonzi's leadership as "beleaguered," the EIU says that although Labour appears as favourite to win the next election "Labour understands that deep divisions within the PN and public dissatisfaction with government's performance may not be enough to win".

The EIU seemingly refers to MaltaToday's most recent poll which has shown that the PL currently enjoys a 12-point lead over the PN.

The EIU's central forecast is that the PN will continue in power until the end of the parliamentary term in mid-2013, even though it remains faced by a deepening political crisis which has resulted in what could almost be termed a "legislative paralysis".

The outcome of the next general election, it says, is difficult to predict, as the margin between the two parties at the time of voting was always traditionally small, and much will depend on the policy programmes that they will eventually present.

The EIU points out that although the degree of disagreement between the two main political parties on pension reform is not particularly wide, even the introduction of the non-controversial voluntary third pillar now seems likely to be shelved until after the election.

"In healthcare, the parties' commitment to maintaining a universal health service free of charge is unsustainable because of population ageing and demand for an ever-increasing range of services," the EIU said, adding that the European Commission has repeatedly warned Malta on the need to put public finances on a sustainable path.

The EIU comments that Malta's public finances made a poor start to 2012, "which could give cause for concern given the continued rise in government debt and the risk that the deepening sovereign debt crisis in the euro area might spread to countries, such as Malta".

It says that so far, investors have remained fairly sanguine as 10-year government bond yields for have averaged around 4.5% since the beginning of 2012, substantially below yields for the financially distressed countries of the euro area. However - it warned - as has happened elsewhere in recent months, notably in Italy, Spain and Cyprus, sentiment can shift quite rapidly.

With tourism arrivals showing a decline in the first quarter of 2012, the EIU reports on how real Gross Domestic Product fell by 0.6% quarter on quarter in October-December 2011. Although this partly reflects the downturn across the euro area, the decline was steeper in Malta than in the euro area as a whole, which registered an average 0.3%.

The currently weak economic environment, coupled with the electoral cycle, leads the EIB to "expect" fiscal slippage, and forecasts problems as government has planned a significant increase in capital spending that is earmarked to be co-financed by EU structural funds.

"However, since such projects require State co-financing, capital spending is likely to be curtailed to below the amounts allocated, to avoid further overshooting of fiscal objectives."

While stressing that public finances deteriorated sharply, the EIU explains that the creation of a special purpose vehicle to finance the construction of the new parliament building will allow government to exclude the cost and related debt from the official accounts.

The EIU also remarks on the recent expansion of the Malta Council for Economic and Social Development which now also includes FOR.UM, and the Gozo Regional Committee, says that this is likely to hinder its effectiveness and make reaching agreement between social partners on issues such as wage indexation reform and pension system more difficult.

The report is updated to Carm Mifsud Bonnici's resignation as home affairs minister and stops at the debate which eventually led to Richard Cachia Caruana's resignation last Monday as Malta's permanent representative to the EU.