Update 2 | Scicluna positive despite divergence in deficit forecasts

The European Commission has described Malta's fiscal and structural reforms as "partially adequate" to support a sound fiscal position.

The EC today passed its proposal on Malta to the European Council, commenting that "all reforms are work-in-progress and their adoption and implementation remain subject to risks".

In a separate opinion on Budget 2014, the EC also said that there was still a risk that the Budget does not fulfill the requirements in the EDP recommendation. "The headline deficit target is expected to be met in 2013, while this is not the case for the headline deficit in 2014 nor the structural effort in both 2013 and 2014. It does not specify in detail the measures that underpin the revenue and expenditure targets for 2014... Malta has made limited progress with regard to the structural part of the fiscal recommendations issued by the Council in the context of the European Semester."

Since 2013, the European Commission oversees all draft budgets by its member states. In the case of Malta, the country is still under an excessive deficit procedure after its deficit breached the 3% of GDP threshold this year. Malta was given a deadline of 1 October 2013 to take effective action and ensure a sustainable correction of the excessive deficit by 2014 and to bring debt down to 60% of GDP.

Malta's budget aims at generated growth of 1.7% in 2014, something the Commission said was "plausible" and verified by the National Audit Office, which is currently serving as an independent fiscal council.

The budget plans a deficit target of 2.7% of GDP and 2.1% of GDP respectively for 2013 and 2014, mainly driven by higher current revenue due to revenue-increasing measures.

But the EC says Malta's GDP will be of 3.4%, because of lower growth in revenue from indirect taxes. The gap widens by 1.3 points in the 2014 projection.

The biggest risk for the EC is that the scale of the revenue from indirect taxes do not appear to be fully explained. "There is a risk of slippages in the public sector wage bill and in intermediate consumption, given previous years' experience. In addition, [there is] the financial situation of the energy provider Enemalta, which could require additional subsidies. On the other hand, as has frequently occurred in the past, net capital expenditure could be lower than planned if it used to compensate for slippages in budgetary execution."

Finance Minister Edward Scicluna said the Commission's report was "positive and encouraging", saying the silver lining was that the EC had not imposed any corrective action on Malta.

Scicluna said the Commission's own cautious outlook is based on a projection where Malta is at risk of not achieving its deficit targets. He however said the proof would be in the way Malta actually implements the budget it has set for itself. "If we slip we will lose everything," he said.

"At the time we presented the Commission with the draft, it had expressed satisfaction at the measures we proposed. It describes them as cautious for this year, and plausible for the next year. The differing projections by Commission and government are in terms of deficit levels, which again are based on previous administrations' optimistic projections when revenue turned out to be lower than envisaged," Scicluna said.

The Commission's proposal, based on the Economic Partnership Programme which Malta presented to the EC and to the Council on 1 October 2013, builds on the 2013 National Reform Programme and Stability Programme that aims at improving efficiency in government spending, strengthen public administration and restructure state-owned enterprises.

But a number of country-specific recommendations are yet to be fully addressed, especially those on corporate taxation and the long-term sustainability of public finances.

Malta has said it will embark on the reform of its fiscal framework, review of ministerial spending, introducing a third-pillar pension, improve health sector services, restructure state companies, increase efficiency in public sepdning, and gradually shift the burden of taxes from direct to indirect taxes.

"The set of measures is broadly adequate and could be expected to contribute to the strengthening of the public finances. Nevertheless, further efforts in some areas, such as ensuring the long-term sustainability of public finances, appear necessary," the EC said.

The EC however noted that the appointment of an independent fiscal council, so far shrouded in the role of the National Audit Office, had not been adopted by the parliament yet.

Spending review

The ongoing spending review that aims to identify expenditure savings and improve the efficiency of public spending can result, on the one hand, in lower growth in expenditure and, on the other, in more growth-friendly public spending.

Third pension pillar

On the introduction of a third pension pillar, the Commission said that on one hand it could improve the adequacy of the pension system, but it would not contribute towards improving its sustainability.

"None of the other relevant measures recommended to Malta, namely accelerating the increase of the statutory retirement age and increasing the effective retirement age, appear to be under consideration."

Health sector

The Commission said that the planned measures to improve the provision of services in the health sector can be expected to improve the efficiency and adequacy of the system.

"Still, at the same time it can contribute to higher demand and take-up of government-funded healthcare services. In the absence of more detailed information on the measures it is not possible to determine to what extent the reform can lower the pressure on public expenditure in the long-term."

Enemalta, energy

It noted that the restructuring of state-owned enterprises - Air Malta and Enemalta - could improve their financial performance and in turn reduce the contingent liabilities on the government finances.

"Policy efforts in the energy sector are particularly notable, where the main energy provider Enemalta holds government-guaranteed debt of around 10% of GDP. In addition, this can be expected to reduce the need for government subsidies in the future," the Commission said.

Taxation

Malta presented a mix of ongoing and new measures that can be expected to raise the capacity of the public administration to enforce tax compliance and to reduce

tax evasion. In addition, the programme contains measures that would reduce the length and increase the efficiency of public procurement procedures.

"The indicated gradual shift from direct to indirect taxation could encourage job creation and improve the growth-friendliness of the tax system. However, the shift is described in very broad terms without providing details. In addition, plans to reduce the debt bias in corporate taxation are still missing."

The Economic Partnership Programme also contained a variety of non-fiscal structural measures that broadly aim at complying with the 2013 Country-Specific Recommendations.

Judicial system reform, diversification of energy sources

The policy plans include comprehensive reforms of the judicial system and the diversification of energy sources.

"The measures appear to be in the right direction and can be expected to contribute to the creation of growth and jobs in Malta, while also safeguarding financial stability," the Commission said.

"Nevertheless, in general they are still work in progress, while the information provided is often limited."

The Commission concluded that further analysis of the impact of the policy plans and their contribution to addressing the challenges identified in the 2013 country specific recommendations will be needed once the policy plans become more concrete and their implementation advances.