Malta set to face Brussels’ deficit procedure. Is it something to worry about?

It’s been an economic point of contention for years across the European bloc.

It was introduced to ensure that the different EU member states adhere to fiscal discipline, in anticipation of introducing the euro currency.

Since then, it’s been criticised for being inflexible, intensifying recessions and promoting austerity policies.

The Stability and Growth Pact is an agreement between the 27 EU member states that established two main targets for fiscal policy. The first is that the annual government deficit should not exceed 3% of GDP. The second is that the national overall debt should not exceed 60% of GDP.

As a preventive measure, member states must submit a compliance report that is subject to the scrutiny of the European Commission and the Council of the European Union. Countries must also adhere to medium-term budgetary objectives, which are set by the EU and updated every three years.

Then there is the corrective arm, known as the excessive deficit procedure.

This regulation ensures that member states adopt certain policies to bring their deficits or debt levels down to the required level should they breach the ceiling for these two markers of economic health.

A country undergoing this procedure is given three to six months to take effective action, and if it fails to do so, could face sanctions.

Increased scrutiny

Last week, the European Commission issued a recommendation saying it intends on opening an excessive deficit procedure for Malta, as the general government deficit exceeded the 3% threshold – a reality provoked by the great government spending in 2020 and 2021 to fight the inertia caused by the COVID pandemic. It recommended the same for six other countries, including France.

Economist J.P. Fabri says being subjected to the EDP means increased scrutiny from the European Commission and potential requirements to implement structural reforms aimed at reducing the deficit, a situation that can result in a tricky balancing act.

“On one hand, enhanced fiscal consolidation could help ensure long-term fiscal sustainability and maintain investor confidence, which is crucial for a small, open economy like Malta’s. On the other, overly aggressive fiscal tightening could impact economic growth, particularly if it results in reduced public investment or social spending,” Fabri says.

Economics professor Philip von Brockdorff notes the procedure itself would not have an impact on the economy. Rather, the impact will result from how the government responds.

“Will the government resort to austerity measures?” he asks. “Will taxes increase? Will government reduce public spending in a way that increases social inequality and redistributes income unfairly? I doubt the government will resort to such measures. What is more sensible is for the government to keep a tight rein on public spending and help boost economic growth that generates tax revenue.”

In agreement, Fabri also says that the excessive deficit procedure is not inherently something to worry about if managed prudently. “Rather, it serves as a reminder of the need for responsible fiscal management. If Malta can address its deficit through thoughtful, growth-friendly measures, the EDP can be a catalyst for positive economic reforms.”

The Stability and Growth Pact: too strict for comfort?

Fabri says the pandemic has significantly altered the economic landscape, and many notable economists and policymakers argue that the rules should be more flexible to accommodate continued fiscal support during the recovery phase.

The European Commission has acknowledged these concerns and allowed for a temporary relaxation of the rules. However, Fabri says the challenge will be in recalibrating these rules so that they remain fit for purpose in a changed economic environment.

“A more nuanced approach that considers the quality and purpose of public spending, rather than rigid numerical targets, could better serve the long-term interests of the EU economies, including Malta,” he says.

Von Brockdorff points out that new fiscal rules introduced this year have some flexibility built into the system, but ultimately, member states need to demonstrate a strong commitment to satisfying the 3% deficit threshold.

“Arguing against the merits of fiscal stability is futile. However, if countries resort once more to austerity measures as happened in the last financial crisis, this would put the EU’s green deal and the shift towards more sustainable economic growth at risk, besides making millions of EU workers worse off than today,” he says.

“Despite being in a much weaker position now, I am certain trade unions all over the EU will not want to see a repeat of the aftermath of the financial crisis.”

Deficits: an economic bogeyman?

A deficit means the government is spending more than it is receiving in revenues. But economists agree that this is not necessarily a bad thing, so long as the deficit and public debt remains sustainable.

“[Deficits] can be a useful tool for stimulating economic growth, especially during periods of economic downturn or when public investment is needed to support long-term growth prospects,” Fabri says. “The key lies in the purpose and sustainability of the deficit.”

However, a deficit can become problematic if it ends up undermining investor confidence or leads to unsustainable debt dynamics. “A deficit is particularly concerning if it is driven by structural imbalances rather than temporary factors. If a government continuously runs deficits to finance current consumption rather than productive investments, it can lead to a build-up of debt without corresponding economic benefits, eventually necessitating painful adjustments,” Fabri says.

Von Brockdorff says sustainability can have various interpretations, but the EU considers the 3% deficit threshold and 60% debt-to-GDP level to be fiscally sustainable. “We may actually satisfy this pace at some stage next year (and possibly totally in three years’ time) and this actually would ease pressure on the Government’s policy response.

“However, a gradual reduction of the deficit and eventually returning to surpluses should be the target for the government, independently of the EU’s new fiscal rules. The worldwide economic outlook remains uncertain, and we need to return to surplus budgets at some stage in the future to deal with the next international economic crisis.”