Malta should be doing more to build up a surplus for a rainy day and the country could do that by revising its one-size-fits-all approach to subsidies, the Central Bank believes.

Acting Central Bank Governor Alexander Demarco said he would like to see “bolder” fiscal policy that gave the country a better runway to manage any future economic shocks. That could happen, he suggested, by “adopting a more targeted approach to subsidies”.

“An economy running at virtually full employment for some years well into the post-pandemic period should not be recording fiscal deficits,” Demarco told financial service practitioners.

“Reducing the fiscal deficit at the pace of around 0.5% of GDP per annum would mean that it will take up to around 2033 to get back to a small surplus.”

Malta is currently running one of the EU’s highest budget deficits and is subject to an EU excessive deficit procedure. That means it must reduce the deficit by at least 0.5% each year to avoid penalties.

The government says it is well on track to meeting that target. It has also said that it will not be removing subsidies on electricity tariffs – which are applicable to all – until it has access to cheaper electricity.

Acting Central Bank Governor Demarco said that while the government’s gradual approach to unwinding the deficit was “understandable”, making subsidies more targeted would give it some leeway to manoeuvre.

The European Commission, International Monetary Fund and various credit rating agencies have all told Malta that its current subsidy model is unsustainable and should be wound back.

Demarco was addressing the annual dinner of the Institute of Financial Services. It was his first time addressing the event, having taken over the lead role at the bank following the suspension of Governor Edward Scicluna in the wake of criminal charges related to his time as minister.

Inflation down, GDP up

Demarco said it was encouraging to see inflation drop across the world and that Malta had benefited from that global process. Local inflation had dropped even faster than the bank expected, he said, and is likely to be closer to 2.5% than 3% by the end of the year.

Malta’s economy also grew at a faster rate than expected, he said, and that was in part due to continued fiscal deficits and subsidies, which supported households’ purchasing power.

The Central Bank, Demarco told sectoral stakeholders, intended to revise its growth projections for the economy upwards.

That meant the government has an opportunity to “re-examine and reprioritise public expenditure towards more vulnerable groups, and initiatives that impact favourably productivity, innovation, and the green and digital transitions,” the acting governor said.

Going green

He however noted that Malta’s small, open economy was vulnerable to geopolitical events out of its control and that the EU-wide transition to a green economy could add inflationary pressures to the economy.

But, he said, while the green transition could bring short-term pain it would stand to benefit Malta in the long run, as aside from its environmental benefits it would reduce reliance on energy imports and their volatility.

Local banks were doing well, he said, though he said he wants to see them do more to encourage green investments and incorporate more ESG criteria into credit assessments.

And as money continues to flow into the local property market “we need to remain vigilant about potential vulnerabilities, particularly if economic conditions shift,” he said.  

The Central Bank, he said, was ready to step in and intervene if risks from the real estate sector manifested themselves.

Fintech risk

Demarco saw other regulatory risks on the horizon: the increased blurring of lines between the financial and tech sectors.

“Entities that perform some bank-like activities are susceptible to propagate bank-like risks and may amplify risks through the liquidity and leverage channels,” he said. “These institutions are typically also less regulated, hence exacerbating counterparty risk for the banking sector. This is why at the European level we are now also looking at implementing macroprudential tools on non-bank financial institutions.”

Improving capital markets

Demarco said he also sees scope for the local capital market to play a bigger role in financing local investment. For that to happen, investors had to trust those markets, he said

“Introducing private debt issuer and issuance ratings should be a fundamental requirement,” he said, as they would enable investors to compare yields to risk.

He also called for the use of sinking funds – money set aside to pay off bonds – to be required, to minimise risk and ensure it was not under-priced.

“Such measures would promote further transparency and resilience within our financial system, ultimately safeguarding economic stability.”