Malta and the UK have strong historic ties, which since 2004 have included membership of the EU. Thus the UK’s decision to exit the Union has macroeconomic implications for Malta. The Central Bank of Malta, in this light, has just published a policy note that tries to estimate the short-to-medium-term economic impact of this development.

Malta’s relative dependence on the UK market has fallen greatly over time, with the share of export of goods to the UK dropping from 40 per cent in the early 1970s to about three per cent in recent years. Maltese exports of goods to the UK as a percentage of GDP amounted to nearly 10 per cent in the mid-1970s, while in 2016 they stood at just 1.4 per cent.

The fall in the relative share of UK tourists, though less acute, is also considerable, from nearly 80 per cent in the early 1980s to less than 30 per cent currently.

Expenditure by UK tourists now amounts to 4.9 per cent of GDP, down from 9.4 per cent in 2001.

Eurostat data suggests that services exports to the UK are equivalent to some 13 per cent of GDP, though a considerable amount are financial services flows, which tend to have nearly equivalent entries as imports of services. In fact, Malta’s net exports of services to the UK amount to six per cent of GDP. The Maltese financial sector’s exposure to the UK is broadly in line with the two countries’ trade relationship.

Malta’s reliance on UK workers has risen over time. About 1.8 per cent of all persons currently in employment in Malta are British citizens, a proportion higher than the proportion of all foreign workers at the time of Malta’s accession to the EU. Besides this growth, there has been a strong rise in the number of UK citizens who retire in Malta, from 1,930 in the 2005 census to 3,537 in the 2011 census.        

At this stage, there is a high degree of uncertainty surrounding the terms under which the UK is likely to exit the EU. Such uncertainties include the position of current UK nationals working in the EU and EU nationals working in the UK. Despite this uncertainty, formal assessments conducted by researchers and international institutions point at significant downward economic risks for the UK economy.

The EU is an important partner for the UK, attracting around half of UK exports. The EU exports a significant amount of goods and services to the UK, implying some EU countries are likely to lose economically as a result of Brexit.

Moreover, given its size, this development is projected to have global effects, though more contained compared to the contractions in economic growth expec-ted in the EU and UK.

The analysis does not consider the possible benefits for the Maltese economy should UK companies relocate to Malta

The quantification of these effects depends on the outcome of the negotiation process between the UK and the EU.

On balance, the vast majority of studies published, most notably those by the IMF and the UK government, suggest a significant long-run deterioration in the UK’s GDP ranging from -1.3  per cent to around -9.5 per cent.

In this light, the Central Bank of Malta’s macroeconometric model was used to study the possible impact on the Maltese economy of this decline in foreign demand. Two scenarios were applied.

The first is the best-case alternative, which assumes that the UK will adopt the so-called Norwegian model that would allow it to retain access to the single market. In return, however, the UK would need to accept the free movement of people, as well as continue to pay contributions to EU countries.

The main negative economic consequences in this case relate to a period of uncertainty surrounding negotiations, as well as potential exit from the customs union.

The second scenario is the worst case and assumes no agreement is reached. Under the WTO rules, the UK and the EU would trade under fixed maximum tariffs. The UK would lose access to the single market but would be free to set its own rules concerning migration and would not contribute to the EU budget.

These scenarios are constructed using predictions for the UK made by the Bank of England in February 2017, those for the EU published by the IMF in 2016 and those concerning the US and the rest of the world by Goldman Sachs in 2016. The results of the analysis suggest the peak effects on Malta’s baseline GDP will be -0.24 per cent under the benign scenario to -0.54 per cent under the worst-case scenario.

As expected, given the nature of the shocks under consideration, the main contributor behind these falls, at least in the first two years, emanate from the external sector.

Falls in aggregate demand also lead to a reduction in private consumption and investment.

Given the uncertainty surrounding the terms of the UK’s exit from the EU, these results should be treated with caution. They focus solely on the impact of the possible drop in foreign demand and the change in exchange rates.

Furthermore, the analysis does not take into consideration the possible benefits for the Maltese economy should UK companies relocate to Malta to retain access to the EU market.

Finally, over the next three years, the Maltese economy is projected to grow by close to 12 per cent, implying that even under the worst-case scenario, Brexit will have a negligible impact on Malta’s pace of economic expansion.

Noel Rapa is a senior research economist at the Research Office of the Central Bank of Malta.