Fiscal support must be “targeted and temporary”, Central Bank governor Edward Scicluna has warned, in a nudge to the finance ministry to plan for life after energy subsidies.

Scicluna, a former finance minister, noted that by fuelling domestic demand, subsidies could make it harder to slow down inflation - effectively counterbalancing the European Central Bank's work to cool Euro economies by raising interest rates.  

However, he made it clear he was not calling for the government to dramatically and suddenly cut its spending.

"Nobody in his or her right senses will ask for a sharp fiscal consolidation," he told financial sector practitioners at the annual dinner of the Institute of Financial Services. "But wherever the economy allows it, we should grab the opportunity to make further progress towards stabilising and reducing the primary imbalance." 

Scicluna’s call for clarity about the government’s subsidy plans comes just one day after the International Monetary Fund reiterated its belief that Malta’s government must set a deadline on energy subsidies and gradually phase them out – something the European Commission is also keen to see.

He said the current and future environment would “definitely be more challenging” than the ones he faced during his time as a finance minister. 

But he argued that a key priority must be finding ways of building fiscal buffers where possible, to allow Malta’s economy to weather any unexpected shocks, and that it will be important for the country to avoid “misalignments” between fiscal and monetary policies.

While the government has full control over its fiscal policy, as a Eurozone member its monetary policy is controlled by the European Central Bank.

The ECB has repeatedly increased interest rates over the past two years as it seeks to curb inflation and cool economies fuelled by years of quantitative easing.

The European Union, meanwhile, wants to discourage member states from overspending by reintroducing debt and deficit caps. 

Locally, however, the government has declined to put the brakes on its spending on energy subsidies, saying any upward revision in energy prices would send the Maltese economy into a tailspin.

The subsidy guarantees fixed energy prices for all consumers, irrespective of how much they consume, and is expected to cost the government €320 million this year alone.

Although the subsidy has contributed to Malta running one of the EU's highest deficits, Finance Minister Clyde Caruana has argued that its economic impact is worth the outlay - though he has also emphasised that cannot come at the cost of curbing the deficit. 

Caruana has indicated that the government would like to keep the subsidy in place until various energy projects that will drive down the unit cost of energy are up and running. Those projects, however, are years away from completion.

Malta's unique challenges

In his Friday speech, the Central Bank governor acknowledged the value of subsidies bolstering economic growth rates, but also noted that they helped fuel demand, and, therefore, further inflation.

Similarly, local banks’ reluctance to pass on higher interest rates to lenders and depositors meant credit growth, especially within the real estate market, continued to be strong.

Those two factors “may be good for economic growth in the short-term,” Scicluna acknowledged. “However, it also means that the power of a key policy tool that is geared towards dampening demand and hence inflationary pressures is severely diluted in Malta, where the direct transmission of tighter monetary policy to the domestic economy is impaired.”

With that in mind, Scicluna said he hoped to see “more ambition” in fixing “impediments” that hamper the reallocation of resources across sectors, and noted that it will be crucial for the government to quickly and successfully absorb EU funds granted to Malta through its NextGenerationEU stimulus package.

Despite those concerns, Scicluna said he expected Malta’s inflation rate to gradually decline in the coming months, in line with the trend being seen across the EU. He attributed that to the easing of supply chain bottlenecks, the lagged impact of tighter monetary policy on imported inflation and the gradual correction in imbalances between demand and supply of consumer services.

October 2023 figures indicate that the annual HICP inflation rate within the Eurozone stands at 2.9% and 4.2% in Malta.

Both those figures represent significant declines from the high rates measured a year ago, but remain above the 2% rate that the ECB favours.