GDP expected to contract by 5.75% in 2020

After several years in surplus, Malta’s general government balance is expected to slip into deficit and public debt to rise in 2020, as the government takes fiscal measures to offset the Covid-19 crisis.

The spring forecast issued yesterday by the European Commission’s’s Directorate General for Economic and Financial Affairs said it expects Malta’s GDP to contract by around 5¾% but rebound by 6.0% in 2021.

The lockdown and closure of non-essential businesses since 26 March is weighing on private consumption and service exports, with limited room for expenditure on recreation or food services. However, the initial tightness in the labour market and households’ high saving rate may cushion the crisis’ impact on consumption, the report said.

The external sector is set to contribute negatively this year, reflecting a weaker external environment, elevated global uncertainty and a substantial decline in tourism revenues. A fall in domestic demand is expected to drag imports down at a slower pace than exports in 2020, before imports growth outpaces exports’ in 2021.

The current account surplus, which peaked in 2017, is projected to gradually narrow over the forecast horizon, but to remain high. An easing in general restrictions is expected to re-stimulate domestic demand in 2021, though it is set to remain below its 2019 level.

As a small open economy, Malta’s economic outlook is highly sensitive to global uncertainties and the growth performance of its trading partners. Their economic development in the wake of the COVID-19 pandemic may weigh on Malta’s exports and pace of recovery more strongly than assumed in this forecast.

The fast pace of economic growth in Malta led to a record-low unemployment rate of 3.5% in 2019, but in the wake of the COVID-19 crisis, the temporary closure of tourism-related activities is set to have a harsh impact on employment.

The EU forecast says that, despite the financial aid made available to employees and the government’s measures to cushion the impact on corporates, the unemployment rate is projected to increase to around 6% in 2020 before decreasing again in 2021 to 4½ %.

The interruption of hospitality-related activities will substantially impact services inflation as a result of demand contraction and wage reductions. In turn, possible disruptions in supply-chains may create inflationary pressures for some imported goods.

In 2020, the general government balance is projected to swing into a large deficit of around 6¾% of GDP. Revenue from indirect taxes is set to decline as household consumption falls. Direct tax revenues are projected to record a slight positive growth given the assumed wage growth and profits recorded by companies in the previous year.

The main drag on the fiscal balance will come from the financial packages adopted to combat the economic impact of COVID-19. Wage supplements, additional spending on healthcare and social benefits, and interest rate subsidies are expected to cost around 4% of GDP. Moreover, the social measures announced in the 2020 budget, which was prepared under a more favourable economic scenario, are expected to be implemented.

Assuming no changes in policies, which implies that the pandemic-related measures would be discontinued after a few months and healthcare spending would decline to pre-2020 levels, the general government balance should improve strongly, but remain in a deficit of around 2½% of GDP.

After declining steadily since 2011, the government debt-to-GDP ratio is forecast to surge to about 51% in 2020 and remain around this level in 2021, driven by adverse developments in the deficit.

EU-wide trends

The shock to the EU economy is symmetric in that the pandemic has hit all Member States, but both the drop in output in 2020 (from -4¼% in Poland to -9¾% in Greece) and the strength of the rebound in 2021 are set to differ markedly.

Each Member State's economic recovery will depend not only on the evolution of the pandemic in that country, but also on the structure of their economies and their capacity to respond with stabilising policies. Given the interdependence of EU economies, the dynamics of the recovery in each Member State will also affect the strength of the recovery of other Member States.   

The pandemic has severely affected consumer spending, industrial output, investment, trade, capital flows and supply chains. The expected progressive easing of containment measures should set the stage for a recovery. However, the EU economy is not expected to have fully made up for this year's losses by the end of 2021. Investment will remain subdued and the labour market will not have completely recovered.

The continued effectiveness of EU and national policy measures to respond to the crisis will be crucial to limit the economic damage and facilitate a swift, robust recovery to set the economies on the path of sustainable and inclusive growth.