Watch the debt

Structural reforms are often the Achilles’ heel in Malta. Yet, the Government should spare no effort to move faster on key reforms. This is because structural reforms are the policy levers aimed at boosting the supply side of the economy and ameliorating the framework in which businesses and people operate.

Global debt has risen significantly over the last two decades. 

The possible adverse consequences of excessive debt levels on the global economy, as well as the macroeconomic, financial, and fiscal stability of countries, should not be underestimated. The risks associated with excessive debt burdens are more prominent now, following the consecutive supply side shocks from the Covid-19 pandemic and the war in Ukraine.

Naturally, the measures taken to mitigate the effects of the pandemic on the economy resulted in an increase in both public and private debt in Malta and around the globe. The Maltese government succeeded in mitigating the pandemic effects on the economy by providing ample liquidity to afflicted households and businesses through its Covid-19 package.

Source: Central Bank of Malta

The chart shows both public and private sector debt ratios going back to 1995.  It is interesting to note that the public debt ratio has been pretty steady, though always exceeding the 60% Maastricht rule between 2000 and 2014.  Two successive Labour governments drove it down to as low as 40% before Covid-19.  The current higher ratio is still lower than historic levels.  The ratio has been lower than the Eurozone ratio practically throughout the whole 24-year period.

Inflation and public debt sustainability

The European Commission believes that the impact of high inflation induces a new vulnerability in a context where public debt needs to decrease.  Fiscal policy measures put in place in 2022 to tackle the energy crisis have had sizeable fiscal costs. According to the Commission’s 2023 Spring Economic Forecast, the net cost of these measures amounted to 1.2% of annual EU GDP in 2022 and a similar amount in 2023.

As a result, the Commission has urged EU Member States to focus on medium-term public debt sustainability while raising potential growth and ensuring the green and digital transition in a sustainable and resilient manner.  Unlike some other Member States which have been found to have excessive macro-economic imbalances, Malta has more leeway.  But the Commission still expects us to ensure a plausible and continuous debt reduction in the medium term.

Private sector debt

Private sector debt, however, is another story.  For over two decades Malta’s private sector debt ratio has exceeded 120% of GDP.  Mind you, apart from a period of eight years between 2005-2012, when it always exceeded 130% of GDP (reaching a peak of 171% in 2010), it has generally been around the 130% mark.  Again, since 2012 it has been on a declining trend, apart from a small spurt during the Covid-19 period. 

Comparing Malta’s consolidated private sector debt ratio with that of the EU, in general we have had a ratio slightly higher than that of the EU but on a rising trend, peaking at over 147% in 2013, since when it has receded to 129%.  Just to provide some comparison, the ratio ranged from 66% in Slovenia to 240% in Cyprus in 2021.   

As there is a theoretical argument that non-consolidated data are more comparable across economies of different sizes, the non-consolidated private sector ratios are also shown in the chart.  Obviously, they are higher since this ratio includes both intragroup financing and financing between non-financial corporations (NFCs) belonging to different groups.  However, the patterns are more or less similar to those of the consolidated ratios.  The non-consolidated ratio in 2021 was 208%, just below Cyprus’s but higher than Ireland’s for example.

Source: Central Bank of Malta

Having said that, the European Commission has indicated a threshold of 133% of GDP for private sector debt.  So, again, Malta’s figures provide some consolation, though the situation has to be watched closely.  The indebtedness of the NFC sector has risen over the past several years, to around 218 percent of GDP (2022: Q2). On a consolidated basis excluding intra-company loans and trade credits, NFC debt was much lower, at about 76 percent (2022: Q2).  Mind you, NFC’s financial asset holdings are also sizeable (150 percent), mitigating potential risks. Still, according to the International Monetary Fund, the NFC sector may face risks arising from the increased costs due to higher inflation and interest rates and weaker demand from Malta’s main trading partners — all contributing to squeezing profits and weakening debt service capacity. The reliance on intercompany loans (accounting for 42 percent of total corporate debt) could potentially propagate and amplify intragroup shocks.

A potential “trap”

It is well-known that when government, households and corporations are excessively indebted, it may impair their ability to borrow and finance their consumption and investment needs.  Growth prospects may be affected adversely, as may the stability of the financial and banking system.  If repayments of debt increase unsustainably, this could also lead to an economic slowdown.  It is no wonder that some economists refer to the current situation as a potential “trap” that needs to be addressed.

The linkages through which excessive debt, private and public, affect the economy are widely acknowledged in economic literature.  In particular, high indebtedness could deprive an economy from reaching its potential growth due to the so called “crowding-out” effect. More specifically, when private debt is high, consumers and businesses have to divert an increased portion of their income to paying interest and principal on that debt. Consequently, the ability to consume and invest is reduced.

In Malta, particular attention needs to be given to the property market.  We continue to experience a strong and continuing increase in house prices with a concomitant rise in household debt.  Low-income households, like vulnerable firms (highly indebted and unprofitable businesses that are struggling to make interest payments) are typically less able to withstand a high level of debt. As a result, they are likely to make sharper cuts to consumption and investment spending when their income stagnates.

An integrated response

These vulnerabilities require an integrated response to enhance the resilience of the economy in the advent of adverse shocks and minimise the risk of sub-par growth in the medium run.  In general, the Government should keep reducing the fiscal deficit, which is the accumulation of new debt.  With a strong recovery it could scale back fiscal support more quickly. Governments should also adhere to a credible, medium-term fiscal framework, in such a way as not to counteract the ECB’s monetary policy decisions to control inflation.

Structural reforms are often the Achilles’ heel in Malta.  Yet, the Government should spare no effort to move faster on key reforms. This is because structural reforms are the policy levers aimed at boosting the supply side of the economy and ameliorating the framework in which businesses and people operate. They can contribute to higher productivity, investment, and employment, thus leading to higher incomes and helping to tackle rising levels of debt.

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