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Developments in an economy’s gross domestic product (GDP), not only impact employment, but also influence the fiscal sustainability of current and future governments. Fiscal sustainability refers to the government’s ability to keep its public finances in a credible position over the long term, safeguarding future fiscal expenditures. Government spending is one of the economy’s aggregate demand-side variables, which can be used to influence the country’s output. However, excessive fiscal deficits, and constant overspending on unproductive segments of the economy can be detrimental to the country’s GDP as well as its potential output.

In Malta, the pandemic has led to two consecutive years of significant fiscal deficits, which were possible to sustain due to fiscal surpluses obtained between 2016-2019. In turn, such fiscal surpluses were possible due to the overall healthy public finances maintained in those years. Thus, the latest fiscal developments confirm that when government spending is a function of both short-term and long-term fiscal sustainability, public finances are more resilient to external economic shocks. 

Governments face a constant trade-off between generating rapid short-term economic growth via aggressive spending at the cost of higher debt in the future, and the creation of sustainable wealth which considers the opportunities of future economies. With respect to the fiscal support given during the pandemic, governments should have been prudent when financing companies hit by lockdowns. Governments which were not prudent in their pandemic spending will be facing further fiscal issues in the coming months due to the latest macroeconomic developments. 

Thus, amidst the rising energy costs, increasing price pressure, and the uncertainty surrounding the war between Russia and Ukraine, it is imperative that policymakers aim to restore fiscal sustainability. Interest rates have also shot up this year, increasing the opportunity cost of higher fiscal deficits. This is unlikely to impact the government debt in the short term but may present an issue in the coming years, raising net interest payments on the debt if interest rates remain elevated. 

One generally applied metric that measures the sustainability of public finances is the debt-to-GDP ratio. The European Union’s Maastricht criteria stipulate that the debt-to-GDP ratio should not exceed the 60 per cent benchmark. Due to the supportive fiscal stance taken by the Maltese government over the past two years, the ratio increased from 40.7 per cent in 2019 to 53.3 per cent and 56.3 per cent in 2020 and 2021, respectively. National debt is expected to further rise in 2022. 

In order to effectively ensure long-term fiscal sustainability, governments have to forecast future expenditures in line with expected revenues. Between 2023 and 2025 public debt in Malta is expected to keep rising in absolute terms. However, the accumulation of debt is expected to get smaller over time as both total revenue and total expenditure are expected to rise, mainly due to higher current taxes on income and wealth as well as higher expected costs in subsidies, reflected by the new energy support measures. Public debt is expected to rise to 58.6 per cent of GDP in 2022 and 59.4 per cent of GDP in 2023, from 57.0 per cent of GDP in 2021. The debt-to-GDP ratio is thereafter expected to fall to 57.2 per cent by 2025. 

Even though debt-to-GDP ratio for the Maltese economy remains well below EU averages, future policies should be aimed at targeting GDP growth rates which exceed the growth in fiscal spending, ensuring fiscal sustainability. High levels of debt that continue to grow are detrimental to governments’ fiscal health and can set off a vicious cycle of escalating debt. Restoring fiscal freedom would be beneficial to prevent any potential negative shocks and increase the economy’s overall resilience. 

PKF Malta is a fast-growing, progressive firm specialising in audit & assurance, tax, advisory services, and internal audit insurance. PKF Malta is known for its dedication, professionalism, and enthusiasm to serve clients. Get in touch with us today via email at: [email protected] or contact us here.

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