A delicate juncture

Silvan Mifsud is director of Advisory at EMCS Tax & Advisory

By the time this article is published we would be just 1 week away from the first anniversary of when the war in Ukraine has started, with no end in sight. This means that global economies are still facing various challenges, with core inflation being the greatest one. In Europe core inflation increased further in January as consumers and businesses continue to face high energy costs and with more than 90% of the core items in the HICP basket registering above average price increases. This means that the tightening monetary policy by the ECB is likely to continue which will exert a downward pressure on economic growth. Thus, weakness in consumption across Europe is set to persist in the near term as inflation is likely to keep eroding purchasing power.

Having said so, there is some silver lining. On one hand, European gas prices have in recent weeks fallen below the pre-war level, helped by a sharp fall in gas consumption due to a diversification of supply sources. Moreover the economic slowdown across Europe for the 3^rd quarter of 2022 turned out to be less than previously estimated and in the fourth quarter, European economies have managed to remain just a step above contraction. Labour markets have also continued to perform strongly, thus avoiding any sensible increase in unemployment rates across Europe.  All in all, considering all the turbulence, economic sentiment has improved. The latest forecasts indicate that, when taken together, European economies stand a change of possibly avoiding a recession in 2023.

This all means that we are at a very delicate juncture. On one hand, we will need to see if the recent decline in energy prices will continue, despite the assumed continued geopolitical tensions and if pressures on core inflation will abate. From a timing perspective, even if the easing of energy inflation does happen, it will take time until this translates in an increase in real wages. Thus in the short term purchasing power is set to continue falling and possibly recover part of the lost ground later on in 2023, if the increase in core inflation and energy prices does abate. One also must see the extent of the increased interest rates, whereby market expectations are that interest rates will peak in 2023, which will obviously have its toll on the amount of credit flows.

In essence this means, that the horizon is still very turbulent and uncertain. Anyone leading an economy to managing a business, needs to have various plans based on different scenarios. It is very likely that a mindset based on the long term, rather than the short term would be more effective. In Malta, whilst in 2022 we would likely register a real GDP growth way above 6%, the latest projections is that our economy will slowdown to a GDP growth of around 3% in 2023, due to slowdown in European economies which are Malta’s main trading partners, leading to a lower consumer purchasing power, dampening domestic demand and weakening external demand from Europe. Citing one example, it is likely that even if we get more tourists in 2023 than the 2.2 million tourists we got in 2022, it is likely that their purchasing power would be lower, meaning the expenditure per tourist would be lower when adjusted for inflation.

It is within the above context, that I believe, policy makers in Malta, should give more weight to the advice that the IMF has recently issued. Should things unfold in a way whereby energy prices remain elevated for the longer term, I believe we should plan for a more resilient and forward looking solution that does not depend on an elevated public spending to sustain energy subsidies. After all, as the IMF gently mentions, our forecast of keeping our increased public debt within the level of 60% to GDP is based on achieving the forecasted GDP growth. Should that growth not materialise it will likely lead to a “forced on an upward path” of public debt. Resilience means that we need to be prepared for every eventuality.