What lies in store for the economy in 2023?

We entered 2022 with promises of economic hope, in what was expected to be a year of booming commercial activity as countries planned pandemic exit strategies. But the hope quickly diminished when Russian president Vladimir Putin announced his ‘special military operation’ in Ukraine, wreaking further havoc to supply chains already strained from COVID-19. Gas supplies were also put under pressure, hampering full economic recovery in many in countries.

MaltaToday spoke to economists Clint Flores and Stephanie Fabri, and EY's Ronald Attard, strategy and transactions leader for central, eastern and southeastern Europe and central Asia, to see which factors will continue to shape the local economy next year, and what new factors could crop up in 2023.

1. War In Ukraine

Ukrainian soldiers at the frontlines of Kharkiv region (Photo: Twitter)

Attard: It is impossible to say when the war will end. Of course, the first thoughts go out to the people in Ukraine who face the immediate and brutal consequences of war in their country. But there are also economic consequences of the war across the globe including Malta. These consequences include supply bottlenecks, raw material shortages, increases in energy prices (which have been shielded to date in Malta) and inflation. And as a consequence of inflation, increased interest rates…

Flores: The war in Ukraine and its outcome after this winter is what will mainly affect the world. Indeed, gas shortages in Europe and persistent inflationary pressures might send the eurozone economy into a recession. Normally in a recession inflation subsides. However, economic shocks will definitely affect the euro currency and its governance.

Certainly, the main attention would primarily fall on Italy’s debt stock and Germany’s industrial production shortages which would limit the latters growth due to the gas dependency of its economy.

The Italian and the German economies are two of the largest in the eurozone and thereby they can affect the stability of the currency. If the euro depreciates due to persistent economic shocks, and in tandem inflation does not subside relative to the global interest rate hikes due to supply side shortages, imports would become dearer. This means that in the medium term, inflation will persist, risking a stagnation in Europe’s economy.

[…] Unless a peace agreement is found, global stability won’t be restored. We are going to see additional conflicts in 2023 in many regions around the globe.

2. The Labour market

The labour market has been experiencing shifts in terms of high demand and low supply

Fabri: In Malta and across the EU, the labour market has been experiencing shifts in terms of high demand and low supply. This labour market situation has been putting increasing pressure on the economy through higher business costs and higher demand amongst other factors, which spiraled inflation. A calmer labour market situation is highly unlikely and this this will continue causing economic stress amongst market players, especially given the wide-ranging disruptions that are shaping and occurring throughout the world of work.

3. Reactions to interest rate hikes

The ECB has raised interest rates to tame inflation and the full impact on companies and households will be felt in 2023

Attard: As the cost of capital continues to go up following the successive hikes in interest rates put in place by central banks, 2023 will see companies, households and investors deal with the full impact of this change in monetary policy stance. We’ll see: increased interest in the bond market as coupons are again going above the 5% mark; companies trying to offload certain assets as bank funding takes its toll; and companies looking at acquisition opportunities to sustain their growth plans.

The cost of capital is also going up for governments, which are also battling higher deficits due to the pandemic and the impacts of the energy/inflation crisis – this will mean increased opportunities for the private sector to assist in co-funding some projects of a public-private nature.

4. Inflation

Inflationary pressures have had a significant impact on governments, businesses and consumers

Fabri: The implications of COVID-19 and the Russia- Ukraine war on inflationary pressures over the recent years have had a significant impact on governments, businesses, and consumers. This is a result of supply-chain shortages caused by these events and a concoction of other economic factors through which their interplay caused economic pressures.

Some experts are predicting that the worst is yet to come whilst others are stating that wage growth will be higher than inflation in the coming year. If inflationary pressures persist in this significant manner, they will continue having an influence on the quantity, and quality of investment and other market choices by businesses and consumers.

It will also be more difficult for governments to focus on the long- term economy in relation to environmental investment and digitalization. There also the possibility that these inflationary pressures will weigh on growth and lead to stagflation.

Flores: Inflation might persist longer than expected as it is a supply side problem not a demand side. If that is the case, then we might risk longer periods of inflation even in Malta. The European economy and its labour market is different to that of the US. Wages in Europe are sticky downwards relative to that of the USA’s labour markets.

Due to the gas shortages in 2023, some companies might need to readjust their production levels. This might create a shortage in private investment. Capital has already become more expensive due to higher interest rates and therefore private investors might postpone investment decisions, which in turn affects unemployment.

[...] In terms of prices Malta is more competitive given that the government is absorbing the energy inflation. I think that Malta will avoid a recession due to its competitiveness and its agile economy which adjusts easily to each and every global circumstance. An important step in 2023 is to make sure that business sentiment remains high, and consumer confidence too, and we take the opportunity to transit to greener practices.

On a separate note, we must promote the circular economy further to cut on unnecessary costs in times of abnormal inflation. The principle of collecting plastic is a great step in the right direction. However, the beverage container deposit must be efficiently and effectively collected to avoid additional increases in inflation expectations and unnecessary inflationary pressures.

5. Business readiness

Businesses need a vision, clarity and a better understanding of how the current volatility is impacting them to be able to become more agile

Fabri: The economic situation is based on high levels of economic volatility, uncertainty, complexity and ambiguity (VUCA). Businesses need to shift this situation by creating a vision, create the means to have more clarity and a better understanding of how the current situation is affecting them, and become more agile. It is easier said than done given the complexity characterizing the economy at present. However, with the right inspiration and people on board, it is not impossible. Future competitiveness depends on businesses who manage to take advantage of the present.

Foreseeing the future has become difficult with the VUCA situation.  Stakeholders should thus proactive and thus prepare a reaction for the different scenarios that could take place.

6. Approval of the European Sustainability Reporting Standards by the European Parliament

Sustainability reporting by companies will have to be standardised in line with an EU directive

Attard: These reporting standards are the equivalent of the accounting IFRS’s, and focus on standardising sustainability reporting under the upcoming Corporate Sustainability Reporting Directive, which starts impacting some of the largest local companies for financial year 2024. About 12 ESRS’s are expected to be approved.

There will be a gradual trickling down to smaller firms, either directly through their reporting requirements, or indirectly by getting requests from their larger supply chain partners. What it means for the local economy is that many firms will gradually need to start ingraining sustainability reporting into their processes – from strategy to governance, to IT architecture.

Initially, many will see it as a cost – the more forward-looking leaders will realise this is required to maintain competitiveness, and eventually can be a source of competitive advantage.

7. Getting closer to price parity for electric vehicles

The price of electric cars needs to drop to ensure a just transition

Attard: We’ve seen an increased take-up of hybrid and fully electric vehicles here in Malta, mainly driven by the generous government grants, but also as people realise there are advantages to be gained in having a cleaner and smoother mobility tool. However, there is still a feeling that these large grants are possibly helping higher income households, while one of the key principles the EU harps about is a just transition – one hopes that 2023 should see us make a step closer to price parity (ICEA vehicles vs EVs).

8. US property market

Not enough attention is being given to how the US property market will react to persistent interest rate increases

Flores: Economic forecasts are based on historical data projected to the future, and I hasten to add that some outliers, even by US economists, are not being captured in such forecasts such as the property market’s reaction to the persistent increase in interest rates. If the USA’s property market is affected, it might send additional shockwaves to the financial markets in Europe, which might create a global contagion effect akin to the one of 2008. Clearly, we must avoid another economic shock, as that would be fatal for many economies around the world.

9. Gas storages

Europe has to fill its gas storage supplies before the winter if it is to avoid instability that will erode investor sentiment and consumer spending

Flores: Personally, I believe that if Europe does not manage to fill up gas storages in time for 2023, it would create additional instability, especially if diplomatic relations now also with Qatar degenerate. That instability might erode private investors’ sentiment and consumer spending, which are all important components of aggregate demand.

The dip in business sentiment and consumer spending will take longer to recover due to the post-COVID economic shocks and the ensuing slow recovery of the labour market. Several workers left the retail sector, consumer spending was eroded due to income losses emanating from the closure of the retail sector in response to the pandemic, and the ensuing energy and food inflationary pressures further eroded the disposable income of workers.