Today, Standard & Poor's Ratings Services affirmed its 'BBB+/A-2' longand short-term foreign and local currency sovereign credit ratings on Malta. The outlook remains positive.
Rationale
The ratings on Malta are supported by our assessment of the country's economic growth prospects and gradual budgetary consolidation, which we expect will place the government's debt-to-GDP trajectory on a steady downward course. At the same time, the ratings are constrained by what we view as moderate contingent liabilities and a relatively low degree of economic diversification compared with eurozone peers.
Malta's real GDP grew by 4.5% in 2015, by our estimate, and we project that it will expand by 2.8% annually on average in 2016-2018. We believe Malta's economic growth will continue to outpace that of the eurozone as a whole, driven by strong investment in the energy sector and growth in consumption, underpinned by wage growth, employment growth, steady net migration, the decline in oil prices, and moderate inflation. Lastly, consumption trends are also supported by an increased participation in the labor market by women and older people, which until recent years lagged well behind the large majority of eurozone peers. The total employment rate in Malta among 20-to-64-year-olds has increased to 66.3% in 2014 from about 57% in 2005.
Energy investments, most of them frontloaded to 2015, include the laying of an electricity interconnector cable to Sicily, as well as the building of a liquefied natural gas terminal, a natural gas plant, and the conversion of an oil-fired power plant to gas. Coupled with lower global energy prices, we believe that these investments will not only reduce Malta's import bill, but will also improve the business environment in Malta as access to electricity eases. In expectation of lower energy prices, the government has mandated 25% cuts to utility tariffs, which have provided further support to private consumption. Beyond 2016, further diversification of the economy--particularly into information and communication technology, education, and medical tourism--could support further investment activity.
Malta's tax regime has attracted significant foreign investment into the country's banking, insurance, and IT industries, implying that the economy would be sensitive to a eurozone-wide standardization of corporate tax regimes. In addition, the business environment in Malta is still constrained by Malta's judicial framework, leading to slow contract enforcement. Despite this problem, we see the overall political and institutional framework of Malta as broadly supportive of the ratings.
On the external side, we view Malta as an open, services-oriented economy. Since 2007, the services surplus has doubled, with the size of services receipts and payments in 2014 having increased to 3.7x and 4.7x their 2007 levels, respectively, reflecting both actual flows and balance of payments methodology changes. Maltese service exports consist principally of financial services, transportation, tourism, and remote gaming; we project that tourism will continue to perform well on the back of a favorable euro/pound sterling exchange rate and a more challenging security situation in competing tourist destinations to the south and the east. Over our 2016-2018 forecast horizon, we expect that Malta will run a current account surplus on the back of improving trade and service balances. We see this as a structural shift from the pre-2012 situation of small but consistent deficits, and we see the strength of the service sector as a key driver of this change.
The methodology for calculating Malta's International Investment Position (IIP) has switched to the new statistical standard of BPM6 for 2013 and 2014 historical data, which creates a break in our series between 2012 and 2013. Under the new methodology, the external debt of the nonbank private sector is calculated at a much higher level than previously, which puts our preferred external indebtedness measure of narrow net external debt at a net liability position of 59% of current account receipts (CARs) in 2015. We continue to see the high level of short-term debt in the banking sector as a potential source of volatility of financial flows, which could undermine Malta's external liquidity. We expect Malta's gross external financing needs to average 326% of CARs plus usable reserves in 2016-2018 and to be stable over the period.
We believe that Malta's favorable economic growth prospects support further budgetary consolidation. We forecast that the general government deficit will decline gradually through 2018, primarily owing to increased tax receipts from strengthening domestic demand and the expected decline in current expenditure growth from 2016 onward. We nevertheless believe that, in the light of likely higher-thanbudgeted revenues, the pressure on spending slippages may be difficult to contain.
As a result, we expect net general government debt to decrease to 54% of GDP by the end of 2018, from 57% in 2014. We forecast general government gross debt will be 65% of GDP in 2016, excluding the guarantees related to the European Financial Stability Facility
We forecast general government interest payments will average 6% of general government revenues per year over 2016-2018.
Malta's contingent fiscal liabilities stemming from nonfinancial public enterprises (NFPEs) derive mostly from government-guaranteed debt of power utility Enemalta (estimated at about 9.5% of GDP in 2015). Enemalta will likely not generate profits until 2017, but we note that the current drop in international oil prices is helping its expected return on investments. Other state-owned enterprises also represent fiscal risks, as exemplified by this year's government financial support to Air Malta, estimated at 0.5% of GDP. Government guarantees of NFPEs' debt totaled 14.3% of GDP according to the latest 2015 data. Moreover, we note that without further reforms in the pension and health care systems, the progress in budgetary consolidation will become strained in the medium and long term. That said, the improvement in labor force participation, as well as ongoing economic growth, have led to improvements in the sustainability of the social security system.
Under our criteria, we see contingent fiscal risks to public finances coming from the banking sector. Malta's domestic banking sector operates alongside a large offshore sector that we believe the government would not support in case of financial distress. However, dislocations in the funding of this sector could affect the island's reputation as a financial center and potentially weaken its growth prospects. Nevertheless, these operations do not significantly affect the rest of the financial sector, as exemplified by the October 2015 decision by Deutsche Bank to close its operations on Malta (and in several other jurisdictions) and related repatriation of €4.2 billion (equivalent to about 50% of Malta's GDP).
Assets of the total banking sector are over 6x GDP, while assets of core domestic banks amounted to about 2.5x GDP in June 2015. The largest domestic systemically important banks are 25% state-owned Bank of Valleta (total assets of €9.9 billion in September 2015) and HSBC Malta Bank (total assets of €5.9 billion in June 2015), as well as fastgrowing Mediterranean Bank (total assets of €2.4 billion in September 2015), which in 2015 joined the former two under the European Central Bank's supervision. Malta's Depositor Compensation Scheme (DCS) is financed by cash contributions and assets pledged by all banks licensed by the regulator (the DCS fund accounts for 1.3% of covered deposits as of June 2015, compared with the EU minimum requirement of 0.8%).
Because the DCS is a timely (20-day) deposit guarantee covering household and corporate deposits up to €100,000 across 27 licensed financial institutions, Malta's central government would likely have to provide substantial bridge financing to the DCS to cover any shortfall financing for depositors' claims in the unlikely event that a regulated institution suffered difficulties.
Among core domestic banks, nonperforming loans (NPLs) represented 8.6% of total loans in the first half of 2015, which remains a challenge for the economy, despite a recent decline due to acceleration in credit activity. Almost half of NPLs are in the construction and commercial real estate sectors. Core domestic banks' aggregate loan loss provisioning rose to 45.9% as of end-June 2015, which we still consider low. Indeed, banks take a while to realize collateral in Malta, a characteristic that we regard as common to small jurisdictions.
Membership in the eurozone anchors Malta's monetary policy and provides its banks access to funding at low nominal interest rates. Nevertheless, we believe that membership in a monetary union increases the onus on member governments to support competitiveness through fluid labor, product, and services markets, and to build up fiscal buffers against future shocks. This is more the case now than a year ago,
Government welcomes rating
In a statement, the government this evening welcomed the report and said S&P’s analysis was the opposite of that of the Opposition.
While the Opposition leader forecast a financial bailout, the agency’s outlook was that the country would continue to reduce the debt burden.
Contrary to what the Opposition forecast, S&P also forecast economic growth higher than that being experienced by other countries.
The government said that while the Opposition leader insisted that the investment in the energy sector was unnecessary, the international experts insisted such investments would not only reduce Malta’s import bill, but would also improve the business environment in Malta