DBRS Ratings GmbH (DBRS) confirmed the Republic of Malta’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, DBRS confirmed the Republic of Malta’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The trend on all ratings is stable, DBRS said.
KEY RATING CONSIDERATIONS
The Maltese economy grew close to 7% in 2018, repeating 2017´s strong performance. DBRS expects gross domestic product (GDP) growth to moderate in coming years amid a less favourable global backdrop and high capacity utilisation. Despite this anticipated deceleration, the International Monetary Fund (IMF) projects Maltese average annual GDP growth to remain high at 3.9% between 2019 and 2024. Public finances have benefitted from a buoyant economy.
In 2018, Malta´s fiscal surplus stood at 2.0% of GDP and the debt-to-GDP-ratio declined to 46.0% of GDP. Importantly, Malta recorded a surplus even if the net proceeds from the International Investment Programme (IIP) are excluded. DBRS expects the debt ratio to continue to decline related to the primary surplus and the favourable debt snowball effect. Also, there are some judiciary and regulatory changes ongoing that could improve the overall governance, delivery of which may be forthcoming in the next twelve months, DBRS said.
Malta’s A (high) rating is supported by its euro zone membership, moderate level of public debt, solid external position, and households’ strong financial position. On the other hand, given its size and openness of the Maltese economy, with sectors such as tourism, gaming and financial services highly reliant on external demand and foreign capital, Malta remains exposed to external demand or confidence shocks. In the medium term, potential changes in international corporate taxation, changes to the EU regulatory framework, or weakening perception of the governance framework could reduce Malta’s attractiveness to foreign business. Malta’s contingent liabilities, stemming from its large non-financial state-owned enterprises (SOEs) and concentrated financial sector, and rising age-related costs are potential sources of vulnerability for public finances.
RATING DRIVERS
Upward rating drivers include: (1) a sustained material reduction in the public debt ratio to low levels driven by sound fiscal management and economic performance; (2) effective implementation of reforms to enhance Malta´s governance framework, including the financial and judicial sector; or (3) further evidence of increased economic and fiscal resiliency to external shocks, including changes to the international tax or regulatory environment. While DBRS’s baseline factors in a relatively positive economic and fiscal outlook, a deterioration in the trajectory for public debt in the medium term could exert downward pressure on Malta’s ratings. This could derive from: (1) a deterioration in growth prospects, or (2) a sustained worsening of fiscal and debt indicators, or (3) the materialisation of contingent liabilities.
RATING RATIONALE
Malta Continues to Outperform EU Average Growth Rates Although Bottlenecks Are Emerging
Recent economic performance has been remarkable, with 7.2% annual average GDP growth from 2013 to 2018, well above the 2.1% average rate between 2004 and 2012. In this context, Malta’s GDP per capita (EUR 25,556) continued to converge to European Union (EU) average levels (EUR 30,935) in 2018, as per European Commission (EC) estimates. Growth has been broad-based with outward-facing sectors such as tourism, gaming, financial and business services being key contributors to the expansion. A highly elastic foreign labour supply, increasing female and older worker participation rates, and a rising share of less capital-intensive service sectors have prevented overheating pressures.
Higher investment, a larger labour supply, and enduring benefits from the energy reform will continue to buttress potential output.
Malta’s open economy is the smallest in the euro area and is vulnerable to weak external demand and lower foreign direct investment. In the short term, major risks stem from an escalation of protectionist trade measures hurting global trade and growth as well as the impact on tourism from Brexit. Also, addressing emerging infrastructure bottlenecks and labour shortages in certain sectors, which could weigh increasingly on growth, will remain a challenge. In the medium term, changes in international corporate taxation, changes to the EU regulatory framework, or slow progress in enhancing its governance framework could reduce Malta’s attractiveness as a financial and business location.
Malta Accumulates Fiscal Surpluses Benefitting from Buoyant Macroeconomic Environment
Malta’s fiscal performance has improved significantly over the last two decades, allowing the country to be fully compliant with the EU’s Stability and Growth Pact. The general government budget balance as a percentage of GDP switched to an average surplus of 2.1% for 2016-2018 from an average deficit of 3.5% for 2001-2015. Since 2016, Malta’s budgetary surpluses have been both in nominal and structural terms. Key factors underpinning this trend has been stronger underlying economic fundamentals boosting revenue growth, improved spending efficiency, lower interest payments, and the proceeds from the IIP since its introduction in 2014.
The headline surplus is expected to drop to 1.0% of GDP in 2019 from 2.0% in 2018, principally driven on the expenditure side by an increase in public investment in roads, waste management, health and education, and less dynamic revenues from taxes on production and imports and property income. Encouragingly, the government is allocating more resources to investment to addressing infrastructure bottlenecks whilst projecting fiscal surpluses hovering around 1% of GDP during 2020-2022. Given the difficulty in predicting the IIP proceeds, DBRS considers the authorities’ intention to comply with the government’s Medium-Term Objective, net of the IIP, to be appropriate. Moreover, around 70% of the proceeds from the IIP are allocated to the National Development and Social Fund (NDSF) to finance one-off projects. By the end of 2018, the market value of NDSF amounted to 3.7% of GDP.
Malta’s corporate taxation proceeds represented 16.6% of total revenues in 2017, with around 50% from foreign-owned companies according to IMF. Therefore, Malta´s tax base could be eroded if international tax changes were to reduce significantly the attractiveness to multinationals to locate in Malta relative to other jurisdictions. The potential introduction of new measures to attract foreign capital, still competitive wage costs, an English speaking labour force, and access to the single market could lessen the impact. In the long-term, age-related costs are projected to increase by 6.8 percentage points over 2016-2070, according to the 2018 Ageing Report. Government initiatives, such as gradual lengthening of retirement ages, longer contribution periods, and incentives to deter retirement, appear to have contributed to longer working lives. Nevertheless, additional measures may be required to improve long-term sustainability of the healthcare and pension system.
The Public Debt Ratio is Expected to Continue Falling in Coming Years
Following a substantial drop of 24.2% percentage points over the last seven years, Malta’s debt-to-GDP ratio stood at 46.0% of GDP in 2018, one of the lowest in the EU. In the absence of material shocks, this steep downward trend is projected to continue in coming years, explained by solid primary surpluses and favourable nominal growth-interest expenditure differential. The projections from the Central Bank of Malta (CBM) (38.3% by 2021), the Ministry for Finance (33.2% of GDP by 2022), and the IMF (28.2% of GDP by 2024) point in this direction.
Malta’s current public finance position and debt dynamics provide the government valuable room to support the economy in the event of a negative shock without materially jeopardising debt sustainability. DBRS views the main sources of risks as arising from a sharp deterioration in Malta´s growth outlook, a weakening primary balance, or the materialisation of a contingent liability. In addition to its large and concentrated financial system, another source of contingent liabilities could come from vulnerabilities in its SOEs, with liabilities of 18% of GDP in 2017 and accounting for most of 8.5% of GDP of outstanding guarantees in Q1 2019.
Conservative Core Banks and Strong Households Limit Financial Stability Risks
The Maltese financial system remains sound, underpinned by its conservative core banks’ healthy levels of capitalisation, liquidity and profitability. Core domestic banks, with assets of 194.2% of GDP in Q1 2019, mostly follow a traditional business model based on retail deposits for funding. Core banks’ non-performing loans as a share of total loans, which stood at 3.3% in Q1 2019, continue to decline driven by the overall better economic and housing market conditions as well as tighter regulatory requirements. International banks, with assets of 131.1% of GDP, and domestic non-core banks, with assets of 21.2% of GDP, have limited or no linkages to the domestic economy. Therefore, potential spill-overs to the rest of the system are contained.
Core banks’ high exposure to the real estate market and rapid housing price growth since 2014 is a source of risk. While valuation in the housing market is becoming stretched, strong demand has largely been driven by fundamental factors such as rising disposable income, substantial net migration and low interest rates. An increasingly responsive housing supply, households’ high levels of financial wealth and liquid assets, and banks’ conservative lending practices mitigate the risks to the banks´ mortgage loan book. New borrower-based macroprudential measures became effective in July 2019, broadening the authorities’ ability to counter mounting pressures in the housing market, especially in the buy-to-let segment.
The IMF’s Financial Sector Assessment Program published in March pointed out some supervision capacity and anti-money laundering and counter the financing of terrorism (AML/CFT) implementation and enforcement shortfalls in Malta. Given its many cross-border links, DBRS considers that a continuation of the government’s efforts to address these concerns will remain important to contain reputational risks that may pose a risk to the Maltese financial system. On this front, the government is pursuing strategic action to be implemented by 2020 to enhance its AML/CFT framework, including the creation of national coordinating mechanisms, increasing resources and staffing in the Malta Financial Services Authority and Financial Intelligence Analysis Unit, and the creation of a new financial crime unit, among other initiatives.
Malta’s External Position Remains Strong
Malta’s external position continues to strengthen led by fast-growing service sector exports. On the back of a sizeable services trade surplus at 33.0% of GDP, the current account surplus reached 9.8% of GDP in 2018. The current account shifted from an average 6.2% deficit during 2005-2009 to an average surplus of 2.7% of GDP during 2010-2018, chiefly driven by the enlargement of the trade services balance. The marked improvement in the external accounts since 2009 can be mostly explained by structural factors, such as improving energy intensity, lower import content, the increasing role of the gaming industry, as well as the expansion of sectors such as aviation. In this context, Malta has built up a large positive net international investment position of 63.3% of GDP by 2018. Gross external indebtedness appears extremely high relative to the size of economy, but it reflects a diverse financial industry that poses limited risks to the Maltese economy.
Stable Institutional Framework to Support Policy Continuity
Malta has relatively sound public institutions. The adoption of European procedures has resulted in a stable macroeconomic, fiscal and monetary policy framework. Malta has recently been facing greater scrutiny over allegations of corruption, rule of law, and accountability. In response, the government has implemented several measures to reinforce governance, including measures to curtail corrupt practices and a comprehensive action plan to improve enforcement and effectiveness of its AML/CFT framework. Moreover, the government is working on a plan to improve the separation of powers and the independence of the judiciary.