DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Malta’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, DBRS Morningstar 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.

KEY RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar's view that risks to the ratings remain balanced. The Maltese economy has recovered faster than previously anticipated from the Coronavirus Disease (COVID-19) pandemic shock, despite a partial revival in foreign tourism in 2021. DBRS Morningstar expects Malta’s economic outlook to remain solid, benefitting from a fuller return of foreign tourism, a healthy private-sector balance sheet, sustained fiscal support, and European funds. However, the potential economic impact from Russia’s invasion of Ukraine and, to a lesser extent, the evolution of the coronavirus cloud Malta’s economic outlook. While the country has limited trade and energy links with Russia and Ukraine, Malta remains vulnerable to the impact of the conflict through weaker external demand, higher inflation, and tighter monetary policy conditions. On the other hand, DBRS Morningstar takes the view that the Financial Action Task Force’s (FATF) initial determination that Malta has substantially completed its action plan mitigates the risks associated with Malta’s inclusion in its list of jurisdictions under enhanced monitoring, the so-called grey-list.

Malta’s strong fiscal performance and debt-ratio reduction efforts before the pandemic created valuable headroom to support the economy. While the economic recovery is helping to rebalance fiscal metrics after the severe deterioration in 2020, the measures to deal with the effects of COVID-19 and to mitigate the impact from inflation continue to weigh on public finances. Nevertheless, Malta’s cost of funding remains favourable and DBRS Morningstar expects a gradual return to a healthier fiscal position, supported by the growth outlook and the expected phaseout of temporary measures.

Malta’s euro area membership, a moderate level of public debt, a solid external position, and households’ strong financial position support the country’s A (high) rating. On the other hand, Malta’s small and open economy remains exposed to external demand or confidence shocks. In this sense, the tourism sector—an important source of income, employment, and investment in Malta—presents a potential vulnerability if the pandemic situation were to worsen. Similarly, Malta’s attractiveness to foreign investment could suffer if measures to address financial integrity risks and institutional governance weaknesses noted by international bodies persist. Despite Malta’s sound public finances, medium- to long-term challenges could stem from its contingent liabilities, changes in international taxation affecting its attractive tax system to foreign companies, or increasing age-related spending.

RATING DRIVERS
DBRS Morningstar could upgrade Malta’s ratings if a combination of the following occur: (1) a sustained material reduction in the public debt ratio, 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. DBRS Morningstar could downgrade Malta’s ratings if one or a combination of the following occur: (1) a sustained deviation from a prudent fiscal approach, materially deteriorating the fiscal and public debt outlooks; (2) a material deterioration in Malta’s medium-term growth; or (3) a substantial weakening of investors’ confidence due to insufficient progress on improving the effectiveness of its Anti-Money Laundering and Combating the Financing of Terrorism framework.

RATING RATIONALE

Maltese Economic Outlook Remains Sound, But Clouded By Geopolitical and Pandemic Risks

Malta’s economic performance prior to the pandemic was remarkable. Annual GDP growth averaged 7.0% from 2013 to 2019 with strong job creation and a shrinking GDP per capita gap with the European Union (EU). The pandemic had a massive impact on the Maltese economy, with GDP contracting by 8.3% in 2020 due to the collapse in tourism-related activities and private consumption. Despite a partial rebound in foreign tourism, the recovery was faster than anticipated last year. GDP grew by 10.4% in 2021, mostly driven by the strong rebound in domestic demand. The continued fiscal support, accumulated savings, and greater confidence created the conditions for a solid comeback in private consumption and investments as the economy reopened in 2021. DBRS Morningstar considers that the strong performance of the financial and gaming sectors thus far mitigate concerns over the impact of FATF’s grey-listing on activity. Also, the labour market remained stable throughout the pandemic, benefitting from government support measures, especially the wage compensation scheme. The unemployment rate stood at 3.2% in Q4 2021, below Q4 2019 levels, and employment continued to increase during the pandemic.

As a small and open economy, Malta is vulnerable to the effects of Russia’s invasion of Ukraine principally because of its impact on European demand and higher inflationary pressures. The government’s efforts to lessen the impact of inflation on the private sector, mainly through fuel and energy subsidies, have helped to keep inflation below euro area levels, albeit still high. Malta’s HICP inflation stood at 5.4% YoY in April 2022, compared with 7.4% YoY at the euro-area level. Malta’s direct exposure to both Russia and Ukraine is limited, ranking last in the EU in terms of vulnerability to the conflict according to the European Commission (EC) Member States’ vulnerability matrix. Trade links with Russia and Ukraine are very small, with the combined exposure accounting for less than 1% of total exports and imports. In addition, Malta does not import oil and gas from Russia. However, Malta is indirectly exposed via its electricity imports from Italy, which relies heavily on Russian gas.

DBRS Morningstar takes the view that Malta’s economic growth will remain robust in coming years, despite the intensified risks and dampening effect from the conflict in Ukraine. The government revised its growth projections downward to 4.4% for 2022 and 3.9% for 2023 in its latest Stability Programme compared with 6.5% for 2022 and 4.7% for 2023 projected last Autumn. These projections have been endorsed by Malta’s fiscal council and are broadly in line with the EC’s “Spring 2022 Economic Forecast”. Households’ relatively strong balance sheet and a tight labour market mitigate the negative effects of inflation on consumption. Public investment will remain supportive, boosted by the European funds, and foreign tourism should recover strongly even under conservative assumptions. At the moment, the main downside is linked to a further deterioration in external conditions and inflationary pressures. Higher or more persistent inflation in Europe, and in Malta, could further dampen growth and lead to tighter monetary policy. On the other hand, a faster-than-expected recovery in foreign tourism could lead to a significantly faster overall economic recovery, given the importance of the industry for Malta.