DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Malta’s (Malta) Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, DBRS Morningstar confirmed Malta’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The trend on all ratings is Stable.
KEY CREDIT RATING CONSIDERATIONS
The Stable trend reflects DBRS Morningstar's view that the risks to Malta’s credit ratings remain balanced. Malta’s post-pandemic recovery has been strong, outpacing most other European peers, and helped by the government’s support measures and a robust rebound in foreign tourism. The authorities’ decision to freeze retail electricity and fuel prices at pre-Russian invasion levels and the limited pass-through from monetary policy tightening to the local economy have alleviated the adverse economic effects of the invasion. Malta’s growth prospects remain solid despite the near-term slowdown caused by weak external conditions and elevated inflation. On the other hand, Malta’s price-mitigating fiscal measures are expected to slow the pace of fiscal consolidation. The fiscal deficit is expected to remain among the highest in the European Union (EU) during 2022 and 2023, in spite of strong revenue growth and the phase-out of coronavirus support. DBRS Morningstar considers that Malta’s still moderate public debt levels and positive growth dynamics partly mitigate risks stemming from the fiscal outlook. Nevertheless, DBRS Morningstar notes that the government has so far not articulated a clear exit strategy for the untargeted energy subsidies, and a higher-for-longer global energy prices scenario could complicate the fiscal consolidation path.
Malta’s A (high) rating is supported by its euro area membership, moderate level of public debt, solid external position, and Maltese households’ strong financial position. On the other hand, Malta is a small and open economy, and therefore exposed to external demand or confidence shocks. DBRS Morningstar considers that the authorities’ continued commitment to enhance its Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) will remain important to protect its reputation and attractiveness to foreign investment after the country’s rapid removal from Financial Action Task Force’s (FATF) list of jurisdictions under enhanced monitoring in June 2022. Malta’s public finances are generally sound, but medium- to long-term challenges could stem from its contingent liabilities, changes in international taxation that affect the attractiveness of its tax system to foreign companies, or increases in age-related spending.
CREDIT RATING DRIVERS
DBRS Morningstar could upgrade Malta’s ratings if one or a combination of the following occurs: (1) a material improvement in the public debt trajectory driven by a prudent fiscal approach and strong economic performance; or (2) 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 occurs: (1) a significant deterioration in the public debt trajectory, potentially driven by a prolonged period of fiscal underperformance or weak economic growth; or (2) a reversal of improvements in Malta’s financial crimes and institutional quality reforms.
CREDIT RATING RATIONALE
Malta’s Economic Performance Remains Strong But Growth Is Slowing Amid a Challenging External Environment and High Inflation
After a pandemic-induced GDP contraction of 8.1% in 2020, Malta recorded one of the quickest recoveries in the EU. GDP expanded by 12.3% in 2021 and 6.9% in 2022. The recovery was driven both by domestic demand, which benefitted from the government’s support and the strength of the private sector, as well as a stronger-than-anticipated rebound in foreign tourism last year. The labour market remains tight, with an unemployment rate at 2.5% and employment growth at 4.9% YOY in Q2 2023. Indeed, job growth has been remarkable over the last three years, supported by foreign workers and higher participation rates, especially among female workers. The government decision to freeze energy and fuel prices at pre-invasion levels has shielded Maltese households and firms from the spike in energy prices. Still, the harmonised index of consumer price inflation reached 6.1% in 2022 due to strongly rising import prices and more demand-driven services inflation. Inflation is expected to remain elevated this year and only decline gradually over the next couple of years. It is noteworthy that monetary policy tightening pass-through to domestic lending rates has been limited, especially compared to other euro area member states, contributing to strong domestic demand and lending growth.
The Central Bank of Malta projects GDP growth to decelerate to 3.7% in 2023 and 3.6% in both 2024 and 2025. While growth is expected to significantly outperform most European peers, subdued international developments and the lagged transmission of tight monetary policy are expected to weigh on growth dynamics. On the other hand, recovering purchasing power amid slowing inflation and the inflow of European funds should remain supportive of Malta’s growth outlook. Malta’s structural labour shortages and infrastructure bottlenecks are important limiting factors at this stage. The main downside risks to Malta’s healthy growth prospects are linked to a further weakening of the external backdrop, especially if accompanied by tighter financial conditions.
Support Measures to Deal With the Pandemic and Energy Shocks Have Led to a Deterioration in Malta’s Fiscal Position
Malta’s fiscal performance has deteriorated significantly in recent years. To a large extent, this has been due to the support measures to shield households and firms from the pandemic and the energy/cost-of-living shocks. The fiscal balance shifted from an average surplus of 1.7% of GDP during 2016–19 to an average deficit of 7.6% of GDP during 2020–22. The fiscal deficit is gradually declining but is still among the highest in the EU. The fiscal deficit narrowed to 5.7% of GDP in 2022 from 7.7% in 2021, as the partial removal of COVID-19 support and strong revenue growth more than offset the fiscal cost of energy subsides (2.5% of GDP) and Air Malta’s restructuring efforts (0.9% of GDP). In its latest Pre-Budget Consultation Document 2024, the government projects a deficit of 5.0% of GDP in 2023 and targets a deficit of 4.5% in 2024. The gradual improvement mainly reflects the expectation of lower energy subsidies, in light of the decline of energy prices, and the complete phase out of COVID-19 support. The government estimates that the net budgetary impact of the energy-price measures will be 1.7% of GDP in 2023 and 1.5% of GDP in 2024. This is down from 2.5% of GDP in 2022. The reduction in energy subsidies is expected to be partially offset by higher expenditures, mostly reflecting the effect of inflation on public wages, social security benefits, and intermediate consumption.
The government plans to bring the fiscal deficit below 3.0% of GDP by 2027, one year later than expected in the Update of Stability Programme 2023–26. This plan implies an annual structural adjustment of 0.6 percentage points for the next three years. The main risk to the fiscal outlook is linked to the evolution of the energy subsidies. Additional support measures related to Air Malta’s restructuring to accrue this year appear to be sufficiently provisioned for. Over the medium to long term, revenues from Malta’s citizenship by investment scheme and corporate taxation could come under pressure and require the country to introduce compensatory measures to fill the gap. These factors account for DBRS Morningstar’s negative qualitative adjustment of the Fiscal Management and Policy building block. Finally, while Malta has already extended the working age and contribution periods in its pension system, additional measures might be necessary to contain the long-term costs of age-related spending on these systems.
Malta’s Debt Ratio Deteriorated but Still Leaves Significant Space to Absorb Shocks
The pandemic halted a period of steep reductions in Malta’s public debt-to-GDP ratio. From 2011 to 2019, government debt-to-GDP declined from 70.0% to 40.1%. The support measures to deal with the pandemic and the energy shock resulted in a significant increase in the debt ratio. In 2022, the ratio stood at 52.3%. Nevertheless, DBRS Morningstar notes that the debt ratio is lower than previously anticipated, due to higher real growth and inflation, and remains well below the Maastricht benchmark of 60.0% of GDP and the EU average debt burden of 84.0% of GDP. Malta´s moderate levels of public debt provide valuable space to support the economy if under stress. The government forecasts the debt ratio to gradually increase to 54.5% of GDP in 2024 as the projected primary deficits offset the debt-decreasing impact of the interest-growth differential. The recently announced capital injection to Air Malta could add over 1 percentage points extra to the debt ratio during 2024–25, mostly concentrated in 2024. DBRS Morningstar considers that strengthening the primary balance position will be key to stabilize or decrease the debt ratio in a context of higher interest rates and slower growth. Similar to other euro area economies, Malta’s funding costs for newly issued debt have increased due to higher monetary policy rates and high inflation. Still, the interest burden is expected to remain contained at around 1.3-1.4% of GDP over the next couple years.
Financial System Remains Sound and a Rapid Exit from the Grey List Reduces Reputational Damage
Maltese domestic banks’ strong capital position and ample liquidity levels on aggregate limit financial stability risks. Malta’s policy measures and strong post-pandemic economic recovery have helped mitigate the impact from successive shocks on asset quality. Core banks’ nonperforming loans as a share of total loans continued to improve and remained at a historical low of 2.7% in Q1 2023. The latest stress test performed by Central Bank of Malta (CBM) suggests the domestic banking sector exhibits adequate buffers to absorb substantial losses or liquidity stresses. Still, further inflationary pressures and higher interest rates amid a slowing economy could lead to some deterioration in asset quality going forward. Malta’s healthy labour market and household savings mitigate these risks.
Unlike most of its peers in the euro area, the pass-through of higher key ECB interest rates to lending rates has been limited in Malta thus far and credit growth remains strong, although lending rates to firms have started to pick up. The continuously strong credit growth in mortgage lending is increasing the concentration in the banks’ loan portfolio to the property market. DBRS Morningstar views Malta's macroprudential framework, including its borrower-based measures and the recent introduction of a sectoral systemic risk buffer, as positive, as they should help limit credit to vulnerable borrowers and prevent further accumulation of cyclical and concentration risks, especially linked to the residential property market.
Malta’s significant progress and political commitment to maintaining high standards for AML/CFT in recent years have permitted the country to exit from FATF’s grey list after one year in June 2022. DBRS Morningstar views a continuation of these efforts and commitments as key to limit the reputational impact on banking activities in Malta. Malta’s role as a small financial hub has resulted in the development of a large banking system relative to its domestic economy, including international banks, and domestic noncore banks have few or no linkages to the domestic economy. DBRS Morningstar made a negative qualitative adjustment to the Monetary Policy and Financial Stability building block to reflect its view on Malta’s relative positioning compared with other larger and more sophisticated financial systems in this building block.
The Current Account Position Deteriorated but Overall External Position Remains Sound
Malta’s external accounts are sound. Malta’s current account surplus averaged 4.8% of GDP between 2014 and 2019, with net exports of services (including travel, financial, professional, and gaming) more than offsetting the large deficit in goods and sizable primary income net outflows. The current account surplus narrowed in 2020 and 2021 before shifting to a 3.0% of GDP deficit in 2022. While the travel services balance has recovered strongly since the pandemic slump, one-off investments in the aviation sector both in 2021 and 2022 and swelling energy prices in 2022 have been a drag on the goods balance. DBRS Morningstar notes that large cross-border trade and income flows related to special purpose entities and multinationals, in addition to sizable statistical revisions, could complicate the assessment of current account flows. The CBM expects the current account to swing back to a surplus this year due to base effects related to investment, strong tourism, and lower energy prices, and to stay in the positive territory for 2024 and 2025. From a stock perspective, Malta’s net international investment asset position stood at 76.4% of GDP as of Q2 2023. Gross external indebtedness was high at 1010.3% of GDP as of Q2 2023, but DBRS Morningstar considers the risks to the domestic economy to be limited because this level mainly reflects Malta’s role as an international financial centre and the presence of stable flows of intercompany lending.
Malta Benefits from a Stable Policy Environment but There Is Scope to Strengthen Governance
Malta benefits from a strong national and overarching European policy framework, which has underpinned the country’s economic and public finance improvement since joining the EU. The Worldwide Governance Indicators for Malta are relatively strong and broadly in line with EU averages but compares weakly in terms of Control of Corruption. Malta has made significant progress in improving its governance and institutional framework in recent years, including implementing reforms to the justice system. However, DBRS Morningstar considers there is room for further convergence toward other sovereigns with very strong assessments on the Political Environment building block, including more tangible evidence of enhanced efficiency, and effectiveness in the country’s judiciary and control of corruption. DBRS Morningstar expects Prime Minister Robert Abela (Labour Party) to pursue broad policy continuity and remain committed to improving the country’s institutional and governance framework during the current legislature.