DBRS Ratings GmbH (Morningstar DBRS) confirmed the Republic of Malta’s (Malta) Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, Morningstar DBRS confirmed Malta’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The trend on all ratings is Stable.
In a statement issued late Friday, the credit rating agency however pointed out Malta’s increased deficit and debt, and is weak on the control of corruption.
KEY CREDIT RATING CONSIDERATIONS
The Stable trend reflects Morningstar DBRS' view that the risks to Malta’s credit ratings remain balanced. Malta’s economy has recovered strongly from the pandemic. Real GDP increased by 18.0% between 2019 and 2023, compared to an increase of just 3.3% for the Euro area, driven by a rebound in tourism and strong growth in other important service industries such as professional services, information and communication (ICT), gambling and trade. On the expenditure side, private consumption was bolstered by high inflows of foreign workers and large fiscal support measures which cushioned the impact of inflation on households’ purchasing power. While the economy is exposed to downside risks such as an escalation of geopolitical tensions, the general growth outlook is favourable. The Central Bank of Malta (CBM) forecasts real GDP to expand by a still strong 4.4% in 2024 and by 3.6% in 2025.
Although the strong economic recovery bolstered government revenues, fiscal performance has deteriorated markedly in recent years on the back of still sizeable fiscal support measures. The IMF estimates the general government budget deficit at 4.8% of GDP in 2023, reflecting the fiscal cost of freezing energy prices at pre-crisis levels and budgetary support measures for the restructuring of Air Malta. Looking ahead, the government plans to reduce the budget deficit gradually to 4.0% of GDP in 2025 and to 3.5% in 2026. Moreover, the projected narrowing of budget deficits is not based on a clear exit strategy for the untargeted energy subsidies but rather on the government’s expectation that a decrease in global energy prices will reduce the fiscal cost of subsidies. Therefore, higher-than-expected energy prices constitute a downside risk for public finances.
Malta’s A (high) rating is supported by its Euro area membership, solid external position, and the banking sector’s strong capital buffers. Moreover, although public debt has increased in recent years, it is still moderate and compares favourably with most other Euro area countries. On the other hand, the small and open nature of the Maltese economy renders it vulnerable to external shocks. Furthermore, labour productivity levels are still comparatively low. In terms of governance, Morningstar DBRS views a further strong commitment by authorities to improve the Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) framework as crucial for protecting the international reputation of the banking sector.
CREDIT RATING DRIVERS
Morningstar DBRS 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. Morningstar DBRS 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
Economic Growth Has Started to Ease but Remains Comparatively Strong
Economic growth decelerated moderately over the past year but remained much stronger than in most other Euro area countries. Real GDP expanded by 5.6% in 2023, down from 8.1% in 2022, but remained strong compared to a growth rate of just 0.4% for the Euro area in 2023. The largest growth drivers over the past year were professional and financial services. Growth dynamics in other service industries such as transportation, hotels and restaurants and ICT moderated, albeit to a still strong pace of growth. On the expenditure side, growth was driven by rising net exports particularly for services. Furthermore, private consumption continued to expand at a robust pace, aided by strong labour markets and large energy subsidies. According to the statistical office’s Labour Force Survey, total employment rose by a robust 3.4% year-on-year in Q4 2023, driven by rising levels of foreign workers. Overall, labour markets remain tight with the (harmonized) unemployment rate standing at 3.2% in February 2024.
Looking ahead, the CBM forecasts a continued easing of real GDP growth to an, albeit still strong, 4.4% in 2024 and to 3.6% in 2025 as growth dynamics both for private consumption and for service sector exports are projected to moderate. While the growth outlook is favourable, the economy is exposed to downside risks such as an escalation of geopolitical tensions which might weigh on external demand for Maltese exports. In general, the ratings of Malta continue to be constrained by the small size of its service-driven economy, which renders it vulnerable to external shocks. Furthermore, while the inflow of European funds is projected to bolster growth prospects, infrastructure bottlenecks and still comparatively low labour productivity levels are likely to constrain potential growth. According to Eurostat, the level of nominal GDP per person employed in Malta amounted to 91.7% of the EU27 average in 2023.
The Government Budget Deficit is Large and Planned to be Reduced Gradually
While economic activity recovered strongly from the COVID-19 shock, Malta’s fiscal performance has deteriorated significantly in recent years on the back of large support measures to households and companies during the pandemic and the energy price shock. The IMF estimates the general government budget deficit in 2023 at 4.8% of GDP, down from 5.6% in 2022, compared to an average general government budget surplus of 1.2% of GDP between 2018 and 2019. The narrowing of the budget deficit in 2023 resulted mainly from the phase-out of most COVID-19 support measures and lower global energy prices which lowered the fiscal cost of energy subsidies. The IMF estimates the fiscal cost of energy subsidies at 1.4% of GDP in 2023, down from 2.6% in 2022. At the same time, fiscal accounts in 2023 were adversely affected by support measures for Air Malta’s restructuring to the amount of 0.5% of GDP.
Looking ahead, the government plans to reduce its budget deficit over the next years gradually. The government’s draft budget 2024 forecasts the general government budget deficit at 4.5% of GDP in 2024, 4.0% in 2025 and 3.5% in 2026, thereby limiting the scope of fiscal adjustment efforts to the minimum required by EU fiscal rules. Planned fiscal adjustment is aided by the phase-out of budgetary support measures to Air Malta in 2024 and a projected gradual decrease of energy subsidies over the next few years. In terms of the latter, however, Morningstar DBRS notes that the decrease does not result from a gradual exit from the untargeted energy subsidies but rather from the government’s expectation that global energy prices will decrease gradually over the next few years. As a result, higher-than-expected energy prices constitute an important downside risk for fiscal accounts. Furthermore, 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 corrective measures to fill the gap. These three factors account for Morningstar DBRS’ negative qualitative adjustment of the Fiscal Management and Policy building block assessment.
Public Debt Has Increased over the Past Years But Is Still Moderate
The large fiscal deficits in recent years led to a marked increase in general government gross debt from 40.0% of GDP in December 2019 to 49.6% in September 2023. The latter debt level, however, still compares favourably with levels in most other EU countries and continues to provide the government with valuable space to support the economy if under stress. Looking ahead, a stabilisation or a decrease in the debt ratio would require a step-up in fiscal consolidation measures. Based on the government’s current medium-term budgetary plan, the IMF forecasts Malta’s public debt to increase by around five percentage points of GDP between 2023 and 2026 on the back of still sizeable primary deficits. In terms of financing, the government benefits from stable funding sources. According to Eurostat, around 78% of outstanding general government debt in 2022 was held by residents. The weighted average maturity of central government debt stood at 7.6 years in March 2024 which, in turn, helps to attenuate the pass-through of higher government borrowing costs on future interest payments. The IMF forecasts the government’s interest burden to rise to 1.6% of GDP in 2025 from 1.1% in 2023.
Domestic Banks Have Strong Capital Buffers But Are Exposed to Concentration Risks from The Housing Market
Financial stability in Malta is supported by strong capital and ample liquidity buffers of domestic banks. Furthermore, banks’ profitability was boosted by higher net interest income last year but is likely to moderate over the next years. Asset quality metrics have improved moderately, supported by policy measures and the strong post-pandemic economic recovery which helped to contain the impact from successive shocks on asset quality. The average NPL ratio of core domestic banks stood at 2.5% in December 2023, down from 3.2% in December 2019. Looking ahead, pockets of vulnerability for asset quality might arise from banks’ sizeable loan exposure to the housing market, a large part of which relates to residential real estate. Loans related to housing purchases or other real estate activities accounted for a large 65% of total resident bank loans to the private sector in February 2024.
While cross-country comparisons of residential property price indicators such as the ESRB’s Risk Dashboard point to comparatively low signs of overvaluation in Malta, price growth in the residential real estate market has started to accelerate moderately over the past two years, driven by strong mortgage loan growth and high inflows of foreigners which bolstered housing demand. In view of the recent acceleration of property price growth and banks’ concentration risks towards the real estate sector, Morningstar DBRS regards the recent introduction of a sectoral systemic risk buffer for residential mortgages as a positive development. While most mortgages in Malta have a variable rate, the pass-through of higher policy rates to domestic mortgage rates has so far been very modest. The average interest rate on outstanding mortgage loans stood at 3.1% in February 2024, compared to 2.8% two years earlier.
In terms of the international reputation of the banking sector, Morningstar DBRS views a further strong commitment by authorities to improve the AML/CFT framework as crucial. Malta’s significant progress on this front permitted the country to exit from the grey list of the Financial Action Task Force (FATF) in June 2022, just one year after being added to the list of jurisdictions under enhanced monitoring. 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 which have few or no linkages to the domestic economy. Morningstar DBRS applies a negative qualitative adjustment to the Monetary Policy and Financial Stability building block assessment to reflect its view on Malta’s relative positioning compared with other larger and more sophisticated financial systems in this building block.
External Finances Benefitted From a Lower Energy Import Bill and Rising Tourism Service Exports in 2023
Malta’s current account balance improved over the past year as it turned from a deficit of 3.9% of GDP in 2022 into a surplus of 0.9% in 2023. This improvement resulted from a marked narrowing in the trade balance deficit from 18.2% of GDP in 2022 to 13.0% in 2023 on the back of a lower energy import bill and a drop in aircraft imports. The surplus in the services balance remained large at 29.2% of GDP in 2023, bolstered by rising tourism service exports, which helped to offset the chronic deficits both in the trade balance and the primary income balance. The chronic deficit in the primary balance which amounted to 13.6% of GDP in 2023, can primarily be attributed to high dividend payments by special purpose vehicles and multinational companies operating in Malta. Looking ahead, the CBM forecasts the current account balance to stay in positive territory with a surplus of 2.2% of GDP in 2024 and of 2.1% in 2025. The economy’s international investment position (IIP) is heavily influenced by very large stocks of gross external assets and liabilities of special purpose entities and multinational companies. Total gross external assets and liabilities of residents in December 2023 exceed the economy’s nominal GDP by factors of 39 and 38, respectively. On a net basis, the economy has maintained a large external creditor position over the past decade. Recently revised figures from the national statistical office show a NIIP of around 74% of GDP in December 2023. High gross external debt of 1,036% of GDP in December 2023 mainly reflects Malta’s role as an international financial centre and the presence of very large levels of intercompany lending. Therefore, Morningstar DBRS considers its risk to the domestic economy to be limited.
Malta Benefits from a Stable Policy Environment but There Is Scope to Strengthen Governance
Malta’s institutional quality benefits from strong national and EU policy frameworks. The Worldwide Governance Indicators for Malta are relatively strong and broadly in line with EU averages but compare weakly in terms of control of corruption. Malta has made significant progress in improving its governance and its institutional framework in recent years, including implementing reforms to the justice system. However, Morningstar DBRS considers that 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. Policy continuity is high and Morningstar DBRS expects Prime Minister Robert Abela (Labour Party) to remain committed to improving the country’s institutional and governance framework during the current legislature.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Social (S) Factors
The Human Capital and Human Rights factor significantly affects Malta’s credit ratings. In comparison to other Euro area countries, Malta’s GDP per capita is relatively low at USD 38,715 in 2023 in part due to its lower labour productivity. Respect for human rights is high, and there is widespread access to quality healthcare and other basic services. Malta ranks 27th among the 170 countries assessed in the 2024 Social Progress Index.
Governance (G) Factors
The Institutional Strength, Governance and Transparency factor significantly affects Malta’s credit ratings. The country ranks broadly in line with the EU average in the Worldwide Governance Indicators for Voice and Accountability (83.6 percentile rank), Rule of Law (76.4 percentile rank), and Government Effectiveness (76.9 percentile rank), but compares weakly in terms of Control of Corruption (61.8 percentile rank). Furthermore, Malta’s ranking for Control of Corruption, Rule of Law, and Regulatory Quality have been deteriorating in recent years. While the EC commended Malta for its progress on reforms, the EC also noted that there is room for further improvement in the government’s efforts to strengthen the judiciary’s independence and to ensure effective criminal prosecution.
There were no Environmental (E) factors that had a significant or relevant effect on the credit analysis.