DBRS Ratings Limited (DBRS) confirmed the Republic of Malta’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high) and its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (middle). The trend on all ratings is Stable.
KEY RATING CONSIDERATIONS
The Maltese economy remains one of the euro area’s top growth performers, with economic growth accelerating to 6.4% in 2017. Albeit remaining strong, DBRS expects economic activity to decelerate gradually, with downside risks mostly stemming from the external sector. Benefitting from strong citizenship scheme (Individual Investors Programme or IIP) proceeds and tax-rich economic growth, the fiscal surplus reached 3.9% of GDP in 2017, surpassing its target. Against this backdrop, the government debt-to-GDP ratio dropped 5.5 percentage points to 50.7% of GDP. DBRS expects the debt ratio to continue declining related to the primary surplus and the favourable debt snowball effect.
Malta’s A (high) rating is supported by its Eurozone membership, strong external position and low reliance on external financing, favourable public debt structure, and households’ strong financial position. Notwithstanding these credit strengths, Malta faces some challenges. Malta’s contingent liabilities, stemming from its large state-owned enterprises and concentrated financial sector, and rising age-related costs are sources of vulnerability for public finances.
Malta’s small and open economy, with some sectors highly dependent on foreign demand, such as tourism, exposes the country to external developments.
The Stable trend reflects DBRS’s opinion that further upgrades are unlikely in the absence of: (1) a sustained material reduction in the public debt ratio to low levels driven by sound fiscal management and economic performance; or (2) a significant increase in Malta’s income per capita levels, fully converging to the European Union (EU) average. 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, (2) a relaxation of fiscal discipline, or (3) the materialisation of contingent liabilities.
Malta Continues to Outperform EU Average Growth Rates with Broad-based Expansion
Recent economic performance has been remarkable, with 6.8% annual average GDP growth during 2013-2017, well above the 2.1% average rate in 2004-2012. Growth has been broad-based with outward-facing sectors such as tourism, gaming, financial and business services as key contributors to Malta’s outperformance. A highly elastic foreign labour supply and a rising share of less capital-intensive service sectors have prevented overheating pressures. A steady increase in the labour supply, led by net migration flows and increased participation, and productivity gains, underpinned the increase in potential GDP growth to 6.1% in 2013-2017 from 2.5% in 2004-2012, according to the European Commission. Malta’s GDP per capita, EUR 23,900 in 2017, continues to converge to EU average levels of EUR 29,900.
Medium-term growth prospects remain solid despite some risks. The IMF’s GDP growth projections point to an annual average rate of 4.8% between 2018 and 2020, and to gradually converge to its long-term growth potential of above 3%. Addressing emerging infrastructure bottlenecks and labour shortages in certain sectors, which could weigh increasingly on growth, will remain a challenge. Malta’s open economy is the smallest in the euro area and is vulnerable to weak external demand and lower foreign direct investment. Major risks stem from an escalation of protectionist trade measures hurting global trade and growth as well as the impact on tourism from Brexit. On the other hand, the private and public-sector reliance on domestic funding reduces the risks from financial markets contagion. In the longer term, corporate tax reforms at the EU level and in the US could to some degree diminish the attractiveness of Malta for multinational companies. The gaming industry in Malta could also be affected by regulatory changes at the EU level.
Budgetary Surpluses and Steadily Declining Public Debt Ratio Mitigate Contingent Liability Risks
Since 2013, Malta has experienced a significant improvement in its fiscal performance driven by: (1) fiscal consolidation efforts, (2) markedly higher GDP growth, (3) lower funding costs, (4) introduction of the IIP. The general government deficit averaged 1.1% a year during 2013-2016, compared with 4.0% during 2001-2012. Benefitting from higher than-expected-revenues from the citizenship scheme, a tax-rich economic expansion, and lower spending, the general government fiscal surplus reached 3.9% of GDP in 2017, surpassing its 0.8% budget target.
Proceeds from the IIP stepped up to 2.6% of GDP in 2017 from 1.7% in 2016. The structural balance, which turned positive in 2016, stood at 3.6% of potential GDP according to government estimates. In 2018, the headline fiscal surplus is expected to drop to 1.1% as the decline in expenditure relative to GDP will be more than offset by a drop in the revenue ratio, partly explained by base-effects from the citizenship scheme revenues.
In 2018-2021, the government aims to maintain an annual average headline surplus of 1% of GDP and a structural surplus. Malta’s Fiscal Advisory Council has endorsed the prudent macroeconomic forecasts. Given the difficulty in predicting the IIP proceeds, DBRS considers appropriate the authorities’ intention to comply with the government’s Medium-Term Objective, net of the IIP. In the medium term, changes to corporate taxation at an international level could have a disproportionate impact on Malta, given its reliance on corporate taxation. Age-related costs are also expected to increase rapidly and may require additional measures to improve long-term sustainability of the healthcare and pension system.
Malta’s government debt-to-GDP ratio is on a downward trend. After peaking at 70.1% of GDP in 2011, the debt ratio declined to 50.7% in 2017. Malta’s debt ratio is one of the lowest in the EU and the government projects it to fall to 35.6% by 2021. Although less optimistic relative to the pace, the IMF, European Commission and Central Bank of Malta all estimate the debt ratio to continue to decline steadily. Debt is predominantly in euros and the weighted-average maturity is lengthy at around nine years. The government relies heavily on a domestic investor base. While DBRS considers that the favourable debt profile significantly reduces refinancing and exchange rate risks, Malta’s debt stock remains vulnerable to contingent liability shocks. The central government’s outstanding guarantees remain high at an estimated 9.6% of GDP in 2017, albeit declining from 13.7% in 2016.
Conservative Core Banks and Strong Households Limit Financial Stability Risks
While the banking system is large relative to the size of the economy at 405.6% of GDP, only the core and non-core domestic banks, with assets of 205.3% and 19.6% of GDP, respectively, are linked to the Maltese economy. The loan portfolios of Malta’s core domestic banks are concentrated in property market-related activities. However, core domestic banks rely on retail deposits for funding and their healthy Tier 1 capital ratio of 15.2% in Q1 2018, high levels of liquidity, and good levels of profitability support the banks’ ability to weather adversity. Non-performing loans, mainly legacy ones concentrated in the real estate development sector, have declined to 4.0% of total loans in Q1 2018 amid economic buoyancy, stronger housing market, and tighter regulatory requirements.
House prices continue to grow strongly, with transaction-based prices rising 5.2% and advertised-based 13.6% in Q1 2018, following an average increase of 4.8% and 9.1%, respectively, during 2014-2017. Strong demand is fuelling house price inflation, driven by low interest rates, government tax incentives, rising disposable income, net migration and to a lesser extent the citizenship scheme. Although pressure is mounting, DBRS does not see any immediate risks given favourable labour market conditions and increasing housing supply. Moreover, some Maltese features also lessen the risks emanating from the housing market such as: households’ high levels of financial wealth and liquid assets, high levels of home ownership outright, and banks’ conservative lending practices and prudent haircuts on collateral values.
The so-called international banks have limited or no linkages to the domestic economy; therefore, potential spillovers to the rest of the system are contained. The alleged shortfalls in the implementation of the anti-money laundering and countering the financing of terrorism (AML/CFT) EU directive in relation to Pilatus Bank, a small bank with no systemic implications, has raised concerns over reputational risks to the sector. Based on a national risks assessment, the government presented a series of strategic initiatives to be completed by 2020 to enhance the AML/CFT framework, establish national coordinating mechanisms, and increase resources in this area.
Malta’s External Position Remains Strong
Malta’s external position continues to strengthen led by fast-growing service sector exports. The marked improvement in the external accounts since 2009 can be mostly explained by structural factors, such as improving energy intensity, lower import content and the increasing role of the gaming industry. In 2017, the current account surplus reached its highest level in the last three decades, almost doubling to 13.6% of GDP in 2017 from 7.0% in 2016. In this context, Malta has built up a large positive net international investment position (NIIP) of 63.0% of GDP by end-2017. 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. DBRS believes the primary risks from this sector are reputational, and specific vulnerabilities could be difficult to anticipate.
Stable Institutional Framework to Support Policy Continuity
The main parties, the ruling Labour Party and the Nationalist Party, are centrist and supportive of Malta’s Eurozone membership. This has resulted in stable macroeconomic, fiscal and monetary policy institutions, and a high degree of policy continuity. The World Bank Governance Indicators place Malta within the top 25th percentile for its six indicators in its latest ranking (2016), although Malta has been dropping in the Rule of Law ranking since 2007. After calling snap elections in response to allegations of corruption in the government, the Labour Party won an additional term in power in June 2017, ensuring policy continuity in DBRS’s view. Recently, a magisterial inquiry into the allegations concluded there was no evidence of corrupt practices, money laundering or suspect financial transactions. The government is making additional efforts to improve governance and strengthen its institutional framework.
RATING COMMITTEE SUMMARY
The DBRS Sovereign Scorecard generates a result in the AA (high) – AA (low) range. Additional considerations factoring into the Rating Committee decision included: (1) heightened risks to growth and fiscal performance due to the small size of the Maltese economy, and (2) potential risks stemming from regulatory or policy harmonisation changes. The main points discussed during the Rating Committee include Malta’s economic performance and outlook, fiscal and debt metrics, developments in the financial system, and the political environment.
Fiscal Balance (% GDP): 3.9 (2017); 1.1 (2018F); 1.3 (2019F)
Gross Debt (% GDP): 50.7 (2017); 47.1 (2018F); 43.4 (2019F)
Nominal GDP (EUR billions): 11.1 (2017); 12.0 (2018F); 12.9 (2019F)
GDP per Capita (EUR): 23,900 (2017); 25,233.4 (2018F); 26,615.6 (2019F)
Real GDP growth (%): 6.4 (2017); 5.8 (2018F); 5.1 (2019F)
Consumer Price Inflation (%): 1.3 (2017); 1.6 (2018F); 1.8 (2019F)
Domestic Credit (% GDP): 262.1 (2016); 254.4 (2017); 254.2 (Mar-2018)
Current Account (% GDP): 13.6 (2017); 9.9 (2018F); 9.5 (2019F)
International Investment Position (% GDP): 45.2 (2016); 63.0 (2017); 6.0 (Mar-2018)
Gross External Debt (% GDP): 849.3 (2016); 809.2(2017); 784.6 (Mar-2018)
Governance Indicator (percentile rank): 77.4 (2016)
Human Development Index: 0.86 (2015)
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