Fitch Ratings – Frankfurt am Main – 24 Mar 2023: Fitch Ratings has affirmed Malta's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'A+' with a Stable Outlook.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
Ratings Strengths and Weaknesses: Malta's rating is supported by high per-capita income and a pre-pandemic record of strong growth and sizeable debt reduction. These strengths are balanced against its large banking sector, the small size of its economy, which is highly vulnerable to external developments, and a recent deterioration in public finances with large fiscal deficits, which have led to a sharp increase in the moderate public debt burden.
Growth Moderates Following 2022 Expansion: The Maltese economy continued to expand rapidly at 6.9% in real terms in 2022, outperforming the rest of the EU (when excluding the inflated Irish GDP figures). The main contribution to growth came from investments which were however heavily impacted by the acquisition of imported aircraft equipment. Private consumption remained sound in 2022, supported by the accumulation of past savings and favourable labour market conditions while inflation levels remained relatively contained relative to other EU countries.
Online gaming, information and technology (ICT) and professional services were key sectors driving growth while construction contracted quite sharply. Recovery in the tourism sector continued narrowing the gap of tourist arrivals relative to 2019 to around 17% in 2022.
We forecast growth to slow to 3.5% in 2023, due to the projected economic slowdown in Malta's main trading partners and as evidenced by a moderation in economic indicators. Growth will be close to potential in 2024, reaching 3.7%. The lifting of international travel restrictions has helped support the return of foreign workers, further uplifting domestic consumption and potential growth while somewhat easing structural labour supply shortages, Unemployment reached a new record low of 2.9% in 2022 well below the pre-pandemic rate of 3.6% in 2019.
Import Prices Drive Inflation: HICP inflation averaged 6.1% in 2022, below the eurozone average of 8.4%. in 2022, as energy prices were frozen by the authorities. Headline inflation reached 7.0% in February, driven by continued high core inflation of 6.3%. As a small and open island economy, a large portion of core inflation is imported and Malta has been disproportionally affected by higher food and construction prices.
The government remains committed to limiting the increase in electricity and fuel prices, implying that we expect a zero contribution from energy prices to inflation throughout the projection horizon. We project that inflation will somewhat moderate to 4.9% in 2023 as food prices normalise and international price pressures abate but wage inflation picks up with a lag.
Subsidies Weigh on Fiscal Balance: Fitch estimates that Malta's fiscal deficit narrowed to 5.8% of GDP in 2022 from 7.5% in 2021. While sizeable energy and food subsidies weighed on the budget balance year, these were offset by the government's ad-hoc spending review during the summer and the continued phasing out of Covid-19 expenditure. We now project that the 2023 deficit will reach 5.4% of GDP, close to the government's budget target of 5.5% but exceeding the 'A' median of 4.1%.
The 2023 budget's key priority is to keep inflation under control and a total of EUR605 million (3.4% of forecasted GDP) are budgeted for this purpose. The government lacks a clear exit strategy from the current fixed price policy, creating fiscal risks around the future cost of energy subsidies as these are closely tied to the development of international energy prices (especially to fluctuations in Brent oil prices).
Fiscal Uncertainties: The European Commission has yet to approve the bailout package for state-owned airline Air Malta and the timing and total cost of any state aid to the airline remains unknown, although some restructuring costs are already priced into the budget at close to 0.4% of GDP for 2022/23. Moreover, the European Commission has referred Malta to the European Court of Justice due to concerns over its Citizenship by Direct Investment Programme, which could result in a revenue loss between 0.3% and 0.4% of GDP annually.
Public Debt Peaking Below 60%: Malta has seen one of the largest increases in public debt since 2019 among 'A' rated peers, with debt increasing by around 15pp since 2019, reaching an estimated 55.3% of GDP by end-2022. We expect that total general government debt will peak at slightly below 60% in 2024, in line with the government's goal to keep the public debt burden close to 60% of GDP.
A relatively high potential growth rate between 3-4% will help support debt reduction in the medium to long term, even in the absence of large expenditure cuts or tax hikes. Risks from higher interest rates and a phasing out of the ECB's quantitative easing are mitigated by a long average maturity of marketable debt and a strong domestic investor base.
Sound Banking Sector: Fitch sees no immediate risks to the Maltese banking sector from the recent international banking turmoil. Liquidity levels in the banking sector are exceptionally strong, with Malta reporting the largest liquidity coverage ratio among EU countries as of 3Q22 (391% according to EBA data).
The pace of monetary transmission in Malta has also been slower compared with other eurozone economies and Maltese banks have only recently started to pass on higher ECB interest rates to depositors and borrowers. Concerns over Malta's anti-money-laundering framework have somewhat abated, following the Financial Action Task Force's (FATF) decision in June 2022 to remove Malta from its so-called greylist.
Deteriorating Current Account Balance: Malta's current account balance turned into a deficit of 5.8% of GDP in 2022, from a surplus of 1.2% in 2021. The deterioration was the result of a sharp widening of the merchandise trade deficit amid higher energy prices and the import of aircraft equipment. This was only partially offset by a strengthening of the services balance as tourism receipts recovered and a continued strong performance in the export of online gaming and ICT services.
We forecast that the current account deficit will narrow again to 3.8% of GDP this year as we currently do not expect that last year's import of aircraft will be repeated this year while the tourism sector further recovers from the pandemic shock. Additionally, the primary income balance will remain deeply negative over the forecast horizon and is heavily influenced by the investment activities of multinational companies. Malta is a large net external creditor compared with the rest of the world, but hosts a large number of special-purpose entities and multinationals in financial and insurance activities, distorting the international accounts.
ESG – Governance: Malta has an ESG Relevance Score (RS) of '5[+]' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Malta has a high WBGI ranking at 77.2, reflecting its long track record of stable and peaceful political transitions, well established rights for participation in the political process, strong institutional capacity, effective rule of law and a low level of corruption.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Public Finances: Continued upward trend in general government debt, for example, due to a more prolonged period of energy related subsidies, weaker growth prospects or loss of key sources of revenues.
– Structural Features: Further deterioration in governance or banking supervision or concerns over wider financial sector transparency that could adversely impact Malta's attractiveness as an investment destination.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– Public Finances: General government debt/GDP returning to a firm downward path over the medium term, for example due to sustained economic growth and/or fiscal consolidation.
– Structural Features: Further progress in addressing key weaknesses in governance, banking supervision and the business environment.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Malta a score equivalent to a rating of 'A' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:
– Macro: +1 notch reflecting macroeconomic performance, policies and prospects. The positive notch adjustment offsets the deterioration in the SRM output driven by volatility from the pandemic shock, including on GDP growth. The deterioration of the GDP growth volatility variable reflects a very substantial and unprecedented exogenous shock that has hit the vast majority of sovereigns, and Fitch believes that Malta has the capacity to absorb it without lasting effects on its long-term macroeconomic stability.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
Malta has an ESG Relevance Score of '5[+]' for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Malta has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
Malta has an ESG Relevance Score of '5[+]' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Malta has a percentile rank above 50 for the respective Governance Indicators, this has a positive impact on the credit profile.
Malta has an ESG Relevance Score of '4[+]'for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As Malta has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.
Malta has an ESG Relevance Score of '4[+]' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Malta, as for all sovereigns. As Malta has track record of 20+ years without a restructuring of public debt and captured in our SRM variable, this has a positive impact on the credit profile.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
Source: Fitch Ratings
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