DBRS Ratings GmbH (DBRS) confirmed the Republic of Malta's Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, DBRS 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
Economic momentum remains strong, with gross domestic product (GDP) growth accelerating to 7.5% year over year (yoy) in Q3 2018. The Central Bank of Malta's (CBM) latest estimates point to full year growth at 5.9% in 2018. DBRS expects GDP growth to decelerate gradually but to remain high in years to come, especially when compared with its European peers. Benefiting from tax-rich economic growth, fuelled by domestic demand, strong job creation, and the impulse from its International Investment Programme (IIP), the CBM estimates Malta's fiscal surplus stood at 2.1% of GDP in 2018. Against this backdrop, the Maltese government's debt-to-GDP ratio could drop to 45.0% in 2018, according to the CBM. DBRS expects the debt ratio to continue to decline related to the primary surplus and the favourable debt snowball effect.
The rating confirmation reflects DBRS's view that despite the upward pressure from improving economic and public finance metrics, Malta's structural challenges continue to constrain the ratings. Given the size and openness of the economy, external developments, including international corporate taxation or regulatory changes, could negatively affect economic and fiscal variables.
Malta's A (high) rating is supported by its euro zone membership, strong external position, low reliance on external financing, favourable public debt structure, and households' strong financial position. However, Malta's contingent liabilities, stemming from its large state-owned enterprises and concentrated financial sector, and rising age-related costs are potential sources of vulnerability for public finances. Malta's small and open economy 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) further evidence of increased economic and fiscal resiliency to external shocks, including changes to the international tax or regulatory environment. 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) sustained worsening of fiscal and debt indicators, 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 7.2% annual average GDP growth from 2013 to 2017, well above the 2.1% average rate between 2004 and 2012. In this context, Malta's GDP per capita (EUR 24,984) continued to converge to EU average levels (EUR 30,946) in 2018, as per EC estimates. Growth has been broad-based with outward-facing sectors such as tourism, gaming, financial and business services being key contributors to Malta's outperformance. A highly elastic foreign labour supply, increased labour participation rates, and a rising share of less capital-intensive service sectors have prevented overheating pressures. According to EC estimates, potential GDP growth jumped from 2.5% from 2004 to 2012 to 6.0% from 2013 to 2018.
The International Monetary Fund's projects an annual average GDP growth rate of 3.8% between 2019 and 2022. Strong domestic demand, as well as supply factors, will continue to support growth in Malta. Higher investment, increased labour supply, and enduring benefits from the energy reform will continue to buttress potential output. 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. On the other hand, the private and public-sector reliance on domestic funding reduces the risks from financial markets contagion. In the short term, major risks stem from an escalation of protectionist trade measures hurting global trade and growth as well as the impact on tourism from Brexit. In the medium term, changes in international corporate taxation could to some degree diminish the attractiveness of Malta for multinational companies. Also, 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
Malta's public finances have improved significantly in the past five years, allowing the country to be fully compliant with the EU's Stability and Growth Pact. The proceeds from the IIP, introduced in 2014, and Malta's outstanding economic performance played a crucial role in strengthening its fiscal accounts in conjunction with the government fiscal consolidation efforts and lower funding costs. The general government budget, which recorded an average deficit of 4.0% between 2001 and 2012, has been roughly balanced on average between 2013 and 2017. Since 2016, Malta has registered budgetary surpluses, both in nominal and structural terms. The budget surplus rose to 3.5% of GDP in 2017, well above the official target, because of substantially higher than expected revenues from the IIP as well stronger growth. In 2018, the CBM estimates the headline fiscal surplus dropped to 2.1%, driven by lower IIP revenues and a step up in investment spending - including a one-off capital transfer to Air Malta.
Going forward, both the Ministry of Finance and Central Bank of Malta project budgetary surpluses exceeding 1% of GDP at least until 2021. Given the difficulty in predicting the IIP proceeds, DBRS considers the authorities' intention to comply with the government's Medium-Term Objective, net of the IIP, to be appropriate. Despite Air Malta progress on its restructuring plan, strong airline sector competition could put further pressure on the company's financial position. In the medium term, changes to corporate taxation at an international level could have an adverse 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 fiscal surplus and low debt ratio provide a buffer to face adverse shocks and mitigate the risks from an ageing population. Malta's debt-to-GDP ratio, which is one of the lowest in the EU, continues on a steep downward trend. The debt ratio stood at 50.2% in 2017 following a substantial drop of around 20 percentage points during the previous six years. The CBM projects this to continue falling rapidly to 34.9% by 2021. 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 9.0% of GDP in Q3 2018.
Conservative Core Banks and Strong Households Limit Financial Stability Risks
The Maltese financial system remains sound, underpinned by its conservative core banks' healthy levels of capitalisation, liquidity and profitability. Core domestic banks, with assets of 198.3% of GDP in Q3 2018, mostly follow a traditional business model based on retail deposits for funding. High levels of liquidity and a healthy Tier 1 capital to risk-weighted assets ratio (14.8% in Q3 2018) enhances core banks' ability to weather adversity. Profitability remains good, although challenged by the low interest rate environment. Non-performing loans, mainly legacy loans concentrated in the construction and real estate sector, continue to decline driven by a stronger economy, buoyant housing market and tighter regulatory requirements. As of Q3 2018, the NPL ratio for core-banks dropped to 3.78% compared with 9.39% reached in Q2 2014.
On the other hand, the core domestic banks' loan portfolio is concentrated in property market-related activities. While pressures are mounting in the housing market, strong demand has largely been driven by fundamental factors such as rising disposable income, substantial net migration and low interest rates. DBRS does not see any immediate risks given favourable labour market conditions and an increasingly responsive housing supply. This view is reinforced by Maltese 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. Furthermore, the planned introduction of new borrower-based macroprudential measures during this year will broaden the toolkit to counter mounting pressures in the housing market, especially in the buy-to-let segment.
The so-called international banks, with assets of 165.3% of GDP, and domestic non-core banks, with assets of 21.9% of GDP, have limited or no linkages to the domestic economy. Therefore, potential spill-overs to the rest of the system are contained. The main risk from the international banks is reputational. Based on a national risk assessment, the government is following a strategic action plan to enhance the anti-money laundering and countering the financing of terrorism (AML/CFT), including the creation national coordinating mechanisms, and increase resources in this area. The implementation of the strategic initiatives is envisaged to be completed by 2020.
Malta's External Position Remains Strong
Malta's external position continues to strengthen led by fast-growing service sector exports. On the back of a sizable services trade surplus, the current account surplus reached 10.4% of GDP in 2017. The marked improvement in the external accounts since 2009 can be mostly explained by structural factors, such as improving energy intensity, lower import content, the increasing role of the gaming industry, as well as the expansion of sectors such as aviation. Going forward, Malta's current account surplus is expected to remain sizable. In this context, Malta has built up a large positive net international investment position of 62.3% of GDP by Q3 2018. 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.
Stable Institutional Framework to Support Policy Continuity
Malta has relatively sound public institutions. The dominance of centrist parties, like the ruling Labour Party and the Nationalist Party, and adoption of European procedures has resulted in stable macroeconomic, fiscal and monetary policy framework, and a high degree of policy continuity. In the recent past, Malta has been facing greater scrutiny over allegations of corruption, rule of law, and accountability. In response, the government has implemented several measures to reinforce governance, including measures to curtail corrupt practices and a comprehensive action plan to improve enforcement and effectiveness of its AML/CFT framework. Moreover, the government is working on a plan to improve the separation of powers and the independence of the judiciary.
RATING COMMITTEE SUMMARY
The DBRS Sovereign Scorecard generates a result in the AAA – AA 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, financial system, housing market developments, external position, and the political environment.
Fiscal Balance (% GDP): 3.5 (2017); 2.1 (2018E); 1.6
Gross Debt (% GDP): 50.2 (2017); 45.0 (2018E); 41.5 (2019F)
Nominal GDP (EUR billions): 11.3 (2017); 12.2 (2018E); 13.1 (2019F)
GDP per Capita (EUR): 23,777.4 (2017); 24,984.3 (2018E); 26,350.5 (2019F)
Real GDP growth (%): 6.6 (2017); 5.9 (2018E); 4.8 (2019F)
Consumer Price Inflation (%): 1.4 (2017); 1.2 (2018E); 1.7 (2019F)
Domestic Credit (% GDP): 284.2 (2017); 284.5 (Sep-2018)
Current Account (% GDP): 10.4 (2017); 10.2 (2018E); 9.2 (2019F)
International Investment Position (% GDP): 66.2 (2017); 62.3 (Sep-2018)
Gross External Debt (% GDP): 822.3 (2017); 772.1 (Sep-2018)
Governance Indicator (percentile rank): 80.8 (2017)
Human Development Index: 0.88 (2017)
EURO AREA RISK CATEGORY: LOW
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Date Issued Debt Rated Action Rating Trend Issued
15-Feb-19 Long-Term Foreign Currency - Issuer Rating Confirmed A (high) Stb EU
15-Feb-19 Long-Term Local Currency - Issuer Rating Confirmed A (high) Stb EU
15-Feb-19 Short-Term Foreign Currency - Issuer Rating Confirmed R-1 (middle) Stb EU
15-Feb-19 Short-Term Local Currency - Issuer Rating Confirmed R-1 (middle) Stb EU
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