DBRS Ratings Limited has upgraded the Republic of Malta's Long-Term Foreign and Local Currency – Issuer Ratings to A (high) from A and upgraded its Short-Term Foreign and Local Currency – Issuer Ratings to R-1 (middle) from R-1 (low). The trend on all ratings has been changed to Stable from Positive.
The rating upgrade reflects DBRS's assessment that the trajectory of Malta's public debt has improved considerably. Since DBRS's latest review, the projection of the general government debt ratio has been materially revised downwards due to more favourable growth prospects and stronger primary balances in coming years. The debt-to-GDP ratio is now forecast to decrease to 41.2% of GDP by 2022, almost seven percentage points less than previously anticipated. In 2017, the government is expected to have exceeded its fiscal objective and reduced its debt ratio thanks to stronger-than-expected revenues. Improvements in the "Debt and Liquidity", "Economic Structure and Performance", and "Fiscal Management and Policy" sections of our analysis were the key factors for the rating upgrade.
The rating is supported by Malta's Eurozone membership. This ensures reliable access to European markets, fosters strong and credible macroeconomic policies and makes available financial facilities from European institutions. Malta's strong external position and low reliance on external financing help mitigate the vulnerabilities linked to its small and open economy. The public-sector debt's long average maturity, primarily denominated in euros, and high domestic ownership help shield the debt ratio from interest, currency or financial markets contagion risks. Also, households' strong financial position enhances private consumption resiliency.
Malta nonetheless faces some challenges. Malta's contingent liabilities, stemming from its large state-owned enterprises and concentrated financial sector, remain a source of vulnerability. Malta's small and open economy with some sectors highly dependent on foreign demand, such as tourism, exposes the country to external developments. Pressures from rising age-related costs, if unaddressed, could pose a concern for the pension and healthcare system.
THE MALTESE ECONOMY CONTINUES TO POWER AHEAD
The Maltese economy continues to surprise on the upside and remains one of the top performers in the euro area. Recent economic performance has been remarkable, with 6.4% average GDP growth during 2013-2017 tripling the 2.1% average rate in 2004-2012. While remote gaming was a determining factor, other sectors such as tourism which is a major source of income and employment in Malta and financial and business services also contributed to the outperformance. A highly elastic foreign labour supply and a rising share of less capital-intensive service sectors, have prevented very high growth rates leading to overheating pressures in the economy. DBRS expects GDP to continue to expand at an annual average rate of 5% between 2018 and 2020, and to gradually converge to its long-term growth potential of just above 3%. Increasing labour force participation and addressing emerging infrastructure bottlenecks are expected to help Malta's GDP per capita, at EUR 22,724, to continue to converge to EU average levels of EUR 29,148 both in 2016.
Malta's small and open economy, the smallest in the Euro area, is vulnerable to external oscillations. However, a more diversified economic base and Malta's low reliance on external financing help mitigate these risks. In DBRS's view, downside risks to the outlook largely stem from a downturn in Malta's main export markets and policy uncertainties related to the post-Brexit arrangement and US policymaking. In the longer term, corporate tax reforms at the EU level and in the US, could diminish to some degree the attractiveness of several jurisdictions, including Malta, for multinational companies. Also, the gaming industry in Malta could be impacted by regulatory changes at the EU level. On the domestic side, higher wage increases could put upside pressure on GDP growth, while delays in construction projects or increasing physical bottlenecks could constrain growth.
GROWTH CONTINUES TO SUPPORT PUBLIC FINANCES
Malta has significantly improved its fiscal management and performance. The adoption of the 2014 Fiscal Responsibility Act has been crucial in strengthening its fiscal framework and ongoing spending reviews are helping to improve efficiency in the public sector. 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 citizenship scheme (the International Investor Programme). The general government deficit averaged 1.1% during 2013-2016 compared to 4.0% during 2001-2012. The structural balance turned positive in 2016. Proceeds from the IIP played an important role in the improvement of the structural deficit, contributing 0.5%, 1.7%, and 2.1% of GDP in 2015, 2016, and 2017, respectively.
Related to a buoyant economy and higher than-expected-revenues from the citizenship scheme, the general government is expected to have over-achieved its fiscal targets in 2017. The Central Bank of Malta's (CBM) latest estimates, show the general government balance at 2.1% of GDP in 2017, well above the budget target of 0.8%. In 2018-2020, the government aims to maintain an average headline surplus of 0.5% of GDP and a structural surplus, supported by prudent macroeconomic forecasts endorsed by Malta Fiscal Advisory Council. Given the volatility and the difficulty in predicting the IIP proceeds, DBRS considers appropriate the authorities' intention to ensure compliance with the government's Medium Term Objective (MTO), net of IIP.
Efforts to continue building fiscal buffers will be important to mitigate Malta's medium-term fiscal risks. Firstly, the central government's outstanding guarantees remain high at an estimated 9.7% of GDP in 2017, albeit declining from 14.1% of GDP in 2016. Secondly, age-related costs are expected to increase rapidly and may require additional measures to improve long-term sustainability of the healthcare and pension system. Thirdly, possible changes to international taxation could impact disproportionally Malta, given its higher reliance on corporate taxation (close to 17% of total revenues). Broadening the tax base and reducing tax evasion could mitigate this risk.
Malta's government debt ratio is on a downward trend, driven by primary surpluses and a favourable interest-growth differential. After peaking at 70.1% of GDP in 2011, the debt ratio is estimated to have declined to 53.6% of GDP in 2017. Malta's debt ratio is one the lowest in the EU and is projected to fall to 41.2% of GDP by 2022, according to the IMF. Debt is predominantly in euros and the weighted-average maturity is lengthy at around 9 years. Moreover, the government relies heavily on a domestic investor base. While DBRS considers the favourable debt profile significantly reduces refinancing and exchange rate risks, Malta's debt stock remains vulnerable to growth and contingent liability shocks.
CONSERVATIVE CORE BANKS AND STRONG HOUSEHOLDS LIMIT FINANCIAL STABILITY RISKS
While the banking system is large relative to the size of the economy, 440.7% of GDP in Q2 2017, only the core and non-core domestic banks, with assets 217.8% and 22.2% of GDP, respectively are tightly linked to the Maltese economy. The so-called international banks, with assets of 200.7% of GDP have limited or no linkages to the domestic economy, therefore, potential spillovers to the rest of the system are contained. Core domestic banks' loan portfolio is concentrated in real estate-related activities. However, their conservative business model, reliant on retail deposits for funding, mitigates against risks. Core domestic banks' healthy regulatory Tier 1 capital ratio of 13.4% in Q2 2017, high levels of liquid assets, and still good levels of profitability despite low interest rate levels support the banks' ability to weather adversity. Legacy non-performing loans amounting to 4.6% of total loans in Q2 2017, concentrated in the real estate development sector, have declined due to the buoyant economy, the stronger housing market, and tighter regulatory requirements.
Strong demand, driven by rising disposable income and net migration, is fuelling housing price inflation in Malta. Although residential property prices continue to be roughly in line with fundamentals, a continuation of this trend could lead to significant imbalances. However, there are several factors that may lessen the risks emanating from the housing market such as: (1) high levels of home ownership, (2) households' high financial wealth and liquid assets, and (3) banks' conservative lending practices and prudent haircuts on collateral values. Moreover, the government has eased some of the constraints on the housing supply side to alleviate the pressures.
MALTA'S EXTERNAL POSITION REMAINS STRONG
Malta's external position continues to strengthen led by fast-growing service sector exports. The current account surplus is expected to have widened to 9.6% of GDP in 2017 from 6.6% in 2016, contributing to a large positive net international investment position of 63.1% of GDP in Q3 2017. While the goods balance remains in deficit, the services balance continues to display a large surplus. 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 BUT INCREASED POLITICAL NOISE
Malta's political environment is broadly stable. The main parties, the ruling Labour party (PL) and the Nationalist party (PN), are centrist and supportive of Malta's Eurozone membership, which was adopted in 2008 after joining the EU in 2004. This has resulted in stable macroeconomic, fiscal and monetary policy institutions, more transparency, and in a high degree of policy continuity. The Labour Party won an additional term in power in early elections held in June 2017, and DBRS expects no major policy changes. The government is making additional efforts to improve governance and strengthen its institutional framework. Various ongoing investigations and court proceedings are indicative of the need for further governance improvements, but also of the government's commitment to address past shortcomings.
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 robust economic performance; or (2) a significant increase in Malta's income per capita levels, fully converging to the 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 materialization of contingent liabilities, from state-owned enterprises or the financial sector.
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 of the Rating Committee discussion included the fiscal performance, fiscal framework, government guarantees, debt trajectory, political environment, economic performance and structure, and balance of risks to the economic and fiscal outlook.
- Fiscal Balance (% GDP): 1.1 (2016); 2.1 (2017F); 1.6 (2018F)
- Gross Debt (% GDP): 57.7 (2016); 53.6 (2017F); 49.1 (2018F)
- Nominal GDP (EUR billions): 9.9 (2016); 10.8 (2017F); 11.5 (2018F)
- GDP per Capita (EUR): 22,700 (2016); 24,537 (2017F); 26,369 (2018F)
- Real GDP growth (%): 5.5 (2016); 7.1 (2017F); 6.2 (2018F)
- Consumer Price Inflation (%): 0.9 (2016); 1.3 (2017F); 1.6 (2018F)
- Domestic Credit (% GDP): 269.2 (2016); 262.5 (Sept-2017)
- Current Account (% GDP): 6.6 (2016); 9.6 (2017F); 9.8 (2018F)
- International Investment Position (% GDP): 46.5 (2016); 63.1 (Sept-2017)
- Gross External Debt (% GDP): 872.4 (2016); 843.5 (Sept-2017)
- Governance Indicator (percentile rank): 77.4 (2016)
- Human Development Index: 0.86 (2015)
All figures are in EUR unless otherwise noted. Public finance statistics reported on a general government basis unless specified. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development. Key indicator sources: Central Bank of Malta (CBM), Malta National Statistical Office (NSO), European Commission, World Bank, UNDP, Haver Analytics, and DBRS.
The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.
The sources of information used for this rating include Malta Ministry for Finance, Central Bank of Malta (CBM), Malta National Statistical Office (NSO), Malta Fiscal Advisory Council, Malta Financial Services Authority, European Commission, European Central Bank (ECB), Eurostat, IMF, World Bank, UNDP, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.
DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.
Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS's outlooks and ratings are under regular surveillance.
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