DBRS Assigns ‘A’ Rating to Republic of Malta

DBRS, Inc. has assigned long-term foreign and local currency issuer ratings of A to the Republic of Malta. DBRS has also assigned short-term foreign and local currency issuer ratings of R-1 (low). The trend on all ratings is Stable.

The A rating reflects Malta’s strong growth performance and Eurozone membership. Membership in the Eurozone plays an integral role in Malta’s economy, ensuring reliable access to European markets. Eurozone membership also fosters strong macroeconomic policies and makes available financial support from European institutions. With prudent lending practices and stable household finances, Malta did not generate the financial imbalances that have plagued other Eurozone periphery countries. However, Malta’s weak productivity growth combined with high and rising costs pose a challenge for competitiveness, while low participation in the formal labor force limits fiscal flexibility and raises additional social challenges. Furthermore, the economy and public finances are exposed to external shocks, particularly those emanating from within the EU.

The Stable trends reflect DBRS’s assessment that risks to the ratings are broadly balanced. Continued progress on fiscal consolidation and a gradual reduction in public indebtedness could put upward pressure on the ratings. In addition, successful implementation of reforms to improve the efficiency of the public sector, boost private sector investment and increase formal labor force participation could have a positive effect. On the other hand, the emergence of additional contingent liabilities, particularly from the energy or financial sector, could have adverse implications for Malta’s ratings. Large or prolonged external shocks could also present downside risks to the ratings.

Malta joined the European Union in 2004 and adopted the Euro in 2008. The expansion of trade and travel links with Europe – and with other countries seeking an access point to Europe – has provided a significant boost to Malta’s growth prospects. Rising employment generated by trade and tourism have increased national income and contributed to rising property values. Furthermore, Malta has benefited by strengthening fiscal, monetary and financial policy institutions in line with EU and Eurozone rules.

Maltese households enjoy high levels of savings and limited leverage. Real estate values rose dramatically in the decade prior to the global financial crisis, but without an excessively large increase in household financial liabilities. Although Malta’s small market displays a low level of financial sophistication and its predominantly family-owned businesses have limited access to capital, this has also prevented the emergence of financial imbalances. Domestic consumption growth is consequently quite resilient.

Malta benefits from a flexible labor force and favorable tax climate. Educational outcomes are relatively poor, showing weak basic skills attainment and a high rate of early school leaving. Nonetheless, with a considerable amount of seasonal employment and open immigration policies, the labor force adjusts quickly. The younger generation shows higher levels of educational attainment than older generations, and Malta has been able to adapt training programs in response to the needs of key employers. Multinational corporations are attracted to Malta in spite of relatively high marginal tax rates, due to a full imputation tax system that eliminates the double taxation of dividends paid out of company profits, including capital gains, already subject to tax.

Malta also features a large banking system but a small number of banks account for the majority of domestic financial activity. The domestic banks remain traditional in terms of their reliance on retail deposit-based funding and property collateral-based lending. A lack of space for new construction and relatively high credit costs appear to have helped insulate the islands from overbuilding, and evidence of overvaluation in the real estate market is limited. Consequently, the overall financial system fundamentals remain strong and risks to the government’s balance sheet appear contained. Non-domestic banking activity may pose reputational risks, but is unlikely to have any material direct impact on the Maltese economy.

In spite of these strengths, Malta has exhibited relatively weak productivity growth that could undermine its competitiveness as labor costs continue to rise. Since 2007 in particular, growth in Malta’s output per worker has underperformed most other southern EU countries, while labor costs have risen in excess of 25% (compared to roughly 10% in France, Italy and Spain). Structural characteristics, including the small size of firms, lack of innovation, high degree of informality and limited access to credit appear to be primary factors in Malta’s low rate of productivity growth. Infrastructure bottlenecks may also be playing a role. Malta also has a low rate of labor force participation. Rising real wages and government policies to encourage employment, particularly among women and older workers, have had positive but largely transitory effects on growth. An apparently high degree of informality may limit further progress and ultimately make long-term pension commitments less affordable.

Although Malta’s level of indebtedness compares favorably to many other European economies, it remains elevated compared to historical levels. The average interest cost of public debt is relatively high, though declining, and the government has extended guarantees to several large state owned enterprises (particularly Enemalta). The restructuring of these companies has reduced risks to the public sector balance sheet, and the new fiscal framework may help to achieve a durable reduction in debt over coming years. Nonetheless, the public sector remains exposed to debt and financing shocks, particularly given the high degree of concentration in the domestic financial sector.

Finally, Malta’s reliance on tourism and other industries catering to foreign demand expose the economy to external shocks. Although tourism emanates from a diverse set of wealthy economies, Malta could be adversely affected by a downturn in European economic activity. If a sustained erosion in tourist arrivals or other shocks in external demand were to have an impact on domestic real estate prices, this could have a serious impact on household finances and financial stability. The island economy’s competitive position could also be eroded as stability returns to nearby North African countries, or as domestic costs rise. Similarly, the financial and gaming industries could be adversely affected by competition from other markets, including in advanced countries engaging in tax and regulatory reforms.

Notes:
All figures are in euros unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under 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 under Rating Scales.

The sources of information used for this rating include Malta Ministry for Finance; Central Bank of Malta; National Statistical Office; European Commission; IMF; UN; BIS; Enemalta; Air Malta. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Thomas R. Torgerson
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 3 April 2015
Most Recent Rating Update: 3 April 2015