DBRS Confirms Republic of Malta at ‘A’, Stable Trend

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

The A rating reflects Malta’s Eurozone membership, which ensures reliable access to European markets, fosters strong and credible macroeconomic policies and makes available financial support from European institutions. The robust financial position of households and an attractive business environment, partly reflecting a favorable tax climate, also support Malta’s ratings, together with the country’s solid external position. However, Malta’s public finances, while improving, remain a source of vulnerability, and its economy is exposed to external shocks, particularly those emanating from within the EU. Furthermore, weak productivity growth combined with rapid wage growth could gradually erode Malta’s competitiveness.

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

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, while fiscal, monetary and financial policy institutions have strengthened in line with EU and Eurozone rules.

Maltese households enjoy high levels of savings and moderate indebtedness. Real estate values rose significantly in the decade prior to the global financial crisis, but without an excessively large increase in household financial liabilities. Prudent lending practices and stable household finances prevented Malta from building up the financial imbalances that have afflicted other Eurozone periphery countries. Domestic consumption growth is consequently quite resilient and overall economic performance has been strong.

Malta benefits from a flexible labor market and favorable tax climate, fostering a business-friendly environment and an attractive destination for investment. Educational outcomes are relatively poor, showing weak basic skills attainment and a high rate of early school leaving. Nevertheless, the younger generation shows higher levels of educational attainment, and with open immigration policies the labor force adjusts quickly. Multinational corporations are also attracted to Malta in spite of relatively high marginal tax rates, thanks to a full imputation tax system that eliminates the double taxation of dividends paid out of company profits.

Malta’s solid external position is another credit strength, supported by a current account surplus and positive net international investment position. Moreover, while the economy is open and external demand for Malta’s tourism industry exposes the country to adverse external shocks, the Maltese government meets its financing requirements domestically, and the core domestic banking sector is conservatively funded by domestic retail deposits. Therefore, low reliance on external financing has been a fundamental factor explaining Malta’s resilience over recent years.

Some of Malta’s credit challenges are associated with the exposure of its public sector and the still high level of public debt. The government has extended guarantees to several large state owned enterprises (SOEs). The high degree of concentration in the domestic financial sector could also be a source of contingent liabilities, though the overall financial condition of the core domestic banks appears to be strong. The restructuring of some of the SOEs has reduced risks to the public sector balance sheet, and the new fiscal framework may help achieve a durable reduction in debt over coming years. Nevertheless, the public sector remains vulnerable to debt shocks. Moreover, although public sector debt compares favorably to other European economies, it remains elevated at just over 68% of GDP in 2014. Government debt, however, has started to decline, and its favorable composition and maturity profile mitigate some of the risks.

Malta’s reliance on tourism and other industries catering to foreign demand also exposes the economy to external shocks. Although tourism benefits from a market of wealthy economies, it 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 serious implications for household finances and financial stability. The islands’ competitive position could also be eroded if domestic costs rise. Similarly, the financial and gaming industries could be adversely impacted by competition from other markets.

Finally, Malta’s relatively low rate of productivity growth could gradually undermine its competitiveness as labor costs continue to rise. Structural features, including the small size of firms, lack of innovation, and a high degree of informality may be contributing factors in Malta’s low rate of productivity growth. Malta also has a low rate of labor force participation, although this is improving.

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.

DBRS does not typically accept editorial changes other than to correct for factual, accuracy and/or to remove confidential, material non-public, or sensitive information that might otherwise be inadvertently disclosed.

Lead Analyst: Thomas R. Torgerson
Rating Committee Chair: Roger Lister
Initial Rating Date: 3 April 2015
Most Recent Rating Update: 3 April 2015