DBRS Morningstar Confirms Republic of Malta at A (high), Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Malta’s Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, DBRS Morningstar 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
The Stable trend reflects the fact that Malta’s strong economic and fiscal performance in recent years has left the country relatively well placed to mitigate the risks posed by the Coronavirus Disease (COVID-19) outbreak. The partial lockdown and travel restrictions to deal with the pandemic will likely result in a deep but temporary recession in Malta this year. A strong rebound should follow the gradual opening of the economy although there is still high uncertainty over the evolution of the pandemic and the tourism sector. The fiscal balance and debt ratios will deteriorate sharply in 2020 because of the intense economic contraction and the fiscal support package. However, Malta’s public debt ratio is expected to remain one of the lowest in the European Union.

Malta’s A (high) rating is supported by its euro zone membership, moderate level of public debt, solid external position, and households’ strong financial position. On the other hand, Malta’s small and open economy remains exposed to external demand or confidence shocks. In this sense, the tourism sector, an important source of income, employment, and investment in Malta, will face significant headwinds in the medium-term. Similarly, Malta’s attractiveness to foreign investment could suffer if measures to address the financial integrity risks and institutional governance weaknesses noted by international bodies are deemed insufficient. Despite Malta’s sound public finances, medium to long-term challenges could come from its contingent liabilities, changes in international taxation affecting Malta’s attractive tax system to foreign companies, or increasing age-related spending.

RATING DRIVERS
Although unlikely in the current environment, the ratings could be upgraded if two of the following occur: (1) a sustained material reduction in the public debt ratio driven by sound fiscal management and economic performance; (2) effective implementation of reforms to enhance Malta´s governance framework, including the financial and judicial sector; or (3) further evidence of increased economic and fiscal resiliency to external shocks. The ratings could be downgraded if one or a combination of the following occur: (1) a sustained deviation from a prudent fiscal approach materially deteriorating the fiscal and public debt outlooks; (2) the pandemic shock to the economy results in substantial deterioration in Malta´s potential growth; or (3) a substantial weakening of investors’ confidence due to insufficient progress on improving its governance framework.

RATING RATIONALE

The Maltese Economy Will Be Severely Hit by The Pandemic But Less Than Euro Area Peers

The healthcare crisis has been less acute in Malta when compared with the most affected European nations, with 677 confirmed cases and 9 deaths from coronavirus as of July 21. The restrictions needed to control the spread of the virus have abruptly halted a period of remarkable economic performance, characterised by strong output growth (averaging 7% a year during 2013-2019) and shrinking the GDP per capita gap with the EU. The latest forecast from the European Commission (EC) points to a 6.0% contraction in Malta’s GDP in 2020 followed by a relatively swift rebound of 6.3% in 2021. The main uncertainties are posed by the future evolution of the pandemic and the tourism sector. Even so, the EC expects Malta’s GDP contraction to be the smallest among the euro area member states in 2020.

Malta’s partial lockdown, including travel bans and the closure of non-essential services, has been gradually relaxed since May from its start in mid-March. Importantly, travel bans have been further eased on 15 July. The sectoral impact from the restrictions will be uneven with tourism-related activities, including travel, hospitality, cultural and recreational activities, expected to suffer significantly. The tourism sector is a key source of income to the Maltese economy, contributing 12.8% to Malta´s GDP and 14.9% of total employment in 2018, according to the OECD. The reopening of the economy and the government measures to support the tourism-related sector (e.g., vouchers) will help the sector to recover; however, the Maltese tourism sector is predominantly reliant on foreign tourist arrivals that could take some time to return to pre-pandemic levels. The confinement, physical distancing, and slump in tourism arrivals is also expected to undermine retail sales. On the other hand, sectors exempt from the lockdown (i.e., construction and manufacturing) and those with greater remote working capabilities (e.g., iGaming, financial, and business services sectors) are expected to suffer much less from the restrictions.

While the near-term outlook remains uncertain, Malta’s potential growth rate remains strong and expected to converge to levels above 3% in the medium term. The supply of foreign workers, an important driver of potential growth in recent years, is expected to falter in 2020, but to recover over time. Also, government support measures have prevented substantial losses of employment, although more lasting effects are still possible. Over the medium to long-term, Malta’s attractiveness as a financial and business location could face challenges from: (1) slow progress in enhancing its governance framework, (2) changes in international corporate taxation, or (3) changes to the EU regulatory framework.

The Pandemic Shock Temporarily Halted Malta’s Strong Fiscal Performance

The pandemic shock has substantially deteriorated the budgetary outlook in the near term, halting four years of consecutive fiscal surpluses averaging 1.7% of GDP during 2016-2019 on the back of a buoyant economy. The ‘Updated Stability Programme’, 2020-2021, foresees a substantial deterioration in the budgetary balance from a 0.5% surplus in 2019 to a deficit of 7.5% of GDP in 2020 driven by the hit to revenues from the slump in activity as well as the measures to respond to the pandemic. This included the budgetary impact of around EUR 520 million (4.1% of GDP) from the first set of measures, such as the COVID-19 wage supplement to prevent job losses and higher healthcare related spending. Also, the government introduced tax deferrals and a state guarantee scheme (2.8% of GDP) to support the liquidity of the firms affected by the coronavirus pandemic. In June, the government announced its Economic Regeneration Plan of EUR 900 million (6.7% of GDP). This second wave of support includes additional spending for this year through the extension of the wage supplement, the introduction of time-bound vouchers to support the tourism-related sector, and subsidisation of rent and electricity bills for firms. This will likely widen further the fiscal deficit in 2020. However, the majority of the plan is related to a EUR 400 million multi-year infrastructure investment plan and EUR 200 million of additional liquidity linked to the extension of tax deferrals.

DBRS Morningstar expects the budget to already start rebalancing in 2021 as the economy rebounds and the temporary support is rolled back. Malta’s fiscal track-record and the authorities’ commitment to its medium-term fiscal target supports the fiscal rebalancing in coming years. Nevertheless, over the medium to long-term, important drivers of revenue growth such as Malta’s impressive economic expansion, its citizenship by investment scheme, and corporate taxation could face challenges. This accounts for DBRS Morningstar’s negative qualitative assessment of the “Fiscal Management and Policy” building block.

The Public Debt Ratio Is Expected To Deteriorate Substantially But Remain Relatively Low

Prior to the pandemic outbreak, Malta’s debt-to-GDP ratio stood at 42.9%, one of the lowest in the EU, following a period of steep reductions in the ratio. This has provided the government with valuable room to respond to the coronavirus shock, without materially jeopardising debt sustainability. The government projects the debt ratio to jump to 54.5% in 2020 in light of the sharp increase in financing needs and nominal GDP losses. Once the pandemic effects subside, DBRS Morningstar expects the debt ratio to resume its downward trajectory on the back of a favourable nominal growth-interest expenditure differential.

However, a sharp deterioration in Malta´s growth outlook or the materialisation of contingent liabilities could challenge this. In an adverse scenario, the government might decide to financially support its large and concentrated financial system or its SOEs outside of the general government (e.g., Air Malta). Although Malta has implemented measures to lengthen the work life and contribution period and strengthen the pension system, further measures might be needed to contain the long-term pressures of age-related spending on the healthcare and pension systems.

Financial System Remains Sound But the Pandemic Shock and Reputational Risk are Concerns

Malta’s role as a small financial hub has resulted in the development of a large banking system relative to its domestic economy. Core domestic banks, with assets of around 186% of GDP in Q4 2019, mostly follow a traditional business model based on retail deposits for funding. The international banks and domestic non-core banks have limited or no linkages to the domestic economy. Overall, the Maltese financial system remains sound, underpinned by its conservative core banks’ healthy levels of capitalisation, liquidity, and profitability. However, the economic fallout from the pandemic will likely pressure banks’ asset quality and profitability. The Maltese authorities have introduced several measures to mitigate this impact and support the supply of credit to the economy, in addition to the extraordinary euro-system support. For example, a temporary loan moratorium, a sizable state guarantee programme, and temporarily less stringent supervisory requirements.

Banks’ nonperforming loans as a share of total loans, at 3.2% in Q4 2019, will likely increase over time as the measures to alleviate the strains on the private sector debt capacity start to wane (e.g., loan moratorium, wage supplement, or tax deferrals). Malta’s real estate market remains a source of risk, given the banks’ high exposure to the sector and strong price growth since 2014, especially under these challenging conditions. The downturn in tourism and net migration could pressure the buy-to-let market. On the other hand, households’ strong financial position and banks’ conservative lending practices mitigate the risks to the banks’ mortgage loan books.

Several international institutions, including the IMF and Moneyval, have stressed the need for Malta to swiftly address some deficiencies in its framework and enforcement of combating money laundering and the financing of terrorism (AML/CFT). In response, the Maltese authorities have been implementing a series of ambitions reforms in this direction. If Moneyval, and later the Financial Action Task Force (FATF), considers that Malta failed to address the shortcomings in the system, the country risks being identified by the FATF as a country with strategic AML/CFT deficiencies. This could deepen the reputational and financial integrity risks Malta faces. DBRS Morningstar makes a negative qualitative assessment of the “Monetary Policy and Financial Stability” building block to reflect the potential impact of this on banks’ intermediation and economic activity.

Malta’s External Position Remains Strong Despite the Blow to the Tourism Sector

Malta’s external accounts will mostly be affected by the adverse impact on the tourism sector, but also by overall lower external demand and supply side disruptions. Nevertheless, Malta is expected to continue to record current account surpluses in coming years. On the back of strong current account surpluses mostly driven by its export-oriented business sector, notably the gaming industry, Malta has accumulated a large positive net international investment position of 64.3% of GDP in Q1 2020. Although gross external indebtedness is very high at 700.4% of GDP in Q1 2020, it poses limited risks to the domestic economy as it is mainly reflective of stable flows of inter-company lending and Malta’s role as an international financial centre.

A Stable Policy Environment Is Credit Positive But Further Steps to Strengthen Governance Are Needed

Malta benefits from a strong national and overarching European policy framework. Looking at the World Bank’s governance indicators for 2018, Malta compares favourably with the EU average scores, except on corruption and government effectiveness. However, Malta’s governance and institutional set-up has been under increasing scrutiny. The political fallout triggered by alleged corruption cases involving former senior government officials being linked to the death of a journalist precipitated the resignation of former Prime Minister Joseph Muscat. The new Labour Party Prime Minister Robert Abela has kept the economic agenda and pledged to take further steps to strengthen the rule of law.

The government has adopted a number of reforms in response to the Venice Commission report in December 2018. Furthermore, in July 2020 the government sent to parliament a series of bills to implement many of the Venice Commission recommendations to strengthen the rule of law. For example, changing the presidential election process and overhauling the judiciary, among other initiatives. The Venice Commission has commended these legislative proposals as a positive step, although not yet sufficient to achieve an adequate system of checks and balances. The presence of these shortcomings has led to a negative qualitative assessment of the “Political Environment” building block.

ESG CONSIDERATIONS
Human Rights and Human Capital (S) were among the key ESG drivers behind this rating action. Malta’s per capita GDP is relatively low at USD 30,637 in 2019 compared with its euro system peers. A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/364468/.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in euros (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (17, September, 2019):
https://www.dbrsmorningstar.com/research/350410/global-methodology-for-rating-sovereign-governments.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The sources of information used for this rating include Malta Ministry for Finance (Stability Programme Update 2020-2021, April 2020; Economic Regeneration Plan, June 2020), Central Bank of Malta (Economic Projections 2020-2022, June 2020), Malta National Statistical Office (NSO), Malta Fiscal Advisory Council, Malta Financial Services Authority, Moneyval, Venice Commission (Opinion on Proposed Legislative Changes, June 2020), European Commission (Assessment of the 2020 Stability Programme for Malta, May 2020), Organisation for Economic Co-operation and Development (OECD Tourism Trends and Policies 2020, March 2020), World Health Organisation, European Central Bank (ECB), Eurostat, International Monetary Fund (World Economic Outlook October 2019 and April 2020, Fiscal Monitor April 2020), World Bank, United Nations Development Programme, Bank of International Settlements, and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS Morningstar 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 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/364467/.

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings
Initial Rating Date: April 3, 2015
Last Rating Date: January 31, 2020

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