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 DBRS Morningstar’s view that Malta’s strong economic and fiscal track record prior to the Coronavirus Disease (COVID-19) shock offsets the risks to the ratings. DBRS Morningstar considers that economic impact from the Financial Action Task Force’s (FATF) decision to grey-list Malta in June 2021 remains unclear and, to a great degree, will depend on the speed with which the Maltese authorities provide tangible evidence of the effectiveness of their framework. DBRS Morningstar views Malta’s recent progress on improving its Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) framework and the commitment from authorities to continue addressing lingering shortcomings as mitigating risk factors.

Malta entered the current crisis after a prolonged period of strong economic and fiscal performance, which supported the resilience of the private sector and provided the public sector with valuable fiscal headroom to soften the pandemic-related setback. Following a sharp contraction of 7.8% in 2020, GDP is expected to recover only partially in 2021 due to the reintroduction of restrictions in March and April to contain the spread of the pandemic and the expectation that foreign tourism will remain below pre-crisis levels for some time in spite of Malta’s remarkable vaccination progress.

The reinforced fiscal support is expected to result in another sizeable fiscal deficit in 2021 and further deterioration in the public debt ratio. Nevertheless, Malta’s strong starting point and favourable financing costs curb the risks. Going forward, DBRS Morningstar expects Malta to gradually return to a healthier fiscal position as the support measures are phased out and the economy recovers more strongly, helping to stabilise the public debt ratio. Rebuilding the fiscal buffers and strengthening the fiscal balance further will require a fiscal consolidation plan once the economy reaches a self-sustaining path.

Malta’s euro zone membership, moderate level of public debt, solid external position, and households’ strong financial position support the country’s A (high) rating. 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—presents a vulnerability as long as the adverse effects of the pandemic continue. 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 remain unaddressed. Despite Malta’s sound public finances, medium- to long-term challenges could stem 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, DBRS Morningstar could upgrade Malta’s ratings 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. DBRS Morningstar could downgrade the ratings 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 a material deterioration in Malta’s medium-term growth; or (3) a substantial weakening of investors’ confidence due to insufficient progress on improving the effectiveness of its Anti-Money Laundering and Combating the Financing of Terrorism framework.

RATING RATIONALE

Recovery Is Underway, But Uncertainty Remains

The magnitude of the potential economic cost from FATF’s grey-listing for the Maltese economy remains unclear and will depend on firms' ability to manage the repercussions and the response of international investors to the change in status (please see https://www.dbrsmorningstar.com/research/380646). DBRS Morningstar considers that the impact could remain limited if the Maltese authorities provide tangible evidence of the effectiveness of their framework to quell FATF’s concerns. If concerns over the effectiveness of its frameworks remain unresolved for a prolonged period of time, however, this could have long-lasting implications for Malta's attractiveness as a small financial hub and a destination of foreign investment.

Malta’s economic performance prior to the pandemic was remarkable, permitting the private sector to enter the crisis in a strong position. Annual GDP growth averaged 6.5% from 2013 to 2019 with strong job creation and a shrinking GDP per capita gap with the European Union (EU). Despite sizeable and timely support from the government, the pandemic and the restrictions to contain its spread had a large impact on tourism-related activities, resulting in GDP contracting by 7.8% in 2020. The strong performance of the gaming, financial, and information and communications sectors only partially compensated for the slump in activity in the trade, transport, and hospitality sectors. While Malta has been diversifying its economy over time, the tourism sector remains a key source of income for the economy. According to the World Travel & Tourism Council, total contribution from the travel and tourism sector to GDP dropped to 5.4% in 2020 from 15.9% in 2019. On the other hand, the labour market has withstood the massive pandemic-related shock relatively well thanks to government support, especially the wage supplement scheme. The unemployment rate edged higher to 4.3% and employment growth was 2.9% in 2020.

The Central Bank of Malta expects the recovery to be gradual, with GDP growth of 4.9% in 2021 and 5.4% in 2022. GDP could surpass its 2019 level by 2022 and the negative output gap could progressively narrow. The rebound in 2021 will be principally driven by domestic demand as foreign tourism is expected to remain below pre-crisis levels for some years. Still-expansive fiscal policy in 2021 and higher adaptation of households and businesses to the pandemic environment should support the rebound in private consumption and investment as the economy reopens. The potential emergence of labour supply shortages could slow down the recovery as travel restrictions limit the migration of third-country nationals. The evolution of the pandemic and its impact on the tourism sector, which predominantly relies on foreign tourist arrivals, remain the main economic uncertainties. Malta’s remarkable pace of vaccination, with almost 80% of adults fully vaccinated, could bring back foreign tourism; however, tourist flows will remain subject to travel restrictions both in Malta and in its key source markets. Over the medium term, the funds and reforms attached to the Next Generation EU and EU Budget, if fully implemented, represent upside risks to Malta’s economic outlook.

The Pandemic Continues To Weigh on the Fiscal Deficit, But Track Record Mitigates Risks

Malta’s fiscal performance improved significantly over the past two decades, including annual average fiscal surpluses of 1.6% of GDP between 2016 and 2019. Key factors underpinning this trend include its strong economic performance, improved spending efficiency, lower interest payments, and proceeds from the Individual Investor Programme (IIP) since its introduction in 2014. However, the pandemic triggered a substantial deterioration in public finances driven by the government’s response and the substantially weaker macroeconomic environment. The budget balance turned to a sizeable deficit of 10.2% of GDP in 2020 from a surplus of 0.4% of GDP in 2019. The government projects the deficit ratio to remain very high at 12.0% of GDP in 2021, worse than previously expected, following the extension and introduction of new support measures to mitigate the pandemic’s side effects.

The immediate fiscal impact of the measures to mitigate the pandemic’s impact is estimated to be around 5.0% of GDP in 2020 and 5.3% of GDP in 2021, with the latter including support for Air Malta pending European Commission (EC) approval. The main measures include the wage supplement scheme to protect employment, direct subsidies to firms in the most affected sectors, a voucher scheme to support domestic demand, higher healthcare spending, and a temporary reduction in the property transaction tax. In addition to this, the government introduced tax deferrals (1.5% of GDP) and a state guarantee scheme (2.8% of GDP) to alleviate firms’ liquidity constraints.

In line with Malta’s fiscal prudence in the past, DBRS Morningstar expects the government to gradually return to a healthier fiscal position over time as the pandemic fades and the economy recovers. The government projects the deficit to fall below 3.0% by 2024 if the macroeconomic assumptions hold. The main risks remain linked to the evolution of the pandemic. Over the medium to long term, important drivers of revenue growth including Malta’s impressive economic expansion, 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 potential changes to the international tax system currently being discussed at the OECD/G-20 level could significantly erode Malta’s corporate tax revenues, an important budgetary revenue source. However, DBRS Morningstar notes that its effects will hinge on the details still to be agreed upon, which could challenge and delay its implementation. In relation to the potential loss of future revenues from the citizenship by investment programme, DBRS Morningstar takes comfort in the authorities’ prudent management of the revenue windfalls from the scheme.

Public Debt Ratio is Expected to Deteriorate Substantially, But Remain Manageable

Prior to the outbreak of the pandemic, Malta’s public debt-to-GDP ratio stood at 42.0% following a period of steep reductions. This provided the government with valuable room to respond to the coronavirus shock without materially jeopardising debt sustainability. The public debt ratio deteriorated sharply in 2020 to 54.5% of GDP in light of the sudden increase in financing needs and nominal GDP losses. The additional fiscal support implemented to counteract the pandemic consequences will postpone the rebalancing process and lead to higher-than-previously expected levels of debt. The government projects that the debt ratio will climb to 65.0% of GDP in 2021, peak at 66.0% in 2023, and only start to decline afterward in the no-policy change scenario. DBRS Morningstar introduced a negative qualitative assessment for the “Debt and Liquidity” building block to reflect the deterioration in these projections. Nevertheless, DBRS Morningstar expects Malta’s debt dynamics to improve as the pandemic effects fade.

Potential risks to this debt path could stem from a sharp deterioration in Malta’s growth outlook or the materialisation of contingent liabilities. In an adverse scenario, the government might decide to financially support its large and concentrated financial system or its state-owned enterprises outside the general government. Over the long term, further measures might be necessary to contain the costs of age-related spending on the healthcare and pension systems. Measures already implemented include lengthening the working age and contribution periods as well as strengthening the pension system.

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

The FATF’s decision in June 2021 to include Malta on its list of countries under enhanced monitoring, often referred as FATF’s grey-list, reflects a need to continue improving the Maltese framework’s effectiveness to combat money laundering and terrorist financing, especially in criminal tax and related money laundering cases as well as the accuracy of the beneficial ownership information. On the other hand, Moneyval’s favourable assessment of Malta’s AML/CFT framework recognises the significant improvement in its level of compliance with FATF’s standards due to positive legislative, regulatory, and institutional reforms from authorities. Addressing the AML/CFT effectiveness concerns will remain key in containing the potential reputational damage to the banking system to avoid further de-risking and straining Maltese banks’ correspondent banking relationships. 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 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 202.7% of GDP in Q4 2020, mostly follow a traditional business model based on retail deposits for funding. Core banks’ main exposure is to the real estate market, which has remained relatively resilient in the face of the pandemic thus far on the back of a robust labour market and government support measures. The international banks and domestic non-core banks have limited or no linkages to the domestic economy.

The Maltese core domestic banks’ strong capital (CET1 ratio at 18.3% Q1 2021) and liquidity (liquidity coverage ratio at 375% Q1 2021) positions, on aggregate, have helped them weather the pandemic-related shock. The economic fallout from the coronavirus has affected core banks’ profitability through higher provisions and lower net interest flows. The level of provisions has been increased significantly to reflect the weaker operating environment affecting credit risks. The impact on asset quality has so far been contained and mitigated by the government support measures, with core banks’ nonperforming loans as a share of total loans standing at 3.7% in Q4 2020. Credit performance in the most affected sectors, such as hospitality, remains a concern as the government rolls back its massive support measures. DBRS Morningstar notes, however, that arrears appear to be contained, despite the significant number of loans exiting the loan payment moratorium. The share of private-sector loans benefiting from the moratoria dropped to 2.5% in April 2021 from 17% in July 2020.

Malta’s External Position Remains Strong, Despite the Adverse Impact of the Pandemic on the Tourism Sector

Before the pandemic hit, Malta experienced a period of sizeable current account surpluses on the back of strong performance from its service exports. The current account surplus averaged 4.2% of GDP during 2014 to 2019, with net exports of services (including travel, financial, professional, and gaming) more than offsetting the large deficit in goods. The pandemic and the measures to control its spread, including travel bans, have abruptly halted a prolonged period of growth in inbound tourism to Malta as the number of inbound tourists slumped by 76.2% in 2020. The substantial deterioration in the travel balance was the primary factor behind the shift in the current account to a 3.6% deficit in 2020.

Despite Malta’s vaccination campaign progress, the pandemic has continued to hold back foreign tourism, with inbound tourism for January to April 2021 at only 6.6% of 2019 levels for the same period. A return to pre-pandemic levels could take some years. The Central Bank of Malta expects the current account deficits to persist until 2022 and turn to a small surplus in 2023. From a stock perspective, Malta’s net international investment position stood at 60.9% of GDP in Q1 2021. Gross external indebtedness is very high at 707.7% of GDP in Q1 2021, but DBRS Morningstar considers the risks to the domestic economy as limited because this mainly reflects Malta’s role as an international financial centre and stable flows of intercompany lending.

Stable Policy Environment, But Further Scope to Strengthen Governance

Malta benefits from a strong national and overarching European policy framework, which has underpinned the country’s economic and public finance improvement since joining the EU. The World Bank’s governance indicators for Malta are broadly in line with those of the EU average, with the exception for ‘Control of Corruption’ where Malta exhibits weak performance. Malta’s governance indicators exhibited a widespread deterioration during 2018–19, especially marked in the ‘Control of Corruption’ and ‘Regulatory Quality’.

Malta’s governance and institutional setup have been under increased scrutiny in recent years, triggered by the alleged corruption scandal involving former government officials that precipitated the resignation of the former Prime Minister, Joseph Muscat. Prime Minister Robert Abela has provided a new impetus to strengthen the rule of law since coming into office in January 2020. The Venice Commission commended the passage of six new laws by the Maltese Parliament to strengthen the separation of powers and checks and balances (e.g., judicial reform and appointment procedures), but underscored the fact that more needs to be done. These shortcomings have led to a negative qualitative assessment of the “Political Environment” building block.

ESG CONSIDERATIONS
Human Rights and Human Capital (S) and Institutional Strength as well as Governance & Transparency (G) were among the key ESG drivers behind this rating action. Malta’s per-capita GDP was relatively low at USD 28,294 in 2020 compared with its euro area peers. The World Bank’s governance indicators for Malta exhibited a significant deterioration during 2018–2019, especially in ‘Control of Corruption’ and ‘Regulatory Quality’. DBRS Morningstar has taken these considerations into account in the “Economic Structure and Performance”, “Monetary Policy and Financial Stability”, and “Political Environment” building blocks.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/381424.

EURO AREA RISK CATEGORY: LOW

Notes:
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

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, https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments (July 27, 2020). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).

The sources of information used for this rating include the Ministry for Finance and Employment (Update of Stability Programme 2021–24), Central Bank of Malta (Outlook for the Maltese Economy 2021:2; Economic Update 6/2021), Ministry for Energy and Water Management (National Energy and Climate Plan, December 2019), Malta National Statistical Office (NSO), Malta Financial Services Authority, Moneyval, FATF, Venice Commission (Opinion on Ten Acts and Bills Implementing Legislative Proposals, October 2020), World Travel & Tourism Council (Malta, 2021 Annual Research: Key Highlights), European Commission (2020 European Semester: Country Report; Assessment of the Final National Energy and Climate Plan of Malta), Global Carbon Atlas, The Social Progress Imperative (2020 Social Progress Index), European Centre for Disease Prevention and Control, European Central Bank, Eurostat, International Monetary Fund, 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/381425.

This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.

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 8, 2021

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