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 high economic growth rates and fiscal surpluses prior to the Coronavirus Disease (COVID-19) shock have supported its private and public sector’s capacity to soften the pandemic setback and mitigate the risks to the ratings. Malta’s high vaccination coverage, a gradual return of foreign tourism, and continued fiscal support are underpinning a robust recovery in 2021. In the first three quarters of 2021, real GDP grew by a cumulative 7.6% YoY. The extension of COVID-19 fiscal support in 2021 will lead to another sizable fiscal deficit and a higher public debt ratio this year. Nevertheless, Malta’s cost of funding remains favourable and DBRS Morningstar expects a gradual return to a healthier fiscal position, helped by the growth outlook and the phase-out of COVID-19 support to lead to a stabilisation, or even a reduction, of the public debt ratio in coming years.

The evolution of the pandemic poses risks to the outlook with the resurgence of COVID-19 cases across Europe and the emergence of the new Omicron variant, remaining a source of concern. Nevertheless, Malta’s high vaccination rate and improved adaptability to the pandemic environment should mitigate the risks. DBRS Morningstar takes the view that no significant or discernible impact on the real economy has materialised thus far as a consequence of the decision of the Financial Action Task Force’s (FATF) decision in June 2021 to include Malta on its list of countries under enhanced monitoring. The ultimate impact from the grey-listing remains unclear and will most likely depend on the speed with which the Maltese authorities provide tangible evidence of the effectiveness of their Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) framework.

Malta’s euro area membership, a moderate level of public debt, a 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 potential 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 persist. 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 a combination 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) a more prolonged 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

The Maltese Economy Is Expected To Experience A Robust Recovery Albeit Risks Remain

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 7.1% from 2013 to 2019 with strong job creation and a shrinking GDP per capita gap with the European Union (EU). In spite of the government’s sizable support, the pandemic and the restrictions to contain its spread had a large impact on tourism-related activities, triggering a sharp contraction in GDP of 8.2% in 2020. While Malta has been diversifying its economy over time, the tourism sector remains a key source of income for the economy.

Malta’s recovery is progressing strongly but still experiences subdued tourism activity. The economic reopening has permitted a strong rebound in private consumption and investment in 2021 underpinned by households’ high savings, continued fiscal stimulus, and the restarting of postponed investment projects. According to preliminary estimates, GDP grew by a cumulative 7.6% YoY during the first three quarters of 2021. The labour market continues to tighten and the unemployment rate stood below pre-pandemic levels at 3.5% in Q2 2021. The Central Bank of Malta’s August projections point to GDP growth of 5.1% in 2021 and 5.9% in 2022, and 4.7% in 2023. However, a stronger than anticipated recovery and the recently released national account figures might render these projections conservative. Domestic demand will remain the key growth driver over the forecasting horizon as private consumption continues to recover and EU funds raise public investment. A stronger recovery in foreign tourism arrivals expected to take place in 2022 and 2023 should give a boost to net exports.

Until now, DBRS Morningstar does not discern any material impact from FATF’s grey-listing on Malta’s economic performance, with the financial and gaming sectors posting strong growth rates. Nevertheless, DBRS Morningstar will continue to monitor the developments on that front. Labour supply shortages could slow down the recovery in the short-run as travel restrictions limit the migration of third-country nationals, a key source of employment growth pre-pandemic, until international travel normalises further. The evolution of the pandemic and its impact on the tourism sector, which predominantly relies on foreign tourist arrivals, remain the main economic uncertainties. On the other hand, a faster decline in the historically high savings ratio and a full implementation of the reforms and investments attached to the Next Generation EU represent upside risks to Malta’s economic outlook.

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

Malta’s strong economic performance, improved spending efficiency, and lower interest payments, before the pandemic in addition to the proceeds from the Individual Investor Programme (IIP) since its introduction in 2014, have led to a significant improvement in public finances resulting in annual average fiscal surpluses of 1.7% of GDP between 2016 and 2019.

The government’s response to the pandemic, has been critical to mitigate its impact, and a massive activity contraction shifted the budget balance from a surplus of 0.5% of GDP in 2019 to a deficit of 9.7% of GDP in 2020. According to the European Commission, the fiscal impact from the crisis-related temporary emergency measures is estimated at 6.3% of GDP in 2020, 3.9% of GDP in 2021, and 0.1% in 2022. The main measures include the wage supplement scheme, direct subsidies to firms in the most affected sectors, a voucher scheme, 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 Malta Development Bank (MDB) guarantee scheme (of up to 2.8% of GDP) to alleviate firms’ liquidity constraints. The government projects the fiscal deficit to remain very high at 11.1% of GDP in 2021 due to the extension of COVID-19 support and still below trend output. DBRS Morningstar takes the view that the stronger-than-anticipated growth in fiscal revenues could offset the potential introduction of additional measures to shield the private sector from the surge in energy prices.

In line with Malta’s fiscal prudence in the past, DBRS Morningstar expects the government to gradually return to a stronger fiscal position over time as the pandemic effects wane and the economy recovers to full potential. The government projects the deficit to fall below 3.0% of GDP by 2024, which under the current macroeconomic assumptions will require around 0.5% of annual structural adjustment in 2023-2024 still to be defined. DBRS Morningstar continues to consider that the main downside risks to the fiscal outlook in the short-run are tied to the evolution of the pandemic. Financial assistance to national airline Air Malta and potential calls on the MDB administered loan guarantee scheme could also widen the deficit in coming years.

Over the medium to long term, revenues from Malta’s citizenship by investment scheme and corporate taxation could come under pressure. This accounts for DBRS Morningstar’s negative qualitative assessment of the “Fiscal Management and Policy” building block. The multinational initiative led by the OECD to overhaul the global corporate tax system could reduce Malta’s tax regime attractiveness to investors and ultimately erode its corporate tax base. The potential impact on future corporate tax revenues, an important revenue source for the country, remain unclear and will hinge on the ultimate implementation details. In relation to the potential loss of future revenues from the citizenship by investment programme, which is currently being challenged by the European Commission, DBRS Morningstar views positively the authorities’ prudent management of the revenue windfalls from the scheme.

The Public Debt Ratio Deteriorated Substantially, But Remains Manageable

Prior to the outbreak of the pandemic, Malta’s public debt-to-GDP ratio stood at 40.7% 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 53.3% of GDP in light of the sudden increase in financing needs and nominal GDP losses but still remained well below the 90.1% of GDP for the EU. The decreasing but still sizable deficits are expected to continue to lead to a higher debt ratio in the next couple of years. The government projects the debt ratio to increase to 61.3% of GDP in 2021, to peak at 62.7% in 2023, and to start to decline afterwards. DBRS Morningstar notes that debt projections for 2021-2024 have nonetheless improved due to a stronger economic and fiscal performance thus far. Malta’s cost of funding remains favourable, with the 10-year bond yield averaging 0.5% during January-October 2021.

Potential risks to the public debt ratio 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

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 197.8% of GDP as of Q2 2021, 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’ positions of strong capital with a Tier 1 capital ratio of 18.5% in Q2 2021 and liquidity with a liquidity coverage ratio of 418.2% in Q2 2021, on aggregate, have helped them weather the pandemic-related shock. Core banks’ profitability levels improved during H1 2021 due to lower loan loss provisioning and increased lending volumes under an improving operating environment. Resident credit expanded 7.2% YoY in September 2021 mostly due to household mortgage lending and to a lesser degree to corporate credit growth. MDB administered COVID-19 guarantee scheme has supported corporate credit extension. The pandemic impact on asset quality has so far been contained and mitigated by government support measures, with core banks’ nonperforming loans as a share of total loans increasing slightly to 3.85% in Q2 2021. While loan exposures to the most affected sectors could deteriorate as support is withdrawn, DBRS Morningstar notes that the loans still benefiting from the loan repayment moratoria represented only 0.3% of total outstanding loans to Maltese residents as of September 2021. Furthermore, Maltese core banks’ comfortable capital and liquidity levels should provide adequate buffers to absorb substantial losses or a liquidity stress. Finally, Malta’s macroprudential framework, including its borrower-based measures, should prevent financial vulnerabilities from building-up.

The repercussions from FATF’s grey-listing remains a source of risk. While Malta’s jurisdiction has improved materially its AML/CFT framework as reflected by Moneyval’s favourable assessment in May 2021, the grey-listing highlights short-comings on its effectiveness. Addressing 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. The private sector debt to GDP ratio has increased since the start of the pandemic, partially driven by the sharp contraction in nominal GDP in 2020. Nevertheless, financial risks are mitigated by a similar increase in the domestic savings ratio and the fact that the GDP denominator effect is expected to be reversed overtime. DBRS Morningstar makes a negative qualitative assessment to the “Monetary Policy and Financial Stability” building block to reflect the potential impact of Malta’s grey-listing on banks’ intermediation and economic activity while at the same time taking the view that financial risks have remain broadly unchanged despite the increase in the private indebtedness ratio.

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

Malta entered the current crisis after a period of sizeable current account surpluses on the back of strong performance of 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 and sizable primary income net outflows. The pandemic and the measures to control its spread, including travel bans, abruptly halted a prolonged period of growth in inbound tourism to Malta as the number of inbound tourists slumped by 76.1% in 2020. The substantial deterioration in the travel balance was the primary factor behind the shift in the current account to a 2.9% deficit in 2020.

The vaccination rollout across Europe, especially brisk in Malta, and the easing of travel restrictions permitted a stronger rebound in tourist arrivals to the country this Summer. Nevertheless, inbound tourism remained subdued in January to September 2021 at only 27.5% of 2019 levels for the same period, and 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 to return to a small surplus in 2023. From a stock perspective, Malta’s net international investment position stood at 58.0% of GDP in Q2 2021. Gross external indebtedness is very high at 673.4% of GDP in Q2 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 relatively strong and broadly in line with those of the EU average, with the exception of ‘Control of Corruption’ where the country exhibits a weak performance. The Maltese authorities have made significant progress to improve the governance and institutional framework in recent years, rebalancing the power of the Prime Minister, the President and the Judiciary, which previously was more concentrated in the figure of the Prime Minister. The reform of the appointment/removal procedures for judges and magistrates, the split of the Attorney-General’s prosecution and advocacy roles, and reforms to the police force are some examples. While the European Commission has commended Malta for the progress of its reforms, it also noted that there is scope for further progress in its implementation towards strengthening the independence of the judiciary and ensuring effective criminal prosecution. These shortcomings have led to a negative qualitative assessment of the “Political Environment” building block. General elections are scheduled to take place during 2022. DBRS Morningstar currently does not expect a significant shift in economic or fiscal policy as consequence.

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 28,930 in 2020 compared with its euro area peers. Malta’s ranking in the World Bank’s governance indicators for ‘Control of Corruption’ and ‘Rule of Law’ have been deteriorating in recent years. Also, the FATF’s decision to grey-list Malta in June 2021 underscores significant deficiencies in the effectiveness of its AML/CFT framework. 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/389531.

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 https://www.dbrsmorningstar.com/research/381451/global-methodology-for-rating-sovereign-governments (July 9, 2021). 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 (Draft Budgetary Plan
2022; Malta’s Recovery & Resilience Plan; Update of Stability Programme 2021–24), Central Bank of Malta (Outlook for the Maltese Economy 2021:3; Interim Financial Stability Report 2021; Economic Update 11/2021), Malta National Statistical Office (NSO), Malta Financial Services Authority, Moneyval, FATF, European Commission (Analysis of the Recovery and Resilience Plan of Malta; Autumn 2021 Economic Forecast; 2020 European Semester: Country Report), The Social Progress Imperative (2021 Social Progress Index), European Centre for Disease Prevention and Control, European Central Bank, Eurostat, International Monetary Fund, World Bank, 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/389530.

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: July 9, 2021

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