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

DBRS Ratings GmbH (DBRS Morningstar) confirmed the Republic of Malta’s (Malta) Long-Term Foreign and Local Currency – Issuer Ratings at A (high). At the same time, DBRS Morningstar confirmed 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 the risks to the ratings remain balanced. After a sharp contraction in 2020, Malta recovered strongly from the Coronavirus Disease (COVID-19) pandemic shock and growth momentum continued throughout 2022. The impact from Russia’s invasion of Ukraine on the Maltese economy has thus far remained limited, in part because of Malta’s low economic and energy ties with both countries, its energy stabilisation measures, and a stronger-than-expected foreign tourism rebound this year. Growth is set to slow down in 2023, reflecting weaker external demand, high inflation reducing real incomes, and tighter financial conditions; however, Malta should significantly outperform most of its European peers in terms of economic growth. On the other hand, Malta’s sizeable energy price stabilisation package will slow down the reduction in its public deficit, which will remain among the highest in the European Union (EU) in spite of strong revenue growth and the phase-out of coronavirus support. While the size of the package will depend on the evolution and the duration of the energy crisis, DBRS Morningstar considers that Malta’s still-moderate public debt levels and positive growth dynamics mitigate the risks. On a positive note, the Financial Action Task Force’s (FATF) decision to remove Malta from its list of jurisdictions under enhanced monitoring, the so-called “grey list”, in June 2022 reflects the country’s significant progress in improving its Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) framework and effectiveness.

Malta’s euro area 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. The country’s rapid removal from FATF’s grey list, combined with a continued commitment to enhance its AML/CFT and institutional governance setup, should limit any long-lasting damage to Malta’s reputation and its attractiveness to foreign investment. Despite Malta’s sound public finances, medium- to long-term challenges could stem from its contingent liabilities, changes in international taxation affecting its attractive tax system to foreign companies, or increases in age-related spending.

RATING DRIVERS
DBRS Morningstar could upgrade Malta’s ratings if one or a combination of the following occur: (1) a sustained material reduction in the public debt ratio, driven by sound fiscal management and economic performance; or (2) further evidence of increased economic and fiscal resiliency to external shocks. DBRS Morningstar could downgrade Malta’s 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 material deterioration in Malta’s medium-term growth; or (3) reversal of improvements in Malta’s financial crimes and institutional quality reforms.

RATING RATIONALE
Malta Economic Performance Remains Strong, but Decelerating Amid Global Energy Shock

Malta’s economic performance prior to the pandemic was remarkable. Annual GDP growth averaged 7.2% from 2013 to 2019 with strong job creation and a shrinking GDP per capita gap with the EU. After a pandemic-induced GDP contraction of 8.6% in 2020, Malta recorded one of the quickest recoveries in the EU with GDP growth rates of 11.7% in 2021 and 7.6% year over year during the first three quarters of 2022. The government support measures have played a key role in shielding the private sector from the pandemic and energy shocks as well as limiting potential persistent effects. In this sense, employment continued to increase during 2020 and 2021, partly because of the wage compensation scheme, and the unemployment rate stood at 2.9% as of Q2 2022. The government’s energy support package, including tax cuts and subsidies, have kept the prices of gas, fuel, and electricity stable. While the muted energy inflation in Malta has reduced the inflationary pressures and eased concerns over more long-term competitiveness and productive capacity erosion, the harmonised index of consumer price inflation nonetheless accelerated to 5.9% during the first ten months of 2022 from 0.7% in 2021. This increase mostly reflects the impact of higher import prices for food and non-energy goods and freight costs.

Malta has thus far experienced a limited impact from Russia’s invasion of Ukraine, in part because of Malta’s reduced economic and energy ties with both countries as well as its energy stabilisation measures. The government projects GDP to grow by 6.0% in 2022, mostly because of private and public consumption as well as the positive contribution from net exports supported by the stronger-than-anticipated recovery in foreign tourism. The government expects growth to decelerate to 3.5% in 2023, which reflects the impact of weaker external demand, a looming risk of recession in Europe, and high inflation affecting real incomes in the country. The main downside risks are linked to a further deterioration in external conditions, new supply chain bottlenecks, and more permanent inflationary pressures leading to tighter monetary policy. On the other hand, Maltese households’ relatively strong balance sheet and a tight labour market mitigate the negative effects of inflation on consumption. Public investment, boosted by the European funds, should remain supportive going forward.

Economic Recovery Helps Fiscal Rebalancing, but Support Measures Still Weigh on Public Finances

Before the pandemic’s onset, Malta’s fiscal performance improved significantly thanks to a buoyant economy, improved spending efficiency, lower interest payments, and proceeds from its Individual Investor Programme since its introduction in 2014. Malta recorded fiscal surpluses averaging 1.8% of GDP between 2016 and 2019. The collapse of activity in 2020 and government measures to cushion the blow from the pandemic severely weakened the fiscal outcome to a deficit of 9.3% of GDP in 2020. Despite stronger-than-expected revenues, the deficit remained high at 7.6% - the highest in the EU - in 2021, due to the extension of coronavirus support measures (including the wage support scheme). In its Draft Budgetary Plan for 2023, the government projects that the deficit will decline but remain elevated at 5.8% of GDP in 2022 and 5.5% of GDP in 2023, despite the phaseout of coronavirus support measures and buoyant revenues. This results from the government’s ample support to deal with the economic and social consequences of higher global energy and food prices with a budgetary cost of 2.7% of GDP in 2022 and 3.6% of GDP in 2023, especially through subsidies to state-owned companies Enemalta plc and Enemed Co Ltd.

The government remains committed to bringing the fiscal deficit below 3.0% of GDP by 2025 through a combination of higher activity, gradual decline of the energy-related subsidies, reduced intermediate consumption, and structural adjustments of around 1.3% of GDP on average in 2024 and 2025. DBRS Morningstar views the government’s fiscal plan as credible given Malta’s track record of fiscal reduction before the pandemic, although the duration and severity of the energy and inflationary shocks remain uncertain. Additional support to state-owned enterprises, including the national airline Air Malta, and potential calls on the Malta Development Bank-administered loan guarantee scheme could also weigh on public finances in coming years. On the other hand, stronger economic performance and/or lower energy subsides if energy prices remain below those assumed by the government could lead to a faster rebalancing path.

Over the medium to long term, revenues from Malta’s citizenship by investment scheme and corporate taxation could come under pressure and require Malta to introduce compensatory measures to fill the gap, which accounts for DBRS Morningstar’s negative qualitative adjustment of the Fiscal Management and Policy building block. In relation to the citizenship by investment programme, which the European Commission (EC) is currently challenging, DBRS Morningstar considers the authorities’ prudent management of the scheme’s revenue windfalls and the conservative revenue assumptions in its fiscal plan as mitigants to the risks. An overhaul of the global corporate tax system could reduce Malta’s tax regime attractiveness to investors and erode its corporate tax base, although final details and timeline remain unclear yet. Finally, while Malta has already extended the working age and contribution periods in its healthcare system as well as strengthened the pension system, additional measures might be necessary to contain the costs of age-related spending on these systems.

Deterioration in Public Debt Ratio Has Stabilised and Remains Manageable

The pandemic halted a period of steep reductions in Malta’s public debt-to-GDP ratio to 40.3% at the end of 2019 from 70.0% at the end of 2011. Since 2019, the country’s public debt ratio has deteriorated rapidly due to the economic conditions as well as the government’s sizeable response to the pandemic and energy shocks. However, DBRS Morningstar highlights that Malta’s public debt ratio, which stood at 55.2% of GDP at the end of 2021, still remained below the Maastricht benchmark of 60.0% of GDP and well below the EU’s aggregate 87.9% of GDP. In its Draft Budgetary Plan for 2023, the Maltese government projects that the debt ratio will increase gradually to 59.1% of GDP in 2023 and hover around 60.0% in 2024 and 2025. While the fiscal deficit will likely remain among the largest in the EU, Malta’s positive differential between nominal GDP growth and interest rates will help to stabilise its debt ratio. Similar to other euro area economies, Malta’s 10-year government bond yield increased rapidly this year to 3.54% at the end of October, 280 basis points higher than one year ago, mostly reflecting the European Central Bank’s (ECB) benchmark increases and the expectation of further tightening ahead. In the context of higher rates and decelerating nominal growth, returning to a declining public debt ratio will require faster improvement in Malta’s budgetary balance.

Potential risks to the public debt ratio in the near to medium term 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 state-owned enterprises outside the general government, including Air Malta.

Financial System Remains Sound and Rapid Exit from Grey List Reduces Reputational Damage

Malta’s role as a small financial hub resulted in the development of a large banking system relative to its domestic economy. Core domestic banks mostly follow a traditional business model based on retail deposits for funding and its main exposure to the real estate market. The international banks and domestic noncore banks have few or no linkages to the domestic economy. The Maltese banking system overall has limited links to the Russia and Ukraine.

The Maltese core domestic banks’ positions of strong capital (i.e., a Tier 1 capital ratio of 18.6% in Q2 2022) and ample liquidity levels provide adequate buffers to absorb substantial losses or liquidity stresses. The pandemic’s impact on the real estate market and on banks’ asset quality has been contained thanks to the government’s support measures, including tax incentives spurring real estate transactions, a quick economic recovery, and a tight labour market. Core banks’ nonperforming loans as a share of total loans stood at 3.1% in Q2 2022. The higher ECB benchmark interest rates should ease Maltese profitability pressures if asset quality holds up, given the predominance of variable rate mortgages and banks’ ample liquidity. On the other hand, the slowdown in economic activity, high inflation, and tighter financial conditions could lead to some deterioration in asset quality going forward. So far, the pass-through of higher key ECB interest rates to lending rates has been limited in Malta, but households and businesses are expected to face higher interest rates in the coming months. Malta’s healthy labour market outcomes and household savings mitigate these risks. In addition, DBRS Morningstar views Malta’s macroprudential framework, including its borrower-based measures, positively as they should help to prevent financial vulnerabilities and limit credit to vulnerable borrowers.

Malta’s exit from the FATF’s grey list reflects the country’s significant progress and political commitment to maintaining high standards for AML/CFT. In DBRS Morningstar’s view, the relatively short time that Malta was greylisted reduce the concerns over the reputational damage to its banking system as well as the strains on its banks’ correspondent banking relationships. DBRS Morningstar made a negative qualitative adjustment to the Monetary Policy and Financial Stability building block to reflect its view of Malta’s relative positioning compared to other larger and more sophisticated financial systems in this building block, but decided to reduce its magnitude to reflect its lower concerns over potential long-lasting effects of the greylisting.

The Recovery in Foreign Tourism Helps Offset the Negative Terms of Trade Shock on External Accounts

DBRS Morningstar considers that Malta’s improved external position since the global financial crisis mitigates the risks associated with the deterioration in its external accounts caused by the pandemic and high energy prices. Between 2014 and 2019, the current account surplus averaged 4.0% of GDP, with net exports of services (including travel, financial, professional, and gaming) more than offsetting the large deficit in goods and sizeable primary income net outflows. The sharp deterioration in the travel balance during 2020 and 2021 as the pandemic collapsed foreign tourist arrivals to Malta coupled with a one-off investment in the aviation sector in 2021 resulted in the current account deficits of 2.8% of GDP in 2020 and 4.5% of GDP in 2021. While the terms of trade shock stemming from soaring global energy prices is weighing on Malta's goods trade balance due to its reliance on energy imports, the recovery in the tourism sector should help the country rebalance its external accounts over time. In fact, tourist arrivals have been recovering faster than expected this year, reaching 80.6% of the level in the corresponding period of 2019 during the first nine months of 2022.

From a stock perspective, Malta’s net international investment asset position stood at 46.0% of GDP as of Q2 2022. Gross external indebtedness was very high at 590.3% of GDP as of Q2 2022, but DBRS Morningstar considers the risks to the domestic economy to be limited because this level 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 and Regulatory Quality where the country exhibits a weak performance. DBRS Morningstar views Malta’s significantly improved governance and institutional framework in recent years positively, including the reforms to the justice system. However, DBRS Morningstar makes a negative qualitative adjustment to the Political Environment building block to reflect its view that there is room for further convergence towards other sovereigns with very strong assessments on this particular building block, including more tangible evidence of enhanced independence, efficiency, and effectiveness in the country’s judiciary and control of corruption.

Malta’s Labour Party victory in the general elections in March 2022 cemented the party’s third consecutive term in office for the 2022–27 period and ratified Robert Abela as Prime Minister. This reinforces DBRS Morningstar’s expectation for broad policy continuity and continued political commitment to improve the country’s institutional and governance framework in the coming years.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Social (S) Factors
The Human Capital and Human Rights factor affects the rating. DBRS Morningstar considers this factor significant and has taken it into account within the Economic Structure and Performance building block. Despite Malta's progress in narrowing the income gap with the EU average, the country's GDP per capita stood at USD 33,667 in 2021 according to the International Monetary Fund (IMF), which is still below the highest-income economies in the EU.

Governance (G) Factors
The Institutional Strength, Governance, and Transparency factor affects the rating. DBRS Morningstar considers this factor significant and has taken it into account within the Political Environment building block. Malta’s World Bank governance indicators are generally good, with the exemption of a relatively weak Control of Corruption score. While the EC commended Malta for its progress on reforms, the EC also noted that there is room for further improvement in the government’s efforts to strengthen the judiciary’s independence and to ensure effective criminal prosecution.

There were no Environmental factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments. https://www.dbrsmorningstar.com/research/407050.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in euros 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/401817/global-methodology-for-rating-sovereign-governments (August 29, 2022). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-andgovernance-risk-factors-in-credit-ratings (May 17, 2022) in its consideration of ESG factors.

The sources of information used for this rating include the Ministry for Finance and Employment (Draft Budgetary Plan
2023, October 2022; Malta’s Recovery and Resilience Plan, July 2021), Central Bank of Malta (Outlook for the Maltese Economy 2022:3, August 2022), Malta National Statistical Office, Malta Financial Services Authority, FATF (Jurisdictions Under Increased Monitoring – June 2022), EC (Commission Opinion on the Draft Budgetary Plan of Malta, November 2022; Autumn 2022 Economic Forecast, November 2022; 2022 Rule of Law Report, July 2022; 2022 European Semester: Country Report, May 2022), The Social Progress Imperative (2022 Social Progress Index), ECB, Eurostat, International Monetary Fund (WEO and IFS), 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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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: https://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/407049.

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 Global Sovereign Ratings
Initial Rating Date: April 3, 2015
Last Rating Date: June 10, 2022

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