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 Malta’s ratings remain balanced. After a sharp contraction in 2020, Malta’s economy rapidly recovered from the shock of the pandemic, helped by the government’s support measures and a stronger-than-anticipated rebound in foreign tourism. The impact of the Russian invasion of Ukraine on the Maltese economy has been modest so far, partly because of Malta's limited economic and energy ties to Russia as well as the government’s decision to freeze retail electricity and fuel prices. Growth is expected to decelerate in 2023, driven by the slowdown in Europe and the effects of elevated inflation on purchasing power. Malta’s price-mitigating fiscal measures are also expected to slow the pace of fiscal consolidation. The fiscal deficit is expected to remain among the highest in the European Union (EU) during 2022 and 2023, in spite of strong revenue growth and the phase-out of coronavirus support. DBRS Morningstar considers that Malta’s still-moderate public debt levels and positive growth dynamics partly mitigate risks stemming from the fiscal outlook. Nevertheless, DBRS Morningstar notes that the government has so far not articulated a clear exit strategy for the untargeted energy subsidies, and a higher-for-longer global energy prices scenario could complicate the fiscal consolidation path.

Malta’s A (high) rating is supported by its euro area membership, moderate level of public debt, solid external position, and Maltese households’ strong financial position. On the other hand, Malta is a small and open economy, and therefore exposed to external demand or confidence shocks. On a positive note, the country’s rapid removal from Financial Action Task Force’s (FATF) list of jurisdictions under enhanced monitoring in June 2022, combined with a continued commitment to enhance its Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) and institutional governance setup, should limit any long-lasting damage to Malta’s reputation and its attractiveness to foreign investment. Malta’s public finances are generally sound, but medium- to long-term challenges could stem from its contingent liabilities, changes in international taxation that affect the attractiveness of its 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 occurs: (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 occurs: (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) a reversal of improvements in Malta’s financial crimes and institutional quality reforms.

RATING RATIONALE
Malta Economic Performance Remains Strong, Albeit Decelerating Amid a Challenging External Environment and High Inflation

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 11.8% in 2021 and 6.9% in 2022. The recovery was driven both by domestic demand and a stronger-than-anticipated rebound in foreign tourism last year. The labour market is tight, with strong job growth over the last three years and an unemployment rate at 3.0% (February 2023). The government’s support measures played a key role in helping the economy weather the pandemic and limiting potential scarring effects. The government’s energy support package, including subsidies to freeze energy and fuel prices at pre-pandemic levels, have also helped to shield economic activity from the spike in global energy prices. Still, the harmonised index of consumer price inflation accelerated to 6.1% in 2022 from less than 1.0% in both 2020 and 2021 on the back of strongly rising import good prices (particularly food).

Malta’s GDP growth is expected to decelerate in 2023 amid a wider economic slowdown for the country’s main trading partners and high inflation but avoid the near-term recessionary risks facing the euro area. The International Monetary Fund (IMF) projects growth in Malta to decelerate to 3.5% in 2023 and hover around 3.5%-3.6% between 2024 and 2027, which is broadly in line with the Central Bank of Malta’s projections for the period from 2023 to 2025. After a strong post-pandemic recovery, Malta’s structural labour shortages and infrastructure bottlenecks could pose a challenge to growth over time. In addition, Malta’s economic outlook remains exposed to a further deterioration in external conditions, an increase in global financial volatility, as well as more persistent 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 inflow of European funds, should also remain supportive of Malta’s growth outlook.

Support Measures to Deal With the Pandemic and Energy Shocks Have Led to a Deterioration in Malta’s Fiscal Position

The pandemic and energy shocks resulted in a significant fiscal deterioration after a period of fiscal surpluses averaging 1.8% between 2016 and 2019. The fiscal deficit reached 9.3% of GDP in 2020, driven by the slump in economic activity and the impact of the coronavirus measures. The deficit remained high at 7.5% in 2021, despite stronger-than-expected revenues, 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. According to the Update of Stability Programme 2022-2025, the budgetary impact of pandemic-related support is estimated to have dropped from 4.7% of GDP in 2021 to 1.6% in 2022, with the most of the remaining measures expiring in 2022. On the other hand, the measures to mitigate the impact of higher global energy and food prices are projected to have 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 on the back of higher activity, a gradual decline in the energy-related subsidies, and reduced intermediate consumption. 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 and an exit strategy from the energy subsidies remains unclear. 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 the coming years. On the other hand, stronger economic performance and/or lower energy subsides if energy prices remain below the government’s assumptions could lead to a faster rebalancing of the fiscal accounts.

Over the medium to long term, revenues from Malta’s citizenship by investment scheme and corporate taxation could come under pressure and require the country to introduce compensatory measures to fill the gap. These factors account for DBRS Morningstar’s negative qualitative adjustment of the Fiscal Management and Policy building block. DBRS Morningstar considers the authorities’ prudent management of the citizenship by investment scheme’s revenue windfalls and the conservative revenue assumptions in its fiscal plan mitigate the risks to the fiscal outlook. With respect to the impact of the planned global minimum corporate tax reform of 15% (Pillar II), the IMF estimates revenue losses at a manageable ¾ percent of GDP as only a few large multinational companies with global sales higher than EUR 750 billion are based in Malta. However, the ultimate impact remains unclear and will depend on the response of foreign companies to the changes proposed to corporate taxation internationally and in Malta, which still remains to be seen. 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 the Public Debt Ratio Has Stabilised and Remains Manageable

The pandemic halted a period of steep reductions in Malta’s public debt-to-GDP ratio. From 2011 to 2019, government debt-to-GDP fell from 70.0% to 40.3%. The economic recession and the government’s response to the pandemic drove the public debt ratio to 55.1% of GDP in 2021. Despite this deterioration, DBRS Morningstar highlights that Malta’s public debt ratio still remained below the Maastricht benchmark of 60.0% of GDP and well below the EU’s aggregate 87.9% of GDP. The Maltese government projects the debt ratio will gradually increase to 57.0% of GDP in 2022, 59.1% in 2023, and 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 the debt ratio. Similar to other euro area economies, Malta’s funding costs for newly issued debt have increased due to higher monetary policy rates and high inflation. The government projects the increase in the interest burden to GDP to remain manageable after almost two decades of steady declines, moving from 1.1% of GDP in 2021 to 1.6% in 2025.

DBRS Morningstar notes that the stronger-than-expected nominal GDP growth in 2022 and potentially lower energy subsidies in 2023, given the retrenchment in energy costs in recent months, could lead to an improvement in the debt metrics compared with the government’s projections. Conversely, debt dynamics could deteriorate if there is a sharp deterioration in Malta’s growth outlook or a 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 a Rapid Exit from the Grey List Reduces Reputational Damage

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 mostly follow a traditional business model based on retail deposits for funding and its main lending exposure is to the Maltese real estate market. The international banks and domestic noncore banks have few or no linkages to the domestic economy. Overall, the Maltese banking system has limited links to the conflict between Russia and Ukraine. While the recent global banking sector turmoil is a source of concern, Maltase banks’ strong capital and ample liquidity limit the risks.

The Maltese core domestic banks’ positions of strong capital (i.e., a Tier 1 capital ratio of 18.6% in Q3 2022) and ample liquidity levels provide adequate buffers to absorb substantial losses or liquidity stresses. The pandemic’s impact on banks’ asset quality has been contained thanks to a strong post-pandemic economic recovery and the government’s support measures. Core banks’ nonperforming loans as a share of total loans stood at 2.9% in Q3 2022. The higher European Central Bank’s (ECB) benchmark interest rates should ease Malta’s 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 over time. 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. Furthermore, Central Bank of Malta decided to set a Sectoral Systemic Risk Buffer of 1.0% by end September 2023 and 1.5% by end March 2024 to be applied on the amount of risk-weighted assets held against domestic mortgages exposures to natural persons and secured by residential real estate.

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 reduces concerns about the reputational damage to its banking system as well as the strains on its banks’ correspondent banking relationships. Nevertheless, DBRS Morningstar made a negative qualitative adjustment to the Monetary Policy and Financial Stability building block to reflect its view on Malta’s relative positioning compared with other larger and more sophisticated financial systems in this building block.

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

Between 2014 and 2019, Malta’s current account surplus averaged 4.9% 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 current account has deteriorated in recent years due to the deterioration in the travel balance amid the pandemic, as well as one-off investments in the aviation sector in 2021. The current account ran a surplus 2.2% of GDP in 2020 and 1.2% of GDP in 2021, before switching to a deficit in 2022 (-5.8% of GDP). The tourism industry recovered strongly last year, but it was offset by a widening energy trade balance, another one-off investment in the aviation sector, and strong domestic demand. Tourist arrivals recovered faster than anticipated in 2022, reaching 83.1% of the level in 2019, and are expected to recover to pre-pandemic levels in the coming years.

From a stock perspective, Malta’s net international investment asset position stood at 53.2% of GDP as of Q4 2022. Gross external indebtedness was high at 565.2% of GDP as of Q4 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 the presence of stable flows of intercompany lending.

Malta Benefits from a Stable Policy Environment but There Is 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 EU averages, with the exception of Control of Corruption and Regulatory Quality where the country exhibits a weaker performance. Malta has made significant progress in improving its governance and institutional framework in recent years, including implementing 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 toward 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.

Following Malta’s general election in March 2022, the Labour Party won a third 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 improving 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 ratings. DBRS Morningstar considered this factor significant and took 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 34,127 in 2022 according to the IMF, which is still below the highest-income economies in the EU.

Governance (G) Factors
The Institutional Strength, Governance, and Transparency factor affects the ratings. DBRS Morningstar considered this factor significant and took 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 at: https://www.dbrsmorningstar.com/research/412678.

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, in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The sources of information used for this rating include the Ministry for Finance and Employment (Draft Budgetary Plan 2023; Update of Stability Programme 2022-2025), Central Bank of Malta (Outlook for the Maltese Economy 2023:1; Statement of Decision on the Implementation of a Sectoral Systemic Risk Buffer on RRE Domestic Mortgages in Malta, January 2023), 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; 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 (2022 Article IV Consultation—Staff Report, 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. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/412679.

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: Michael Heydt, Senior Vice President, Global Sovereign Ratings
Initial Rating Date: April 3, 2015
Last Rating Date: December 9, 2022

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