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

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Republic of Malta's (Malta) Long-Term Foreign and Local Currency - Issuer Ratings at A (high). At the same time, Morningstar DBRS confirmed Malta's Short-Term Foreign and Local Currency - Issuer Ratings at R-1 (middle). The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
The Stable trend reflects Morningstar DBRS' view that the risks to Malta's credit ratings remain balanced. Growth dynamics in the Maltese economy remained strong in recent months. During the first half of 2024, real GDP expanded by 6.0% on a year-on-year basis, driven by strong external demand for service exports from tourism and other service industries. Moreover, domestic demand was bolstered by fiscal support measures for households and large inflows of foreign labour. While economic growth is projected to ease over the medium-term, it is likely to continue to outpace real GDP growth in most other EU countries. The Central Bank of Malta (CBM) forecasts real GDP to expand by 3.5% in 2025 and by 3.4% in 2026. At the same time, fiscal pressures remain comparatively large, reflecting the budgetary cost of support measures such as freezing domestic energy prices at pre-pandemic levels. The government seeks to narrow the general government budget deficit to 4.0% of GDP in 2024 from 4.6% in 2023. By 2027, the government seeks to attain the EU deficit target of 3.0% of GDP. The projected narrowing of budget deficits, however, is not based on a clear exit strategy for the untargeted energy subsidies but rather on the government's expectation that a decrease in global energy prices will reduce the fiscal cost of subsidies. Therefore, higher-than-expected energy prices constitute a downside risk for public finances.

Malta's A (high) rating is supported by its Euro area membership, solid external position, and the banking sector's strong capital buffers. Moreover, although public debt has increased in recent years, it is still moderate and compares favourably with most other Euro area countries. On the other hand, the small and open nature of the Maltese economy renders it vulnerable to external shocks. Furthermore, labour productivity levels are still comparatively low. In terms of governance, Morningstar DBRS views a further strong commitment by authorities to improve the Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) framework as crucial for protecting the international reputation of the banking sector.

CREDIT RATING DRIVERS
Morningstar DBRS could upgrade Malta's ratings if one or a combination of the following occurs: (1) a material improvement in the public debt trajectory driven by a prudent fiscal approach and strong economic performance; or (2) further evidence of increased economic and fiscal resiliency to external shocks. Morningstar DBRS could downgrade Malta's ratings if one or a combination of the following occurs: (1) a significant deterioration in the public debt trajectory, potentially driven by a prolonged period of fiscal underperformance or weak economic growth; or (2) a reversal of improvements in Malta's financial crimes and institutional quality reforms.

CREDIT RATING RATIONALE

Economic Growth Started to Moderate in Recent Months but Remains Comparatively Strong

Economic growth decelerated in recent months but remains much stronger than in most other Euro area countries. Real GDP expanded by 4.4% on a year-on-year basis in Q2 2024, down from growth rate of 7.6% in Q1 2024. Economic growth during the first half of 2024 was driven by rising service exports particularly from tourism, professional services and financial services. Furthermore, private consumption continued to grow at a robust pace, aided by strong employment growth and large energy subsidies. According to the statistical office's Labour Force Survey, total employment rose by 6.2% year-on-year in Q2 2024, driven by rising levels of foreign workers. Overall, labour markets remain tight with the harmonized unemployment rate standing at 3.0% in July 2024.

On an annual basis, the CBM forecasts real GDP growth to ease from 4.4% in 2024 to an, albeit still strong, 3.5% in 2025 as growth dynamics both for private consumption and for service sector exports are projected to moderate. In terms of 2024, Morningstar DBRS notes that annual real GDP growth is likely to be higher than forecast as these projections were based on national accounts data prior to the recent revision by the national statistical office which led to a large upward revision of real GDP growth in Q1 2024. While the growth outlook is favourable, the economy is exposed to downside risks such as an escalation of geopolitical tensions which might weigh on external demand for Maltese exports. In general, the ratings of Malta continue to be constrained by the small size of its service-driven economy, which renders it vulnerable to external shocks. Furthermore, while the inflow of European funds is projected to bolster growth prospects, infrastructure bottlenecks and still comparatively low labour productivity levels are likely to constrain potential growth.

The Government Budget Deficit is Large and Planned to be Reduced Gradually

Budgetary pressures are larger than in most other Euro area countries. In 2023, Malta's general government budget deficit amounted to 4.6% of GDP compared to an average of 3.6% for Euro area countries. Fiscal accounts were adversely affected by the continuation of energy subsidies, the fiscal cost of which is estimated at 1.4% of GDP in 2023, and support measures for the restructuring of Air Malta, the now-liquidated national airline. In July 2024, the European Council launched an excessive deficit procedure against Malta which forces the government to reduce its deficit below 3% of GDP over the next 4 years. The government's Medium-Term Fiscal Structural Plan which was published in September 2024 forecasts the general government budget deficit to decline gradually from 4.0% of GDP in 2024 to 3.0% in 2027.

Planned fiscal adjustment is aided by the phase-out of budgetary support measures to Air Malta in 2024, strong revenue growth and a projected gradual decrease in the fiscal cost of energy subsidies over the next few years. Tax revenues increased markedly during recent months, supported by a favourable economic environment and recent administrative reforms which aimed at strengthening the efficiency of tax revenue collection. During the first eight months of 2024, government revenues from income taxes and VAT (on a cash basis) rose by 21.3% and 20.7%, respectively on a year-on-year basis. In terms of the energy subsidies, Morningstar DBRS notes that the projected decrease in fiscal costs does not result from a gradual exit from the untargeted energy subsidies but rather from the government's expectation that global energy prices will decrease gradually over the next few years. As a result, higher-than-expected energy prices constitute an important downside risk for fiscal accounts. Furthermore, 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 corrective measures to fill the gap. These three factors account for Morningstar DBRS' negative qualitative adjustment of the Fiscal Management and Policy building block assessment.

Public Debt Has Increased over the Past Years But Still Compares Favourably with EU Peers

The large fiscal deficits in recent years led to a marked increase in general government gross debt from 39.2% of GDP in 2019 to 47.3% in 2023. The latter debt level, however, still compares favourably with levels in most other EU countries and continues to provide the government with valuable space to support the economy if under stress. Looking ahead, the Medium-Term Fiscal Structural Plan forecasts general government debt to increase to 49.2% of GDP in 2024, reflecting a still large deficit and a positive stock-flow adjustment which largely relates to the government's capital injection into the new national airline KM Air Malta. Beyond, the government debt-to-GDP ratio is projected to peak in 2026 at 49.9% and to decrease modestly thereafter based on the assumptions of a narrowing fiscal deficit and still favourable debt dynamics. The interest burden is projected to increase but to remain moderate. The EC forecasts general government interest expenditure to rise from 1.1% of GDP in 2023 to 1.3% in 2025. In terms of financing, the government benefits from stable funding sources. According to Eurostat, around 78% of outstanding general government debt in 2023 was held by residents.

Domestic Banks Have Strong Capital Buffers But Are Exposed to Concentration Risks from The Housing Market

Financial stability in Malta is supported by strong capital and ample liquidity buffers of domestic banks. Furthermore, banks' profitability was boosted by higher net interest income over the past two years but is likely to moderate gradually over the next years. Asset quality metrics have improved moderately with the average NPL ratio of core domestic banks standing at 2.4% in Q2 2024, down from 3.1% two years earlier. Asset quality benefitted from a limited pass-through of higher interest rates on domestic lending rates. Furthermore, the repayment capacity of domestic borrowers was bolstered by household support measures and the favourable economic environment in recent years. Looking ahead, pockets of vulnerability for asset quality might arise from banks' sizeable loan exposure to the housing market, a large part of which relates to residential real estate. Loans related to housing purchases or other real estate activities accounted for a large 66% of total resident bank loans to the private sector in August 2024. While the recent introduction of a sectoral systemic risk buffer for residential mortgages raises banks' resilience to a potential shock, Morningstar DBRS notes that mortgage loan growth has so far remained strong.

In terms of the international reputation of the banking sector, Morningstar DBRS views a further strong commitment by authorities to improve the AML/CFT framework as crucial. Malta's significant progress on this front permitted the country to exit from the grey list of the Financial Action Task Force (FATF) in June 2022, just one year after being added to the list of jurisdictions under enhanced monitoring. Malta's role as a small financial hub has resulted in the development of a large banking system relative to its domestic economy, including international banks, and domestic noncore banks which have few or no linkages to the domestic economy. Morningstar DBRS applies a negative qualitative adjustment to the Monetary Policy and Financial Stability building block assessment to reflect its view on Malta's relative positioning compared with other larger and more sophisticated financial systems in this building block.

Current Account Surplus Is Projected to Rise Moderately in 2024

Malta's external finances benefit from strong external demand for service exports and a decrease in the energy import bill. The Central Bank of Malta forecasts the current account surplus to increase to 1.1% of GDP in 2024 from 0.9% in 2023 as the improvement in the goods and services balances more than offsets the deterioration in the primary income balance. Rising service exports are typically accompanied by higher deficits in the primary income balance due to dividend payments by special purpose vehicles and multinational companies operating in Malta. The operations of special purpose entities and multinational companies are also the main reason for the very large stocks of gross external assets and liabilities in the economy's international investment position (IIP). Total gross external assets and liabilities of residents in June 2024 exceed the economy's nominal GDP by factors of 31 and 30, respectively. On a net basis, the economy has maintained a large external creditor position over the past decade. Recently revised figures from the CBM show a NIIP of around 103% of GDP in June 2024. High gross external debt of 855% of GDP in June 2024 mainly reflects Malta's role as an international financial centre and the presence of very large levels of intercompany lending. Therefore, Morningstar DBRS considers its risk to the domestic economy to be limited.

Malta Benefits from a Stable Policy Environment but There Is Scope to Strengthen Governance

Malta's institutional quality benefits from strong national and EU policy frameworks. The Worldwide Governance Indicators for Malta are relatively strong and broadly in line with EU averages but compare weakly in terms of control of corruption. Malta has made significant progress in improving its governance and its institutional framework in recent years, including implementing reforms to the justice system. However, Morningstar DBRS considers that there is room for further convergence toward other sovereigns with very strong assessments on the Political Environment building block, including more tangible evidence of enhanced efficiency, and effectiveness in the country's judiciary and control of corruption. Policy continuity is high and Morningstar DBRS expects Prime Minister Robert Abela (Labour Party) to remain committed to improving the country's institutional and governance framework during the current legislature.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG Considerations had a significant effect on the credit analysis.

Social (S) Factors

The following Social factor had a significant effect on the credit analysis: Human Capital and Human Rights. Labour productivity is relatively low which can partly be ascribed to the important role of labour-intensive industries such as tourism. GDP per capita amounted to USD 38,674 in 2023. Respect for human rights is high, and there is widespread access to quality healthcare and other basic services. Malta ranks 27th among the 170 countries assessed in the 2024 Social Progress Index.

Governance (G) Factors

The following Governance factor had a significant effect on the credit analysis: Institutional Strength, Governance and Transparency. The country ranks broadly in line with the EU average in the Worldwide Governance Indicators for Voice and Accountability (83.6 percentile rank), Rule of Law (76.4 percentile rank), and Government Effectiveness (76.9 percentile rank), but compares weakly in terms of Control of Corruption (61.8 percentile rank). Furthermore, Malta's ranking for Control of Corruption, Rule of Law, and Regulatory Quality have been deteriorating in recent years. 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 relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://dbrs.morningstar.com/research/441099/.

EURO AREA RISK CATEGORY: LOW

Morningstar DBRS notes that this Press Release was amended on 15 October, 2024 to incorporate the phone number of the issuing office.

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 (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

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

The sources of information used for these credit ratings include the Ministry for Finance and Employment (Medium-Term Fiscal Structural Plan, September 2024), Central Bank of Malta (Outlook for the Maltese Economy 2024:3, August 2024; Financial Stability Report 2023, July 2024; Statistics), Government of Malta (Draft National Energy and Climate Plan 2021-2030, September 2023), Malta National Statistical Office (Labour Force Survey; Statistics), European Commission (European Economic Forecast, Spring 2024, May 2024; Analysis of the Recovery and Resilience Plan of Malta, July 2023; Rule of Law Report 2024, July 2024), European Central Bank, European Banking Authority, ESRB (Risk Dashboard, July 2024), Eurostat, European Environment Agency, Social Progress Imperative (2024 Social Progress Index), OECD, IMF (Malta: 2023 Article IV Consultation, January 2024; World Economic Outlook April 2024; International Financial Statistics), World Bank, BIS, International Energy Agency, Macrobond, Haver Analytics. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

Morningstar DBRS 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. Morningstar DBRS' outlooks and ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS 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 credit rating assumptions can be found at: https://dbrs.morningstar.com/research/441098/.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Yesenn El-Radhi, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: April 03, 2015
Last Rating Date: April 12, 2024

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