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 risks to the ratings remain balanced. The Maltese economy has recovered faster than previously anticipated from the Coronavirus Disease (COVID-19) pandemic shock, despite a partial revival in foreign tourism in 2021. DBRS Morningstar expects Malta’s economic outlook to remain solid, benefitting from a fuller return of foreign tourism, a healthy private-sector balance sheet, sustained fiscal support, and European funds.
However, the potential economic impact from Russia’s invasion of Ukraine and, to a lesser extent, the evolution of the coronavirus cloud Malta’s economic outlook. While the country has limited trade and energy links with Russia and Ukraine, Malta remains vulnerable to the impact of the conflict through weaker external demand, higher inflation, and tighter monetary policy conditions. On the other hand, DBRS Morningstar takes the view that the Financial Action Task Force’s (FATF) initial determination that Malta has substantially completed its action plan mitigates the risks associated with Malta’s inclusion in its list of jurisdictions under enhanced monitoring, the so-called grey-list.
Malta’s strong fiscal performance and debt-ratio reduction efforts before the pandemic created valuable headroom to support the economy. While the economic recovery is helping to rebalance fiscal metrics after the severe deterioration in 2020, the measures to deal with the effects of COVID-19 and to mitigate the impact from inflation continue to weigh on public finances. Nevertheless, Malta’s cost of funding remains favourable and DBRS Morningstar expects a gradual return to a healthier fiscal position, supported by the growth outlook and the expected phaseout of temporary measures.
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 if the pandemic situation were to worsen.
Similarly, Malta’s attractiveness to foreign investment could suffer if measures to address 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 its attractive tax system to foreign companies, or increasing age-related spending.
RATING DRIVERS
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 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) 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
Maltese Economic Outlook Remains Sound, But Clouded By Geopolitical and Pandemic Risks
Malta’s economic performance prior to the pandemic was remarkable. Annual GDP growth averaged 7.0% from 2013 to 2019 with strong job creation and a shrinking GDP per capita gap with the European Union (EU). The pandemic had a massive impact on the Maltese economy, with GDP contracting by 8.3% in 2020 due to the collapse in tourism-related activities and private consumption. Despite a partial rebound in foreign tourism, the recovery was faster than anticipated last year. GDP grew by 10.4% in 2021, mostly driven by the strong rebound in domestic demand. The continued fiscal support, accumulated savings, and greater confidence created the conditions for a solid comeback in private consumption and investments as the economy reopened in 2021. DBRS Morningstar considers that the strong performance of the financial and gaming sectors thus far mitigate concerns over the impact of FATF’s grey-listing on activity. Also, the labour market remained stable throughout the pandemic, benefitting from government support measures, especially the wage compensation scheme. The unemployment rate stood at 3.2% in Q4 2021, below Q4 2019 levels, and employment continued to increase during the pandemic.
As a small and open economy, Malta is vulnerable to the effects of Russia’s invasion of Ukraine principally because of its impact on European demand and higher inflationary pressures. The government’s efforts to lessen the impact of inflation on the private sector, mainly through fuel and energy subsidies, have helped to keep inflation below euro area levels, albeit still high. Malta’s HICP inflation stood at 5.4% YoY in April 2022, compared with 7.4% YoY at the euro-area level. Malta’s direct exposure to both Russia and Ukraine is limited, ranking last in the EU in terms of vulnerability to the conflict according to the European Commission (EC) Member States’ vulnerability matrix. Trade links with Russia and Ukraine are very small, with the combined exposure accounting for less than 1% of total exports and imports. In addition, Malta does not import oil and gas from Russia. However, Malta is indirectly exposed via its electricity imports from Italy, which relies heavily on Russian gas.
DBRS Morningstar takes the view that Malta’s economic growth will remain robust in coming years, despite the intensified risks and dampening effect from the conflict in Ukraine. The government revised its growth projections downward to 4.4% for 2022 and 3.9% for 2023 in its latest Stability Programme compared with 6.5% for 2022 and 4.7% for 2023 projected last Autumn. These projections have been endorsed by Malta’s fiscal council and are broadly in line with the EC’s “Spring 2022 Economic Forecast”. Households’ relatively strong balance sheet and a tight labour market mitigate the negative effects of inflation on consumption. Public investment will remain supportive, boosted by the European funds, and foreign tourism should recover strongly even under conservative assumptions. At the moment, the main downside is linked to a further deterioration in external conditions and inflationary pressures. Higher or more persistent inflation in Europe, and in Malta, could further dampen growth and lead to tighter monetary policy. On the other hand, a faster-than-expected recovery in foreign tourism could lead to a significantly faster overall economic recovery, given the importance of the industry for Malta.
Economic Recovery Helps Fiscal Rebalancing, But Support Measures Still Weigh On Public Finances
Malta’s fiscal performance improved significantly in the years before the pandemic hit. Malta recorded fiscal surpluses averaging 1.8% of GDP between 2016 and 2019 thanks to a buoyant economy, improved spending efficiency, lower interest payments, and proceeds from the Individual Investor Programme since its introduction in 2014. The collapse in activity in 2020 triggered by the pandemic and the government’s response severely weakened the fiscal result to a deficit of 9.5% of GDP in 2020 from a surplus of 0.6% of GDP in 2019. The extension of coronavirus-related support and the introduction of measures to shield the private sector from higher energy costs kept the fiscal deficit elevated at 8.0% of GDP in 2021, although significantly below the government’s projection of 11.1% of GDP in Autumn 2021 thanks to higher-than-expected fiscal revenues. According to the Central Bank of Malta’s calculations, the fiscal cost of the coronavirus support measures amounted to 5.0% of GDP in 2020 and to 4.2% of GDP in 2021, with the wage supplement scheme accounting for more than half of it. Other measures affecting the deficit included higher healthcare spending, a temporary reduction in the property transaction tax, and a voucher scheme, which were complemented by tax deferrals and a state guarantee scheme with no immediate fiscal cost.
The government plans to reduce the fiscal deficit to 5.4% of GDP in 2022, driven by higher taxation revenues benefitting from an ongoing recovery and the phaseout of coronavirus expenditures. The phaseout of coronavirus support in 2022, shrinking to 1.6% of GDP from 4.8% of GDP, is expected to more than compensate for the 1.4% of GDP support aimed at shielding the private sector from higher global energy and food prices in 2022. The government remains committed to bringing the fiscal deficit below 3.0% of GDP by 2024 through a combination of higher activity, gradual withdrawal of extraordinary support, and structural adjustment measures.
DBRS Morningstar views the government’s fiscal plan as credible given Malta’s track record of fiscal reduction before the pandemic, but significant uncertainties persist. The macroeconomic risks remain a source of uncertainty, given the lingering pandemic and geopolitical risks to activity and inflation. Persistently high inflation will put additional pressures on public expenditures, through the cost-of-living adjustment, and could lead the government to introduce or extend measures to protect the private sector. Similarly, 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 widen the deficit in coming years. On the other hand, stronger economic performance 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. This 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 EC is currently challenging, DBRS Morningstar considers the authorities’ prudent management of the revenue windfalls from the scheme and conservative revenue assumptions in its fiscal plan as mitigants against 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. The ultimate impact on future corporate revenues will depend on final details and could be offset, at least partially, by new fiscal measures.
Deterioration in Public Debt Ratio Has Stabilised And Remains Manageable
Prior to the onset 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 53.4% of GDP due to the higher financing needs and nominal GDP losses triggered by the pandemic, but still remained well below the 90.0% of GDP for the EU. A better-than-expected economic and fiscal performance resulted in a lower-than-anticipated debt ratio of 57.0% of GDP in 2021 compared with 61.3% of GDP as the government previously projected. Authorities project the public debt ratio to peak around 59.4% of GDP in 2023 and to start to decline afterwards. Similar to other euro-area economies, the yield on Malta’s 10-year government bond rose to 2.0% in May 2022 from 0.7% in December 2021, pressured by higher inflation and the prospect of tighter monetary policy. DBRS Morningstar notes, however, that overall funding costs remain favourable and the nominal GDP growth-interest rate differential remains conducive to debt reduction.
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 state-owned enterprises outside the general government. Also, there could be calls on guarantees covering loans granted by the Malta Development Bank. 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 And Grey-listing Impact Contained
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. 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 noncore 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 19.2% in Q4 2021, and ample liquidity levels provide adequate buffers on aggregate to absorb substantial losses or liquidity stresses. In addition to a strong policy response, this has helped core domestic banks to withstand the pandemic-related shock. Core banks’ profitability levels (as measured by return on equity) improved during 2021, in part benefitting from lower loan-loss provisioning. The impact of the pandemic on asset quality has remained limited thanks to the government’s support measures, with core banks’ nonperforming loans as a share of total loans increasing slightly to 3.4% in Q4 2021 from 3.2% in Q4 2019. Some deterioration in asset quality could occur in the future as the government withdraws coronavirus-related support and European growth faces headwinds posed by higher energy prices and tighter financial conditions. Malta’s healthy labour market outcomes and household savings mitigate these risks. In addition, DBRS Morningstar views positively Malta’s macroprudential framework, including its borrower-based measures, which should help to prevent financial vulnerabilities from building up.
The risks associated with FATF’s grey-listing have moderated in light of FATF’s initial determination in February 2022 that Malta has substantially completed its action plan. This reflects Malta’s progress in terms of ensuring the accuracy of beneficial ownership information, increasing the Financial Intelligence Analysis Unit’s focus on the analysis of criminal tax and related money laundering cases, and the use of this intelligence to support law enforcement authorities in pursuing these cases. Malta could be removed from the grey-list as soon as this June if the FATF plenary confirms that sufficient progress has been made in implementing the reforms and that political commitment to continue and improve them remains in place. DBRS Morningstar takes the view that continuing to address anti-money laundering 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 adjustment to the Monetary Policy and Financial Stability building block to reflect the concerns associated with Malta’s grey-listing, although this risk has somewhat diminished.
Partial Recovery In Tourism Continues To Weigh on Current Account, But Malta’s External Position Remains Solid
DBRS Morningstar considers that the improvement in Malta’s external position since the global financial crisis, driven in part by the strong performance of its service exports, mitigates the risks associated with the deterioration in its current account balances generated by the pandemic shock and, more recently, higher energy prices. 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. From a stock perspective, Malta’s net international investment asset position stood at 52.4% of GDP in Q4 2021. Gross external indebtedness was very high at 641.1% of GDP in Q4 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.
After a prolonged period of growth in inbound tourism to Malta, the pandemic caused a collapse of tourist arrivals to the country. Tourist arrivals represented only 23.7% in 2020 and 34.9% in 2021 compared with 2019 levels, which was reflected in a substantial decline in the travel balance surplus to 1.8% of GDP in 2020 and 3.1% of GDP in 2021 from 8.7% of GDP in 2019. The deterioration in the travel balance in both years as well as higher imports associated with the recovery and one-off investment in the aviation sector in 2021 were behind the shift in the current account to a deficit of 2.9% of GDP in 2020 and 5.8% of GDP in 2021 from a surplus of 5.0% of GDP in 2019. While the terms of trade shock, exacerbated by Russia’s invasion of Ukraine, could weigh on the goods trade balance, the expected recovery in the tourism sector should help Malta rebalance its external accounts over time.
Stable Policy Environment, But Further Scope to Strengthen Governance
Obtaining 55.1% of total votes in the March 2022 general election, the Labour Party won a third consecutive term in office, paving the way for incumbent Prime Minister Robert Abela to remain in office for the 2022–27 period. This reinforces DBRS Morningstar’s expectation for broad policy continuity and continued political commitment to improve the country’s institutional and governance overall framework in the coming years.
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. DBRS Morningstar views positively the significant progress that Maltese authorities have made to improve the governance and institutional framework in recent years, including the reforms in the judicial appointments, the split of the Attorney-General’s prosecution and advocacy roles, and the reforms to the police force. However, DBRS Morningstar makes a negative qualitative adjustment to the Political Environment building block to reflect its view that there is scope for further progress in Malta’s effort to strengthen the independence of the judiciary and to ensure effective criminal prosecution, which still separates Malta from other sovereigns with very strong assessments in this particular building block.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Social (S) Factors
The Human Capital and Human Rights factor affects the rating. DBRS Morningstar considered this factor 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 33,329 in 2021, still below the levels of the highest income economies in the EU.
Governance (G) Factors
The Institutional Strength, Governance and Transparency factor affects the rating. DBRS Morningstar considered this factor within the Monetary Policy and Financial Stability and the Political Environment building blocks. 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 scope for further progress in the government’s efforts to strengthen the independence of the judiciary and ensure effective criminal prosecution. In addition, the FATF’s decision to grey-list Malta in June 2021 underscores significant deficiencies in the effectiveness of its AML/CFT framework that authorities are committed to address.
