Fitch Ratings – Frankfurt am Main – FitchRatings has affirmed Malta’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘A+’ with a Stable Outlook. Malta’s rating is supported by high per-capita income levels, a large net external creditor position and a pre-pandemic record of strong growth and sizeable debt reduction. These strengths are balanced against its large banking sector, the small size of its economy, which is highly vulnerable to external developments, and a recent deterioration in public finances with large fiscal deficits, which have led to a sharp increase in the moderate public debt burden.
The Maltese economy rebounded strongly in 2021, following a severe contraction in 2020. Real GDP rose by 9.4% in 2021, significantly exceeding our November forecast of 5.7%. Fitch has lowered its growth forecast to 4.2% from 6.1% for 2022 due to the stronger-than-expected 2021 recovery and (mostly) indirect effects from the invasion of Ukraine and imposed sanctions on Russia. Malta’s direct economic and energy ties to Ukraine, Russia and Belarus are limited but, as a small and open economy, Malta is highly exposed to the weaker economic outlook in key tourism markets in the EU and the UK. However, we expect Malta’s tourism sector to further recover this year as tourist arrivals remained 65% below their 2019 level in 2021. Private consumption and services exports are projected to further increase in 2022/23, albeit more moderately compared with our previous forecast.
Fitch projects that inflation will reach 4.1% in 2022, largely reflecting partial adjustments in HICP weights and higher services and food prices. Maltese households have so far remained largely unaffected by a sharp increase in international wholesale gas and electricity prices due to fixed-price purchase agreements, protecting real disposable incomes and private consumption. The government remains committed to limit the increase in energy prices. Government measures to control them include sizeable subsidies to the public utility company to cover the loss from keeping electricity prices stable and a reduction in excise duties for petrol and diesel. The government is also intervening in the food market to cap the increase in wheat prices.
Following a large fiscal deficit of 9.5% of GDP in 2020, Malta’s general government deficit narrowed marginally to 8% of GDP in 2021 (higher than the ‘A’ peer and eurozone current medians of 6.3% and 5.2% of GDP, respectively), despite a strong rebound in revenues. Fitch now expects a slower improvement in public finances, forecasting a fiscal deficit of 6.4% of GDP in 2022 and 5.5% in 2023, compared with our November forecast of 6.1% and 4.1%, respectively. Solid nominal GDP growth and a strong labour market will continue to support government revenues but government measures to mitigate the impact from inflation and support the economic recovery will lead to continued fiscal deficits in our baseline scenario. Pandemic-related measures will amount to EUR245 million (1.6% of GDP) in 2022 while another EUR210 million (1.4% of GDP) is budgeted to mitigate the impact from inflation on households and businesses.
General government debt increased to 57% of GDP, in line with the ‘A’ median of 56.6%. Malta has seen one of the largest increases in public debt since 2019 among ‘A’ rated peers with debt increasing by 16.3pp over the past two years (compared with 9.2pp for ‘A’ rated sovereigns). We expect that total general government debt will further increase to above 61% in 2023. Continued fiscal deficits are partially offset by strong nominal GDP growth and negative stock-flow adjustments.
Following the re-election of Malta’s governing Labour party on 26 March, the centre-left party continues to govern alone under Malta’s two-party political system. As part of the Resilience and Recovery Plan, the government has committed to strengthening the institutional framework, including the judicial and anti-money-laundering framework, and partly address the European Commission’s concerns over the availability of aggressive tax planning practices. Malta’s World Governance Indicators (WGI) continue to outperform the ‘A’ median but perceived weaknesses in the quality of Malta’s institutions and governance framework led to a sharp deterioration in 2019/ 2020 and WGI scores only partially recovered in 2021.
The Financial Action Task Force’s (FATF) decision in June 2021 to place Malta on its so-called greylist has not yet materially affected the Maltese economy, as evidenced by the strong economic recovery and continued strong performance of the large financial sector. Following an FATF on-site visit in April this year, the FATF could vote on whether to take Malta off its greylist during its next plenary meeting in June.
The Maltese household and banking sector should be relatively resilient to an increase in the ECB’s main policy rates. Fitch now expects the ECB to raise its main refinancing operations and deposit rate to 0.5% and 0%, respectively, before end-2022. Despite a prevalence of variable mortgage rate loans (93% of the total mortgage stock), Maltese households possess ample liquidity to relatively quickly pay off their debt burdens. Vulnerabilities to the financial sector are further mitigated by banks’ strong balance sheets, including solid capitalisation and low non-performing loans. The Central Bank of Malta introduced borrower-based measures to strengthen the resilience of lenders and borrowers against financial vulnerabilities back in 2019, including limits to the loan-to-value ratio and mandatory stress-testing of borrowers against an interest rate increase of 150bp.
Malta has an ESG Relevance Score (RS) of ‘5[+]’ for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Malta has a high WBGI ranking at 79.8, reflecting its long track record of stable and peaceful political transitions, well established rights for participation in the political process, strong institutional capacity, effective rule of law and a low level of corruption.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Public Finances: Continued upward trend in general government debt over the medium term, for example due to a more prolonged period of fiscal stimulus, weaker growth prospects or loss of key sources of revenues.
-Structural Features: Further deterioration in governance or banking supervision or concerns over wider financial sector transparency that could adversely impact Malta’s attractiveness as an investment destination.
-Macro: Weakening of the economic recovery, for example due to a setback in the revival of tourism
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– Public Finances: General government debt/GDP returning to a firm downward path over the medium term, for example due to sustained economic growth and/or fiscal consolidation
– Macro: Confidence that Malta can return to sustainable high GDP growth in the medium term, supporting a convergence of GDP per capita with that of higher-rated sovereigns.
-Structural Features: Further progress in addressing key weaknesses in governance, banking supervision and the business environment.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Malta a score equivalent to a rating of ‘A’ on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:
– Macro: +1 notch reflecting macroeconomic performance, policies and prospects. The positive notch adjustment offsets the deterioration in the SRM output driven by volatility from the pandemic shock, including on GDP growth. The deterioration of the GDP growth and volatility variables reflects a very substantial and unprecedented exogenous shock that has hit the vast majority of sovereigns, and Fitch believes that Malta has the capacity to absorb it without lasting effects on its long-term macroeconomic stability.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance.