DBRS confirms Republic of Malta at A, Stable Trend

DBRS Ratings Limited has confirmed the Republic of Malta’s long-term foreign and local currency issuer ratings at A and its short-term foreign and local currency issuer ratings at R-1 (low).

The A rating reflects Malta’s Eurozone membership, which ensures reliable access to European markets, fosters strong and credible macroeconomic policies and makes available financial facilities from European institutions.

The country’s solid external position also supports Malta’s ratings, together with a favourable public debt structure and the robust financial position of households.

However, Malta’s public finances remain a source of vulnerability and its economy is exposed to external shocks, particularly those emanating from within the EU.

Furthermore, pressures from the rising costs of Malta’s ageing population, if unaddressed, could pose a concern for the pensions system.

The Stable trends reflect DBRS’s assessment that risks to the ratings are broadly balanced. The ongoing improvement in the fiscal position and strong economic performance counterbalance Malta’s fiscal vulnerabilities and the potential impact from a slowdown in European economies.

The expansion of trade and travel links with Europe – with Malta serving as an access point to the region after it joined the European Union in 2004 and adopted the euro in 2008 – have provided a boost to the country’s economy. Higher employment generated by trade and tourism have increased national income.

Malta’s economy is among the fastest growing in the euro area and its growth prospects look favourable. Fiscal, monetary and financial policy institutions have also strengthened in line with the EU Stability and Growth Pact.

Malta’s solid external position is another credit strength. The current account surplus has averaged 3.9% of GDP in 2011-2015. The country is also a net external creditor, with a net external asset position of 27.7% of GDP on average over the same period.

Although the import content of investment remains high, this has declined, and the current account surplus is supported by large services exports.

Malta’s low reliance on external financing has supported its resilience in recent years. The core domestic banking sector is conservatively funded by domestic retail deposits and the government meets its financing requirements domestically.

Malta’s public debt composition and structure also provide support to its rating. The Maltese Treasury has followed a strategy of lengthening the maturity of government debt in recent years. The average maturity of government bonds was 9.8 years in January 2017, which compares favourably to other European economies. Moreover, financially sound households and the stable financial system have been reliable sources of funding.

Maltese households enjoy high levels of savings and moderate indebtedness. Household net financial assets are sizable at 187% of GDP. Household debt, largely in the form of mortgages, has increased, but it remains moderate.

Prudent lending practices have prevented Malta from building up the significant financial imbalances that have afflicted other Eurozone countries. Private consumption growth is consequently quite resilient.

Some of Malta’s credit challenges are associated with the exposure of its public sector and the still moderately high, albeit declining, level of public debt. Government has historically extended guarantees to several large state-owned enterprises that have faced financial difficulties or could not provide adequate collateral.

The degree of concentration in the domestic financial sector could also be a source of contingent liabilities.

Although the restructuring of some of the SOEs has reduced risks to the public sector balance sheet, and the overall financial condition of the core domestic banks looks strong, the public sector remains vulnerable to debt shocks. Public debt is still moderately high compared to the size of the economy, but it is declining and estimated at just below 60% of GDP in 2016.

Malta’s tourism sector and other industries that rely on foreign demand also expose the economy to unfavourable external developments. Tourism benefits from a market of wealthy European economies, but it could be adversely affected by an economic downturn in the region.

Malta is exposed to a slowdown in the UK economy, as British tourists account for 30% of Malta’s total tourists.

Shocks to external demand could also have an impact on domestic real estate prices, with potential adverse implications for household finances. The increasing diversification of the economy, nevertheless, helps mitigate some of the risks from external shocks.

Finally, pressures from age-related costs present another challenge for Malta. Healthcare costs and pension liabilities, while still below EU averages, have increased rapidly in recent years and demographic trends appear unfavourable.

Labour-market participation is rising, thanks to recent reform efforts, but remains among the lowest in the EU, particularly among women and older workers. Pension reform measures are also being implemented. This should help secure the long-term sustainability of the system, but the overall impact of the measures is still to be assessed.

Rating drivers

Continued progress on fiscal consolidation and a material reduction in public indebtedness could put upward pressure on the ratings.

Successful implementation of reforms to improve the efficiency of the public sector, boost private sector investment and increase further labour force participation could also have a positive effect.

On the other hand, the emergence of additional contingent liabilities, from state-owned enterprises or the financial sector, could have adverse implications for Malta’s ratings.

Large or prolonged external shocks could also pose downside risks.