DBRS confirms Republic of Malta at A, Trend changed to positive
DBRS Ratings Limited confirmed the Republic of Malta’s LongTerm Foreign and Local Currency – Issuer Ratings at A and its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trend on the ratings has been changed to Positive.
The rating is supported by Malta’s Eurozone membership, its solid external position, a favourable public debt structure and the robust financial position of households. However, Malta’s contingent liabilities remain a source of vulnerability, its economy is exposed to external shocks and pressures from the rising age-related costs, if unaddressed, could pose a concern for the pensions system.
Nevertheless, the Positive trend reflects DBRS’s view that the important improvement in the fiscal position over the past three years is likely to be sustained. A sound budget position, together with solid growth, is expected to lead to the further reduction in the public debt ratio.
Improvements in the Fiscal Management and Policy, Debt and Liquidity and Economic Structure and Performance sections of our analysis were the key factors for the trend change.
Following a fiscal consolidation process since 2013, Malta’s fiscal outturns came in better than expected in 2016. Both the head- line and the structural deficits turned into surpluses and the government debt ratio, already 12 percentage points lower than its 2011 peak, fell below 60% of GDP. The improvement in public finances has been driven by strong revenues as well as moderation in expenditure and supported by a strengthened fiscal framework. The fiscal over-performance also meant that Malta complied with the budget balance rule, the debt rule and the expenditure benchmark of the EU Stability and Growth Pact in 2016.
Malta’s Eurozone membership ensures reliable access to European markets, fosters strong and credible macroeconomic policies and makes available financial facilities from European institutions. The expansion of trade and travel links with Europe has also provided a boost to the country’s economy. Malta’s economy is among the fastest growing in the Euro area and its growth prospects look favourable.
Malta’s solid external position is another credit strength. The current account surplus has averaged 4.4% of GDP in 2011-2016 and the country is also a net external creditor with a net external asset position of 31.2% of GDP on average over the same period. Although the import content of production remains high, this has declined as the economy becomes more service oriented. The current account surplus is supported by sizable services exports. Malta’s low reliance on external financing has supported its resilience in recent years as the core domestic banking sector is funded by domestic retail deposits and the government meets its financing requirements domestically.
Malta’s public debt composition and maturity 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 nine years in July 2017, which compares favourably to other European economies.
Government debt is also largely fixed-rate, resulting in a predictable and manageable debt redemption schedule.
On the private sector, Maltese households enjoy high levels of savings and moderate indebtedness. Household net financial assets are large at 182% of GDP. Household debt, mainly in the form of mortgages, has increased but remains moderate. 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. Contingent liabilities from large state-owned enterprises, though reduced, continue to pose a risk to government finances.
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. After remaining above 60% of GDP for decades, public debt has been declining since 2014 and forecast to fall below 53% in 2018.
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 25% 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 external risks.
Finally, pressures from agerelated costs present another challenge for Malta. Healthcare costs and pension liabilities, while still below EU averages, have increased rapidly in recent years.
Labour-market participation is rising, as a result of recent reform efforts, but remains among the lowest in the EU, particularly among women and older workers. Pension reform measures are being implemented and this should help secure the long-term sustainability of the system. However, the overall impact of the measures is still to be assessed.
A reduction in public indebtedness in the near to medium term, in line with DBRS’s expectations, could lead to an upgrade in 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.
However, the emergence of additional contingent liabilities, from state-owned enterprises or the financial sector, could lead to a change in the trend back to stable. Large external shocks could also pose downside risks.