Creditreform Rating affirms M

Creditreform Rating has affirmed the unsolicited long-term sovereign rating of “A+” for the Republic of Malta. Creditreform Rating has also affirmed Malta’s unsolicited ratings for foreign and local currency senior unsecured longterm debt of “A+”. The outlook is stable.

Key Rating Drivers

1. Very strong growth performance supported further improving labour market conditions; output growth set to remain among the strongest in Europe in 2017-18 2. Despite generally high quality of institutional set-up and reform efforts to strengthen the business environment, persisting inefficiencies in administrative procedures and the judicial system 3. Budget consolidation advanced in 2016 and is set to continue in the medium-term; government with track record of overachieving its fiscal targets 4. Underpinned by budgetary surpluses and robust growth prospects, we expect Malta to make further progress on debt reduction, with government’s debt-to-GDP ratio falling close to 50% in 2018 5. Volatility in the current account balance and a high stock of external liabilities are balanced against a strong external asset position and prevalence of domestic funding in the private sector

Reasons Decision for the Rating

The Republic of Malta’s credit rating is underpinned by the economy’s strong macroeconomic performance. Our macroeconomic assessment balances brisk GDP growth, which supports income convergence towards EU-28 levels and employment growth, against some vulnerabilities arising from Malta’s growth model.

We continue to assess Malta’s small, open economy (trade-toGDP ratio, 2016: 268.2%) as wealthy. Standing at $39,878 in 2016 (in PPP terms, IMF data), GDP per capita compares favourably to the median per capita income of our A-rated sovereigns.

More importantly, since the country’s EU accession in 2004, GDP p.c. has increased by 75.6%. Income convergence towards EA19 levels (2016: 89.6% of EA-19 average) was supported by robust real GDP growth over the recent years.

After an exceptionally strong outturn in 2015 (+7.1%), growth moderated to a still high 5.5% in 2016. Last year’s expansion in total output was mainly driven by net external trade, contributing 4 p.p. to GDP growth. Exports sustained their growth momentum, supported by the economic recovery in the euro area. In particular, service exports (+5.3%) demonstrated a strong performance due to vividly growing inbound tourism.

According to data provided by the National Statistical Office, the number of foreign visitors reached 1.96m in 2016, equivalent to an annual change of 10.2%. Moreover, growth in imports sharply decelerated from 7.6 to 0.8% in 2016, reflecting a moderation in investment activity.

Last year, gross fixed capital formation stagnated (-0.4%) owing to base effects, as large scale energy projects and the end of the EU 2007-13 programming period had boosted investment in 2015. On the other hand, private consumption grew by 3% and made a positive contribution to GDP growth, supported by the favourable labour market development and low inflation. Looking forward, we expect further gains in disposable household income and ongoing employment growth to support private consumption in maintaining its growth momentum.

Our expectation is underpinned by quarterly data, with annual growth in household spending posting at 3.3 and 4.8% in Q1 and Q2-17 respectively.

Meanwhile, gross fixed capital formation is set to experience a significant decline this year. Higher investment in machinery and construction are unlikely to compensate for a sharp contraction of investment in transport equipment. The latter was extraordinarily strong in 2016 due to aviation investment linked to aircraft leasing corporations.

Although domestic demand should thus not be supportive to growth this year, we expect economic activity to strengthen as illustrated by yearly GDP growth rates of 5.8 and 6.2% in Q1 and Q2 respectively. Mainly buttressed by net exports, GDP should expand by 5.7% in 2017. While imports are likely to decrease against the backdrop of muted investment activity, we anticipate a robust performance of exports. In particular, service exports should record another strong year, as tourism spending was up by 13.9% y-o-y in the first seven months of 2017.

With regard to next year, domestic demand should take over from net exports as the main driver of GDP growth. Domestic demand should firm on the back of robust private consumption and a recovery in investment activity. At the same time, we expect higher investment-driven demand for imports and some moderation in exports to dampen the growth impact of net exports.

Taken together, the Maltese economy should lose some steam in 2018, prospectively growing at a rate of 5.2%.

In view of these favourable growth prospects, the Maltese labour market is set to fare well in 2017-18, although we believe that employment growth will slow down somewhat. Last year, employment growth (15-64y) leapt to 3.8% – making the Maltese workforce the fastest growing in the EU-28.

The unemployment rate also continued to decline. After having averaged at an already low 5.4% in 2015, Malta’s annual unemployment rate posted at 4.7% in 2016. The strong labour market performance is also mirrored by the development of the activity rate, which remained on an upward trajectory and increased from 67.6 (2015) to 69.1% in 2016. As a result, convergence towards EU28 levels, which are still somewhat higher (2016: 72.9%), advanced.

Thus, labour market policies implemented since 2014 which aimed to strengthen work incentives, seem to be bearing fruit. Among others, government’s making-work-pay measures included the introduction of in-work benefits for families with low income and the provision of free childcare to women.

However, some labour market challenges persist. The participation rate of women is still at a low level by European standards and the differential between activity rates of men and women remains significant. Standing at 25.8 p.p. in Q2-17, Malta exhibits the largest gender gap in activity rates in the EU-28.

Apart from low female labour market participation, skill mismatches may have curbed a further build-up of employment. According to the European business surveys, both the industry and services sector reported labour shortages above the EU-28 levels.

Although we do not believe that Malta can sustain its current growth momentum beyond 2018, medium-term growth prospects remain favourable. According to the latest estimates by the EU commission, Malta exhibits potential growth rates well above the euro area average, largely driven by employment growth and labour productivity gains.

However, some downside risks to the economy’s medium-term outlook have to be pointed out.

Although this is not our baseline scenario, a disorderly exit of the UK from the EU could have a detrimental effect on growth, given its strong trade linkages with Malta. Despite a decrease in the share of tourists from the UK in 2017, due to an increasing number of visitors from other countries, the UK remains an important market for Maltese tourism. In 2016, tourists from the UK represented the largest group of visitors, accounting for 28.5% of inbound tourism.

In the same vein, tighter regulation of gaming and financial services (2016: 18.6% of gross value added), as well as changes in the international tax environment, could dampen growth going forward. As currently being discussed at the EU level, the implementation of a Common Consolidated Corporate Tax Base (CCCTB) could weaken Malta’s attractiveness for foreign direct investment.

Turning to Malta’s budgetary performance, we note significant improvements in 2016, with the budget balance turning positive for the first time in 35 years. Fiscal targets outlined in the 2016 stability programme (-0.7% of GDP) were outperformed by a wide margin, with the general government balance posting a surplus of 1.1% of GDP. The stronger-thanexpected GDP expansion in 2016 translated into brisk revenue growth, which accounted for about three quarters of the budgetary improvement.

Proceeds from government’s Individual Investor Programme came in 0.7 p.p. GDP above expectations, while tax and social security contributions benefited from favourable labour market trends and higher corporate profits. Direct taxes increased by 11.8% and social security contributions were up by 7.2%, reflecting ongoing job creation and higher wages.

Meanwhile, the expenditure side of the budget remained broadly stable as higher spending on employee compensation (5.9%) and intermediate consumption (7.5%) were more than offset by savings on capital expenditure. Government investment dropped by 37.7% as compared with 2015, mirroring the transition to the new EU 2014-20 programming period. In our opinion, Malta will sustain a budgetary surplus in 2017-18, although we expect government to relax its fiscal stance somewhat.