Fitch Ratings has affirmed Malta’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘A+’ with a Stable Outlook.
KEY RATING DRIVERS
Malta’s ratings balance high income per capita, euro area membership and large net external creditor position, against its large banking sector, relatively high government contingent liabilities and vulnerability to shocks due to its small, open economy, and reliance on tourism. Malta outperforms the ‘A’ median on the World Bank governance indicators, although its scores on the ‘Voice and Accountability’ and ‘Control of Corruption’ subcomponents have been slipping in recent years.
Fitch forecasts Malta’s real GDP to contract by 6.9% in 2020, a moderate downward revision from our review in April (5.9%), with declining net exports playing a significant role. The tourism sector suffered a large contraction in 2Q20, owing to continued traveling restrictions. As of April, tourism overnight stays collapsed to under 10,000 stays (871,000 in April 2019), according to Eurostat data. Malta’s government plans on fully lifting traveling restrictions on 15 July. Nevertheless Fitch expects only a slow recovery in 2H20 and for international tourism arrivals and hotel occupancy to remain below 2019 levels in 2021 and 2022.
While the government plans on introducing vouchers for residents to spend on domestic tourism, this might have a limited effect as foreign tourism represents around 97% of total stays in the high-season. The tourism sector contributed about 13% of GDP in 2018 (excluding indirect effects) and 15% of employment, according to the OECD (2020). While there are still material downside risks to growth forecasts, we now believe risks to be more balanced.
Malta’s medium-term potential growth remains strong and well above the eurozone average, at 3.0%-3.5%. Historical GDP was recently revised upwards, with 2019 growth raised to 4.7% from an earlier estimate of 4.4%. Inward migration has helped support growth in recent years. While loss of foreign labour due to the pandemic is expected to generate negative migration for 2020, this should be temporary and reversed once conditions improve. Fitch forecasts growth to rebound to 4.1% in 2021, before easing to 3.6% in 2022.
Fitch estimates the general government balance will deteriorate to a deficit of 9.2% of GDP in 2020 (8.2% in April’s review), from a surplus of 0.5% in 2019, based on the operation of automatic stabilisers and the direct budget impact of government measures. Further to the EUR520 million (4.1% of GDP) in government measures announced in March, in June the government announced a EUR900 million (6.8% of 2019 GDP) fiscal support package, which includes EUR400 million infrastructure spending (3% of GDP) over the coming years as well as the extension of tax deferrals and wage subsidy schemes. In addition, the government allocated EUR350 million (2.6% of GDP) in guarantees through the Malta Development Bank, which could be leveraged to a total portfolio of loans under guarantees of EUR780 million (6% of GDP). Lower spending and a rebound in economic activity should help shrink the deficit in 2021 to 6.1% of GDP and 3.4% in 2022.
The increase in the budget deficit and likely crystallisation of some of the contingent liabilities (7.5% at 4Q19) will increase general government debt to 56.3% of GDP at end-2020, from an estimated 42.9% at end-2019. The authorities estimate a maximum up to EUR2 billion (15.1% of 2019 GDP) could be borrowed in 2020, in line with Fitch’s expectations. Malta had EUR379 million (2.9% of GDP) in cash buffers at end-4Q19, which we expect will be partly used to help finance the large deficit. We forecast public debt will stabilise in 2021-2022 close to 60% of GDP.
Despite the government’s fiscal measures to support the economy, we expect the coronavirus pandemic to affect labour market dynamics, with the registered unemployment rate increasing to 7.1% in 2020, from 3.4% in 2019. The large share of foreign labour in the workforce supports the flexibility of the labour market and the expected outflow of foreign labour could help lower the unemployment rate through the crisis, but would have a further negative effect on private consumption.
Despite the external shock, Fitch projects Malta will maintain a current account surplus in the medium term. We forecast it to narrow to 1.4% of GDP in 2020 from 9.7% in 2019, before rebounding to 5.1% in 2021 and 7.6% in 2022, as the tourism sector starts to recover and exports of services rise to previous levels. Malta will retain its large net creditor position at 143% of GDP at end-2020.
Fitch affirmed Bank of Valletta’s Long-Term IDR at ‘BBB’ with a Negative Outlook on 27 April 2020. We believe financial soundness indicators are strong, with a high common equity Tier 1 ratio of 17.5% at end-2019 for core domestic banks, and provide a buffer to the financial system in the event of a sharper GDP contraction than forecast. While asset quality is likely to deteriorate, non-performing loans (NPLs) had declined to 3.2% at end-2019 (for core domestic banks) from 3.4% a year earlier. Banks were directed to offer a six-month moratorium on repayments on capital and interest for borrowers negatively affected by coronavirus disruption, which could amount to 11% of the credit stock. The share of loans to non-residents (around 11% at end-2019 for core domestic banks) remains high and a risk factor, but they have stabilised around 8%-15% over the past few years.
ESG – Governance: 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, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Malta has a high WBGI ranking at 83.1, despite having deteriorated significantly in 2018, especially in the Control of Corruption and Voice & Accountability sections.
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 did not adjust the output from the SRM to arrive at the final LT FC IDR.
The committee decided to remove the -1 notch on the external finances, which had reflected Malta’s small and highly open nature, including the large share of tourism in the economy activity. The current shock has exposed Malta’s vulnerability to external shocks and resulted in worse macroeconomic and public finance metrics and a moderate deterioration in external finances, which have been partly reflected in the lower SRM score in this review.
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.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– General government debt/GDP returning to a firm downward path over the medium term, for example due to a post-coronavirus-shock fiscal consolidation.
– Confidence that Malta can return to high GDP growth in the medium term, supporting a convergence of GDP per capita with that of higher-rated sovereigns.
– Further progress in addressing key weaknesses in governance, banking supervision and the business environment.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Severe and prolonged economic weakness due to the pandemic, including a failure of the tourism sector to revive.
– Persistent increase in general government debt, for example due to a more prolonged period of fiscal stimulus, weaker growth prospects or materialisation of contingent liabilities.
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. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit [https://www.fitchratings.com/site/re/10111579].
KEY ASSUMPTIONS
Fitch assumes that in case of need the Maltese government would only be predisposed to support core domestic banks, while being unlikely to support international banks and non-core domestic banks.
We assume that the global economy develops in line with our Global Economic Outlook published on 29 June 2020. In particular, eurozone GDP is forecast to decline by 8.0% in 2020, before recovering by 4.5% in 2021 and 2.8% in 2022.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
– Malta has an ESG Relevance Score of 5 for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and a key rating driver with a high weight.
– Malta has an ESG Relevance Score of 5 for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch’s SRM and recent political scandals and subsequent reforms have the capacity to feed into future governance scores; this is highly relevant to the rating and a key rating driver with a high weight.
– Malta has an ESG Relevance Score of 4 for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators are relevant to the rating and a rating driver.
– Malta has an ESG Relevance Score of 4 for Creditors Rights as willingness to service and repay debt is relevant to the rating and a rating driver, as for all sovereigns.