DBRS Ratings GmbH has confirmed Malta’s long-term foreign and local currency – issuer ratings at A (high). It also confirmed the country’s short-term foreign and local currency – issuer ratings at R-1 (middle). The trend on all ratings is stable.
In its considerations, it said the stable trend reflects the fact that Malta’s strong economic and fiscal performance in recent years has left the country relatively well placed to mitigate the risks posed by COVID-19.
The partial lockdown and travel restrictions will likely result in a deep but temporary recession in Malta this year.
A strong rebound should follow the gradual opening of the economy although there is still high uncertainty over the evolution of the pandemic and the tourism sector, it said.
It added that the fiscal balance and debt ratios will deteriorate sharply in 2020 because of the intense economic contraction and the fiscal support package. However, Malta’s public debt ratio is expected to remain one of the lowest in the European Union.
Malta’s A rating is supported by its euro zone membership, moderate level of public debt, solid external position, and households’ strong financial position.
On the other hand, Malta’s small and open economy remains exposed to external demand or confidence shocks.
In this sense, the tourism sector, an important source of income, employment, and investment in Malta, will face significant headwinds in the medium-term.
Similarly, Malta’s attractiveness to foreign investment could suffer if measures to address the financial integrity risks and institutional governance weaknesses noted by international bodies are deemed insufficient.
Despite Malta’s sound public finances, medium to long-term challenges could come from its contingent liabilities, changes in international taxation affecting Malta’s attractive tax system to foreign companies, or increasing age-related spending.
Although unlikely in the current environment, the ratings could be upgraded if two of the following occur:
- a sustained material reduction in the public debt ratio driven by sound fiscal management and economic performance;
- effective implementation of reforms to enhance Malta´s governance framework, including the financial and judicial sector; or
- further evidence of increased economic and fiscal resiliency to external shocks.
The ratings could be downgraded if one or a combination of the following occur:
- a sustained deviation from a prudent fiscal approach materially deteriorating the fiscal and public debt outlooks;
- the pandemic shock to the economy results in substantial deterioration in Malta´s potential growth; or
- a substantial weakening of investors’ confidence due to insufficient progress on improving its governance framework.
Economy to be severely hit but less than euro area peers
The rating agency argued that Maltese economy will be severely hit by the pandemic but less than its euro area peers.
The healthcare crisis has been less acute in Malta when compared with the most affected European nations.
The restrictions needed to control the spread of the virus have abruptly halted a period of remarkable economic performance, characterised by strong output growth (averaging 7% a year during 2013-2019) and shrinking the GDP per capita gap with the EU.
The latest forecast from the European Commission points to a 6% contraction in Malta’s GDP in 2020 followed by a relatively swift rebound of 6.3% in 2021.
The main uncertainties are posed by the future evolution of the pandemic and the tourism sector. Even so, the EC expects Malta’s GDP contraction to be the smallest among the euro area member states in 2020.
Malta’s partial lockdown, including travel bans and the closure of non-essential services, has been gradually relaxed since May from its start in mid-March.
Travel bans have been further eased on July 15. The sectoral impact from the restrictions will be uneven with tourism-related activities, including travel, hospitality, cultural and recreational activities, expected to suffer significantly.
The tourism sector is a key source of income to the Maltese economy, contributing 12.8% to Malta´s GDP and 14.9% of total employment in 2018, according to the Organisation for Economic Co-operation and Development.
The reopening of the economy and the government measures to support the tourism-related sector (such as vouchers) will help the sector to recover; however, the Maltese tourism sector is predominantly reliant on foreign tourist arrivals that could take some time to return to pre-pandemic levels.
The confinement, physical distancing, and slump in tourism arrivals is also expected to undermine retail sales.
On the other hand, sectors exempt from the lockdown (construction and manufacturing) and those with greater remote working capabilities (iGaming, financial, and business services sectors) are expected to suffer much less from the restrictions.
DBRS said that while the near-term outlook remains uncertain, Malta’s potential growth rate remains strong and expected to converge to levels above 3% in the medium term.
The supply of foreign workers, an important driver of potential growth in recent years, is expected to falter in 2020, but to recover over time.
Also, government support measures have prevented substantial losses of employment, although more lasting effects are still possible.
Over the medium to long-term, Malta’s attractiveness as a financial and business location could face challenges from:
- slow progress in enhancing its governance framework,
- changes in international corporate taxation, or
- changes to the EU regulatory framework.
Pandemic temporarily halts Malta’s strong fiscal performance
The pandemic shock has substantially deteriorated the budgetary outlook in the near term, halting four years of consecutive fiscal surpluses averaging 1.7% of GDP during 2016-2019 on the back of a buoyant economy.
The ‘Updated Stability Programme’, 2020-2021, foresees a substantial deterioration in the budgetary balance from a 0.5% surplus in 2019 to a deficit of 7.5% of GDP in 2020 driven by the hit to revenues from the slump in activity as well as the measures to respond to the pandemic.
This included the budgetary impact of around €520 million (4.1% of GDP) from the first set of measures, such as the COVID-19 wage supplement to prevent job losses and higher healthcare-related spending.
Also, the government introduced tax deferrals and a state guarantee scheme (2.8% of GDP) to support the liquidity of the firms affected by the coronavirus pandemic.
In June, the government announced its economic regeneration plan of €900 million (6.7% of GDP). This second wave of support includes additional spending for this year through the extension of the wage supplement, the introduction of time-bound vouchers to support the tourism-related sector, and subsidisation of rent and electricity bills for firms.
This will likely widen further the fiscal deficit in 2020. However, the majority of the plan is related to a €400 million multi-year infrastructure investment plan and 3200 million of additional liquidity linked to the extension of tax deferrals.
DBRS expects the budget to already start rebalancing in 2021 as the economy rebounds and the temporary support is rolled back.
Nevertheless, over the medium to long-term, important drivers of revenue growth such as Malta’s impressive economic expansion, its citizenship by investment scheme, and corporate taxation could face challenges.
This accounts for DBRS’s negative qualitative assessment of the “fiscal management and policy” building block.
Financial system sound, pandemic shock and reputational risk are concerns
The economic fallout from the pandemic will likely pressure banks’ asset quality and profitability. The Maltese authorities have introduced several measures to mitigate this impact and support the supply of credit to the economy, in addition to the extraordinary euro-system support.
Banks’ nonperforming loans as a share of total loans, at 3.2% in Q4 2019, will likely increase over time as the measures to alleviate the strains on the private sector debt capacity start to wane (e.g., loan moratorium, wage supplement, or tax deferrals).
Malta’s real estate market remains a source of risk, given the banks’ high exposure to the sector and strong price growth since 2014, especially under these challenging conditions.
The downturn in tourism and net migration could pressure the buy-to-let market. On the other hand, households’ strong financial position and banks’ conservative lending practices mitigate the risks to the banks’ mortgage loan books.
If Moneyval, and later the financial action task force (FATF), considers that Malta failed to address the shortcomings in the system, the country risks being identified by the FATF as a country with strategic AML/CFT deficiencies.
This could deepen the reputational and financial integrity risks Malta faces.
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