Ratings agency Moody's has confirmed an A2 stable rating for Malta, however, it also reviewed downwards its outlook for the island from stable to negative.

In its most recent update, it blamed the negative outlook on the government’s debt burden, the Financial Action Task Force’s greylisting and risks linked to the recovery of the tourism sector.

Earlier this year, Moody’s had said it expected the Maltese economy to recover from the pandemic without significant lasting scars and public finances brought under control.

Moody's had predicted growth to rebound to 5.1 per cent of GDP this year, however, it had added that this relied on tourism arrivals being substantially higher in the second half of 2021 when compared to 2020, particularly during the summer peak season.

Last month, Malta made COVID-19 vaccination a mandatory prerequisite for travelling to the island, consequently leading to a dramatic drop in bookings.

A month earlier, global money-laundering watchdog FATF greylisted Malta, singling out tax evasion, and lax enforcement of tax laws as one of the main reasons for the downgrade.

Moody's Investors Service has now affirmed the government’s long-term issuer and senior unsecured ratings at A2 and concurrently changed the outlook to negative from stable.

Moody's also affirmed the backed senior unsecured debt rating of Freeport Terminal Limited at A2, while also changed its outlook to negative from stable, in line with Malta’s ratings.

“The affirmation of the A2 ratings reflects the fact that the increase in the government debt burden is mitigated by the government's strong debt affordability metrics.

"It also reflects the relative resilience of the non-tourism-oriented parts of the Maltese economy, the resilience of the banking system to the pandemic shock as well as the government's efforts to tackle some of Malta's longstanding institutional challenges tied to the rule of law, control of corruption and anti-money laundering supervision,” it said on Friday.

Upgrade is 'highly unlikely'

Moody’s added that an upgrade of the ratings was currently “highly unlikely given the negative outlook”.

However, Moody's would consider returning the outlook to stable if the tourism sector produced a strong and sustained recovery, underpinning a robust overall economic recovery and a rapid improvement in the public finances from 2022 onwards.

On the other hand, Moody's would consider downgrading Malta's ratings if the evolution of the pandemic and the associated travel restrictions prevented a sustained recovery of Malta's tourism industry in 2022 and beyond.

It also warned that failure to be removed from the FATF greylist by the end of 2022 would also exert downward pressure on the ratings, as this would magnify risks to the broader economy and banking sector and demonstrate remaining institutional weaknesses.

"Evidence that the government is backtracking on its broader institutional reform programme or that this is not producing the intended results would also be credit negative, as would the crystallization of risks for the banking sector tied to the economic recovery and greylisting," it said.

Why did Moody’s predict a negative outlook?

1. Government-debt burden

According to Moody’s, as with Malta's rating and regional peers, the economic impact of the pandemic and the support measures adopted to mitigate its impact on the economy and public health led to a sharp deterioration of the public finances in 2020.

That said, Malta's headline deficit of 10.2% of GDP in 2020 was the second-highest in the EU and by far the highest among its A2 rated peers.

The increase in the deficit coupled with the sharp economic contraction in 2020 caused the government debt-to-GDP ratio to increase to 54.8% from 42.0% in 2019.

However, Moody's expects Malta's fiscal deficit will further increase to 12.4% of GDP in 2021, the highest in the EU on current projections, as the government will need to continue providing exceptional support to companies and workers that have been hard hit by the pandemic, most notably in the tourism sector.

Coupled with Moody's expectations for a relatively subdued economic recovery for Malta in 2021, this leads the rating agency to project an increase in government debt to a level of 66.4% of GDP by the end of this year, while the median debt burden of its A2 rating peers is projected to peak at 58.7% in 2021, up from 45.6% in 2019.

Moody's forecast incorporates the government's proposed equity injections to Air Malta, however, a more prolonged slump in tourism and air travel could further magnify risks from such state-owned enterprises.

And although Moody's does not currently expect negotiations on international corporate tax harmonization to produce a result that significantly diminishes Malta's corporate tax revenue or its attractiveness to foreign companies, negotiations are ongoing and such an outcome cannot be excluded.

In addition, the ongoing infringement procedure launched by the European Commission against Malta's citizenship-by-investment scheme could eliminate government revenues from the scheme if the Commission succeeded in its efforts to repeal the programme. Given the differences between the EC and Malta on the issue, Moody's is expecting the legality of the scheme to be resolved by the European Court of Justice.

2. Post-pandemic recovery

Although Moody's expects the economy to return to growth of 3.5% in 2021, the rating agency does not expect tourism-related activities to be a principal driver behind this.

Passenger arrivals at Malta airport picked up in June, however, they remained at 28% of 2019 levels and the continued recovery of the tourism sector during the crucial peak of the summer season in July to September has been thrown into doubt by the government's mid-July decision to require that all arrivals in Malta over the age of 12 be fully vaccinated or undergo a 14-day hotel quarantine.

Moody's forecasts a further pick-up in growth rates in 2022 and beyond, however, the uncertainty around the continued evolution of the pandemic, including the likely emergence of new coronavirus variants which could lead to renewed travel restrictions in Malta and key source countries, poses material risks to the recovery of the tourism sector and the economic outlook also beyond 2021.

Malta's potential growth rate was slowing from high levels already prior to the pandemic, and some of the drivers risk being exacerbated by the current crisis, such as a difficulty of sourcing non-EU labour due to the vaccination requirement for foreign arrivals in Malta.

Furthermore, Malta will receive a significantly lower allocation of grants relative to GDP under the EU's post-pandemic recovery fund Next Generation EU than most other tourism-dependent sovereigns in Southern Europe. 

3. FATF greylisting

The decision by FATF to place Malta on its so-called greylist of jurisdictions under increased monitoring over concerns tied to anti-money laundering supervision poses further risks to the economic outlook and the banking sector over the coming 12 to18 months and beyond.

Moody's expects the decision will increase due diligence requirements for firms and banks in Malta and their international partners, and also further complicates some Maltese banks' efforts to maintain stable correspondent banking relationships, above all for the clearing of US dollar transactions.

Moody's expects that the longer Malta remains on the greylist, the larger the broader impact on the economy and banking system will be, as enhanced regulatory burdens will increasingly weigh on the activities of Malta-based entities and their international partners. Ultimately, this increases the risk that some of these entities will reassess their current or future business operations in Malta.

Although the Maltese authorities over the past year have made significant reform efforts to remedy long-standing institutional shortcomings in areas such as the control of corruption, the rule of law and the supervision of money laundering risks, a failure to be removed from the FATF grey list within the next 12 to 18 months would also reflect negatively on Malta's strength of institutions and governance.

So why was the A2 rating confirmed?

The affirmation of the A2 ratings reflects the fact that the increase in Malta's debt is mitigated by the government's strong debt affordability as well as its reliable domestic funding base.

It also reflects the fact the Maltese economy remains diversified for its small size, and that the non-tourism-related sectors of the economy have generally remained resilient to the pandemic shock.

The affirmation also reflects the resilience of Malta's large banking sector to the pandemic shock, although asset quality and profitability have been negatively impacted by the crisis.

Furthermore, the decision to affirm the ratings also reflects the efforts undertaken by the Maltese government since 2020 to tackle some of the country's institutional shortcomings tied to the control of corruption, rule of law and the supervision of money laundering-related risks.

Government reacts, ignores negative outlook

In its reaction to Moody’s rating, the government ignored the negative outlook.

Instead, it said that the agency had confirmed the A2 rating, which was similar to that granted to Malta in 2019 before the pandemic.

“Contrary to what the Opposition keeps saying, according to Moody’s, Malta has ‘a very strong governance profile’. In fact, the report says that ‘on the whole, the country benefits from a strong institutional environment’," it said in a statement.

“At the same time, it is clear that the decision to give Malta an A2 rating ‘also reflects the efforts undertaken by the Maltese government since 2020 to tackle some of the country’s institutional shortcomings’.

“The government reiterates its determination to strengthen good governance and implement the action plan as agreed with the FATF,” it said, adding that the government’s income was already recovering and reaching pre-pandemic conditions.