On October 11, Finance Minister Clyde Caruana delivered the 2022 Budget speech in Parliament. As in most years, while many journalists and Maltese citizens focused on the Budget measures being introduced, not much attention was given to the state of the country’s finances.
This is important to periodically review, especially at a time when the devastating economic impact of the pandemic has left a huge dent across all economies and government finances worldwide.
It is of fundamental importance for investors to assess the financial soundness of a company (by reviewing the financial statements) before contemplating an investment in a bond or equity offering. Likewise, the investing public should also review the government’s finances to gauge its overall creditworthiness since this has a bearing on a multitude of factors, among which the credit rating given by international rating agencies.
In addition to the Budget speech, the finance minister also published the Financial Estimates and Economic Survey which provides detailed information on the government’s finances, including revised estimates for 2021 as well as estimates for the next three years.
The government is expecting a deficit of €1.55bn in 2021 (equivalent to 11% of GDP) compared to the original estimate in last year’s Budget of a deficit of €757m (or 5.9% of GDP). The revised expectation for the 2021 deficit of €1.55bn is also above the deficit incurred in 2020 which amounted to €1.27bn.
While the effects of the pandemic are undoubtedly one of the main reasons for the wide discrepancy between the original expectations for 2021 and the revised estimates for this year, it would be fruitful to obtain a clearer understanding of the reasons for such a material variance as one expects from companies who issue financial instruments to the public when such discrepancies take place.
As a result of this year’s deficit of €1.55bn, the overall public debt is being estimated to rise to €8.56bn by the end of 2021, which is equivalent to 61.3% of GDP. This is an important metric used by international credit rating agencies when assessing a country’s risk profile.
The government is forecasting an improved economic environment in the years ahead, with real GDP growth anticipated to amount to 6.5% in 2022, 4.7% in 2023 and 4.5% in 2024. However, in 2022, the government is forecasting a deficit of €850m which would be equivalent to 5.6% of GDP with the overall public debt, increasing to €9.37bn by the end of 2022 (equivalent to 61.8% of GDP). Furthermore, the government debt is expected to surpass €10bn in 2023 and 2024 as the deficit is expected to amount to €707m in 2023 and €496m in 2024.
Thankfully, Malta entered the pandemic from a position of strength as the debt-to-GDP ratio had dropped to 43% in 2019, which was far superior to the debt metrics of many other countries across the eurozone. It is also worth highlighting that the increase in the debt-to-GDP ratio to over 60% in the coming years compares favourably to the present situation across the eurozone with an average debt-to-GDP ratio of above 100% and the recent peak in Malta which amounted to just over 70% in 2012.
In view of the sizeable deficits over the past two years, the government resorted to record borrowings to finance the deficits as well as to finance Malta Government Stocks that mature on an annual basis.
The total MGS issuance in 2020 amounted to €1.4 billion, including the issuance of a further €95m in the 62+ Government Savings Bonds. At the time of the 2021 Budget speech in October 2020, the total amount of new borrowing anticipated for 2021 amounted to just under €980m. However, in view of the much higher-than-expected deficit (€1.55bn versus the earlier estimate of €757m), the actual borrowings already raised this year coupled with the additional amounts required by the end of the year will amount to a record of €1.8bn (of which €462m were redemptions of MGS that matured in 2021).
This elevated rate of new issuance is anticipated to continue in the coming three years as the government requires €1.2bn in new borrowings in both 2022 and 2023 and a further €1.1bn in 2024. These new borrowings will be required to finance the deficits expected to amount to €850m in 2022, €707m in 2023 and €496m in 2024 as indicated earlier, as well as the MGS redemptions taking place in each of the next three years.
The requirement for the government to continue to issue new MGSs annually will continue in the coming years since more than half of the total MGS in issue of almost €7bn are due for maturity by 2029.
The debt-to-GDP ratio surpassing 60% by next year... should not be overlooked
In recent years, the new MGS issuance was nearly entirely aimed at institutional investors via an auction process as opposed to the customary approach in earlier years at fixed prices targeted at retail investors. This is not surprising given the very low yields on MGS, reflecting the historically low-interest rate environment both across the eurozone and also globally. This development was a positive one for local credit institutions given the very high levels of liquidity held across the banking system and the negative interest rates imposed by the European Central Bank on idle monies.
The assessment of a country’s finances is not only important to evaluate from the perspective of whether this elevated level of MGS issuance can continue to take place at such low rates of interest (which would also be dependent on international interest rate movements), but also due to the possible impact on corporate bond yields since the sovereign yield is an important benchmark used when comparing pricing on corporate bonds.
In this context, it is also worth tracking the recent movements in MGS prices and corresponding yields. The RF MGS Index shows a decline of over 4% since the start of 2021 as a number of MGS prices declined significantly, reflecting the upward movement in international sovereign yields as a result of eventual interest rates hikes due to consistent inflationary pressures and the tapering of ultra-loose monetary policy.
While the RF MGS Index is a good measure of the overall performance of such an asset class, the volatility in the MGS market can be easier to explain by showing the price movements of a selected stock. For example, the 1.5% MGS 2045, which was the longest-dated bond in issue until early 2020 (since then an MGS maturing in 2046 and 2051 were issued), saw its price drop from a weighted-average issue price of 113.22% during the auction in February 2020 to 95% by mid-June 2020, and currently stands at 98.18%. It had recovered from 95% in June 2020 to a 2021 high of 110.01% in mid-January 2021.
Another tranche of the 2045 MGS was issued via an auction in November 2020 at a weighted average price of 102.68%. As such, over the past 11 months since the latter offering, this MGS registered a decline of 4.5 percentage points.
While this is merely the result of price movements reflecting international bond market developments, the state of the government’s finances with the debt-to-GDP ratio surpassing 60% by next year, as well as other factors that may impinge on the credit rating and outlook by the international credit rating agencies, should not be overlooked.
In fact, in August 2021, the rating agency Moody’s confirmed Malta’s ‘A2’ rating but revised the outlook to ‘negative’. The rating agency justified the weakening outlook (which could result in a credit rating downgrade) to the government’s debt burden, the Financial Action Task Force’s greylisting, and the risks linked to the speed of recovery of the tourism sector.
In essence, a downgrade in a country’s credit rating should automatically translate into higher yields (keeping everything else constant) and as a consequence, a further decline in MGS prices. In view of the weakening of the government’s finances projected in the coming years, coupled with the risks of a credit rating downgrade materialising and the additional borrowings required in future years, one would need to understand the potential outcome of such a situation across the bond market.
Hopefully, the local credit institutions will continue to strongly support the new MGS issuances in future years given the continued high levels of idle liquidity across the banking system, thereby enabling the government to continue to finance the large majority of its borrowing requirements locally.
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