Fri 11 Nov, 2022 - 5:01 PM ET

Fitch Ratings - Frankfurt am Main - 11 Nov 2022: Fitch Ratings has affirmed Malta's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'A+' with a Stable Outlook.

A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS

Ratings Strengths and Weaknesses: Malta's rating is supported by high per-capita income, a large net external creditor position and a pre-pandemic record of strong growth and sizeable debt reduction. These strengths are balanced against its large banking sector, the small size of its economy, which is highly vulnerable to external developments, and a recent deterioration in public finances with large fiscal deficits, which have led to a sharp increase in the moderate public debt burden.

Energy Subsidies Weigh on Fiscal Balance: The Maltese government has earmarked substantial funds to limit inflation by controlling the rise of electricity, gas, fuel and certain basic food prices. Energy and food subsidies are estimated to amount to EUR396 million by end-2022 (2.4% of GDP) and EUR605 million (3.5% of GDP) in 2023. Higher energy subsidy costs will be partially offset by stronger-than-expected revenue growth, the phasing out of Covid-19 measures and savings achieved through a comprehensive spending review. The ultimate fiscal cost of energy subsidies over the next years is highly uncertain as the cost of energy subsidies is tied to the development of international wholesale prices.

Fitch now expects that Malta's fiscal deficit will narrow to 5.8% of GDP in 2022 from 7.8% in 2021, in line with the government's revised projections. We also project that the 2023 deficit will further improve to 5.2% of GDP, exceeding the 'A' median of 4.0% of GDP. The 2023 budget is the first budget presented by the re-elected Labour government and maintains an expansionary focus. Various social spending measures aim to mitigate the impact of higher inflation and include an increase in the weekly cost of living adjustment, increases in pensions and child allowances, one-off payments to the most vulnerable and tax refund cheques.

Fiscal Uncertainties: The European Commission has yet to approve the bailout package for state-owned airline Air Malta and the size and timing of any state aid to the airline remains unknown. However, the restructuring process is well underway, a significant share of staff has either opted for the voluntary early retirement scheme or redeployment within the public sector and restructuring costs are priced into the budget at around 0.4% of GDP for 2022/23. Moreover, the European Commission has referred Malta to the European Court of Justice due to concerns over its Citizenship by Direct Investment Programme, which could result in a revenue loss between 0.3% and 0.4% of GDP annually.

Public Debt Forecast to Peak Below 60%: Malta has seen one of the largest increases in public debt since 2019 among 'A' rated peers with debt increasing by 15.6pp over the past two years, reaching 56.3% of GDP by end-2021. We expect that total general government debt will peak at slightly below 60% in 2024, in line with the government's goal to keep the public debt burden close to 60% of GDP. A relatively high potential growth rate between 3-4% and the phasing out of energy and food subsidies beyond 2024 will help support debt reduction in the medium to long term, even in the absence of large expenditure cuts or tax hikes.

Similar to other sovereigns, government bond yields have increased significantly over the past year (+250bp since November 2021) and will gradually phase into higher interest expenses. Risks from higher interest rates and a phasing out of the ECB's quantitative easing are mitigated by a long average maturity of marketable debt and a strong domestic investor base.

Government Intervention Lowers Inflation: Inflation is estimated to have reached 7.5% in October, the lowest rate in the eurozone behind France and Spain. The government remains committed to limiting the increase in electricity and fuel prices, implying that we expect a zero contribution from energy prices to inflation throughout the projection horizon. The government has mandated the public utility company Enemalta to freeze electricity prices at 2014 levels for households (2015 levels for companies) and is intervening to keep gas and fuel prices unchanged. According to government estimates, inflation would have been higher by 7.1pp, compared with a scenario without market interventions.

Fitch anticipates that inflation will average 6.2% in 2022. Malta's dependence on imports for food and raw materials imply that imported inflation has led to an acceleration in food and construction prices. The strong rebound in the tourism sector has further contributed to higher inflation in the accommodation and restaurant sectors. We project that inflation will somewhat moderate to 4.8% in 2023 as food prices normalise and international price pressures abate but wage inflation picks up with a lag.

Resilient Economic Growth Despite Headwinds: Fitch forecasts real GDP growth of 6.3% in 2022, following a very strong recovery of 10.3% in 2021. Our latest GDP forecast represents an upward revision of 2.1pp compared with our May projection, reflecting a stronger than expected performance during 1H22. We have lowered our growth projections to 3.4%, from 3.9% for 2023, but growth is projected to significantly outperform the eurozone average of -0.1%. Private consumption is expected to moderate somewhat as real disposable incomes decline while services exports are projected to further recover next year as tourist arrivals remained 20% below their 2019 levels from January to August.

Strong Labour Market: Malta's labour market has demonstrated a remarkable degree of resilience amid the Covid-19 and energy crises. The government had provided sizeable support to the labour market during the pandemic but the generous wage supplement scheme expired at the end of May with no visible impact on the labour market. We forecast the unemployment rate to average 3.2% in 2022 and increase only slightly to 3.4% in 2023.

Removal from Greylist: The Financial Action Task Force (FATF) decided in June 2022 to remove Malta from its so-called greylist. Malta had been on the list for only one year, limiting any negative repercussions for the Maltese economy and its large banking sector. Greylisting likely contributed to a sharp drop in Malta's 2021 World Governance Indicators (WGIs) for regulatory quality and government effectiveness, which declined by 11.5 and 3.8 points, respectively. Malta's WGIs continue to slightly exceed the 'A' rated peer median at 77.2, but scores experienced some of the largest drops in our rated universe since 2010, declining by more than 9 percentile ranks.

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. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Malta has a high WBGI ranking at 77.2, reflecting its long track record of stable and peaceful political transitions, well established rights for participation in the political process, strong institutional capacity, effective rule of law and a low level of corruption.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- Public Finances: Continued upward trend in general government debt, for example due to a more prolonged period of fiscal stimulus, weaker growth prospects or loss of key sources of revenues.

- Structural Features: Further deterioration in governance or banking supervision or concerns over wider financial sector transparency that could adversely impact Malta's attractiveness as an investment destination.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- Public Finances: General government debt/GDP returning to a firm downward path over the medium term, for example due to sustained economic growth and/or fiscal consolidation.

- Structural Features: Further progress in addressing key weaknesses in governance, banking supervision and the business environment.

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 adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:

- Macro: +1 notch reflecting macroeconomic performance, policies and prospects. The positive notch adjustment offsets the deterioration in the SRM output driven by volatility from the pandemic shock, including on GDP growth. The deterioration of the GDP growth and volatility variables reflects a very substantial and unprecedented exogenous shock that has hit the vast majority of sovereigns, and Fitch believes that Malta has the capacity to absorb it without lasting effects on its long-term macroeconomic stability.

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.

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.

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. As Malta has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.

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 are therefore highly relevant to the rating and are a key rating driver with a high weight. As Malta has a percentile rank above 50 for the respective Governance Indicators, this has a positive impact on the credit profile.

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 is relevant to the rating and a rating driver. As Malta has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.

Malta has an ESG Relevance Score of '4[+]' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Malta, as for all sovereigns. As Malta has track record of 20+ years without a restructuring of public debt and captured in our SRM variable, this has a positive impact on the credit profile.

Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.