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Rating action

Scope Ratings GmbH (Scope) has today affirmed the Republic of Malta’s long-term issuer and senior unsecured debt ratings at A+ in both local and foreign currency and maintained the Stable Outlook. The short-term issuer rating has been affirmed at S-1+ in both local and foreign currency with a Stable Outlook.

Summary and Outlook

The affirmation of Malta’s A+ rating reflects the country’s: i) strong growth potential; ii) sound medium-term fiscal outlook, underpinned by prudent fiscal management and track record of effective fiscal consolidation; and iii) robust external position. The rating is constrained by: i) an externally dependent and resource constrained economy, which presents risks to the stability and sustainability of Malta’s growth model; ii) fiscal risks in the form of age-related cost pressures and elevated government guarantees issued to state-owned enterprises; and iii) lingering, albeit improving, institutional challenges related to the financial oversight and supervision frameworks and the deteriorating governance metrics.

The Stable Outlook reflects Scope’s view that the risks Malta faces over the next 12 to 18 months are well balanced. The country’s economy and fiscal metrics are expected to recover in 2022 with debt returning to a downward trajectory within the forecast horizon.

The ratings/Outlooks could be upgraded if, individually or collectively: i) the continued implementation of structural reforms raises the country’s growth potential and supports greater diversification into higher-value added activities; ii) fiscal discipline is maintained, returning the public debt-to-GDP ratio to a firm downward trajectory; and/or iii) reforms to strengthen institutional frameworks are effectively completed and lead to material improvements in risk perceptions.

Conversely, the ratings/Outlooks could be downgraded if, individually or collectively: i) there is a structural deterioration in the country’s growth outlook; ii) the fiscal outlook weakens substantially; and/or iii) there are material deteriorations in institutional quality were to threaten Malta’s position as an emerging financial centre.

Rating rationale

The first rating driver to affirm Malta’s A+ ratings reflects the economy’s strong growth potential over the medium term as well as Scope’s expectation of a robust economic recovery from H2 2021 onwards. The country has experienced very robust economic growth in recent years, with average real growth rates of 6.5% over 2015-19, making it the EU’s second fastest growing economy after Ireland. Structural changes in the Maltese economy, including a shift away from manufacturing towards higher value-added service sectors along with inflows of highly skilled labour have supported substantial increases in productivity growth. The strong economic expansion has been supported by growth in the e-gaming, professional services and tourism sectors as well as structural reforms aimed at improving the labour supply, among others. Notably, the government’s successful implementation of the reform package included in its multiyear 2014 National Employment Policy has supported substantial declines in total and youth unemployment rates, improvements in labour force participation and increases in disposable incomes in recent years¹. Growth in participation rates, coupled with rising inflows of foreign workers, has helped to support rising total hours worked, with positive implications for potential growth. These elements underpin Malta’s robust growth potential, which Scope estimates at around 3.5-4%, the strongest among peers.

While the Covid-19 crisis has led to a substantial decline in output of 7% in 2020, Scope expects a robust recovery from H1 2021 onwards. The GDP decline in 2020 was mostly driven by net exports and, to a lesser extent, domestic demand. The tourism and travel-related sectors were particularly hard hit given the international travel restrictions, which led to declines in tourist arrivals and overnight stays by 76% and 73% respectively in 2020². Other key sectors such as the ICT and remote gaming industries performed better than expected as international demand shifted towards digital services. Timely and forceful government support measures helped to mitigate the adverse impact of the health crisis on the economy. These included 5.1% of GDP in spending to support the healthcare sector and bolster corporate firms and household’ incomes.

Scope expects the economy to recover rapidly, with real GDP projected to exceed pre-crisis levels as early as 2022. Domestic demand will be supported by the country’s effective implementation of its vaccine programme. Almost 39% of residents have already received their first dose as of April, the highest share among EU countries, which should support private consumption. In addition, investment activity is expected to pick up with the resumption of large investment projects that were delayed in 2020. External demand dynamics will ultimately depend on the vaccine rollout and the economic recoveries of key trading partners, which underpin Scope’s expectation of a full recovery in 2022. Malta’s medium-term growth trajectory will also be supported by the government’s national recovery plan, which includes substantial infrastructure investment, the extension of tax deferrals, wage subsidy schemes and other subsidies and tax cuts. Overall, while the country’s return to a strong growth trajectory depends on the external environment, the extent of long-term economic scarring left from the crisis and the successful implementation of the recovery plan, Scope expects Malta to post robust growth rates from 2022 onwards.

The second rating driver to affirm Malta’s A+ rating reflects the country’s strong track record of fiscal prudence and consolidation over the medium-term. In the years preceding the Covid-19 crisis, Malta’s public debt levels were on a firm downward trajectory. Public debt-to-GDP steadily declined by 26pps from the 2011 peak of 69% to 43% in 2019, the strongest reduction among peers. Strong improvements in the country’s debt metrics were driven by exceptionally strong growth and effective budgetary discipline. Public expenditure as a share of GDP decreased by 4pps over the 2011-19 period as the government exercised fiscal restraint despite buoyant economic conditions. This has supported Malta’s wide primary balances, which averaged 2.7% of GDP in the five years leading to 2019, the widest among peers.

The large counter-cyclical fiscal support package implemented in 2020 has led to material deteriorations in the country’s fiscal metrics. The primary balance turned to a deficit of 9% of GDP and public debt rose to 54% of GDP, with a peak expected at almost 59% of GDP in 2021. Still, Scope expects Malta to stabilise its debt levels in 2022-23, with debt to return to a firm downward trajectory from 2024 onwards on the basis of the primary deficit gradually converging to 0% of GDP by 2026, from an expected deficit of 6% of GDP in 2021. EU funding support will help alleviate the fiscal cost of the recovery package for Malta thanks to over EUR 2bn in Next Generation EU and Multiannual Financial Framework funds for the 2021-27 period. Favourable funding costs provide additional relief. Malta’s 10-year government bond yield was at 0.5% at the time of writing. As such, interest payments should remain broadly stable in the coming years, at around 3.5-3.6% of general government revenue, despite the substantially higher debt. The expected recovery in Malta’s fiscal metrics, with the public debt ratio projected to return to a firm downward trajectory and no material increase in the interest payment burden also underpins the Stable Outlook.

The third driver underpinning Malta’s A+ rating is the country’s robust external position. Wide current account surpluses, which averaged 3.8% of GDP over 2015-19, have led to a net international investment position of 54% of GDP as of year-end 2019, one of the highest in the EU and well above the peer group average of -16% of GDP. The Covid-19 crisis has led to a substantial, temporary deterioration in the current account to -1.3% of GDP in the 12 months to September 2020, mostly due to lower tourism receipts, while the net international investment position increased slightly to 59% of GDP. In line with IMF forecasts, Scope foresees a gradual improvement in the current account as international travel normalises and export performance picks up, with the current account balance increasing steadily to 3.5% of GDP by 2026, which should further bolster the country’s external position.

Despite these key credit strengths, Malta’s ratings remain constrained by the following challenges:

First, Malta’s A+ rating is constrained by its externally dependent and resource constrained economy, which pose long-term stability and sustainability risks. As a small, open economy with exports representing around 143% of GDP in 2020 and high integration with international financial markets, Malta remains very vulnerable to external economic shocks, changes in the international tax regime and investor sentiment. Rapid growth in key sectors such as remote gaming, financial services and tourism has been beneficial for the country. However, future growth in these sectors is reliant on external demand. In particular, slower than expected recovery and/or changes in consumer behaviour in the tourism sector, which represents around 10-15% of GDP, could impede future growth.

In addition, the country has become increasingly dependent on highly skilled foreign workers to address domestic labour shortages and skills mismatches. Reliance on foreign workers could present sustainability challenges given the uncertainty regarding future migration flows and the difficulties reported in retaining skilled workers. Malta’s inherent resource scarcity poses an additional sustainability challenge (ESG factor). Malta is one of the smallest, most urbanised and densely populated countries in the EU. Large inflows of foreign workers coupled with rising economic activity can have negative implications, including, for example, pressures on scarce resources (such as land, water and energy) large increases in domestic greenhouse gas emissions and social integration challenges as highlighted recently by the European Commission³. These pose risks for the long-term sustainability of Malta’s growth model.

Second, contingent liabilities continue to weigh on Malta’s fiscal outlook. An additional fiscal burden could come from the country’s elevated stock of outstanding government guarantees, which represented around 7.3% of GDP at year-end 2019. Contingent liabilities linked to public credit guarantee schemes have increased in the context of the Covid-19 crisis. The government has implemented the Malta Development Bank Covid-19 Guarantee Scheme with a sanctioned amount of EUR 420m (3% of GDP), which could lead to higher contingent fiscal risks. Scope notes however, that the actual take-up of the scheme amounted to 0.4% of GDP as of August 2020, according to the Draft Budget 2021⁴. Other contingent fiscal risks relate to population ageing. The long-term increase in Malta’s age-related costs is expected to be among the highest in the EU. Spending on pension and healthcare as a percentage of GDP is forecast to rise by 5.6pps over 2016-70, presenting a risk to the long-term sustainability of Malta’s public finances.

Finally, Malta faces several institutional challenges related to financial supervision and oversight frameworks on top of recent deteriorations captured in quantitative governance metrics (ESG factor). The government has implemented reforms to address shortcomings in its prevention of money laundering and the financing of terrorism, as identified in the 2019 Mutual Evaluation Report of Malta by Moneyval⁵. These welcome developments have helped to enhance the effectiveness of supervisory frameworks, although Scope notes that risk perceptions remain elevated and have led to the termination of several correspondent banking relationships. The Council of Europe is currently finalising its follow-up assessment of Malta’s reform progress, which could have major ramifications for the country’s position as an emerging financial centre. The current administration has made substantial progress in terms of control of corruption and rule of law through constitutional amendments and reforms to the judiciary⁷. Efforts to further enhance institutional quality need to be maintained to avoid adverse implications on the business environment and foreign investment attractiveness to support the country’s growth potential.

One or more key drivers of the credit rating action are considered an ESG factor.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative rating of ‘a+’ for the Republic of Malta. Malta receives a one-notch positive adjustment for the euro’s status as a global reserve currency under the reserve currency adjustment. The resulting ‘aa-’ indicative rating can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative qualitative credit strengths or weaknesses against a peer group of countries.

For Malta, the growth potential of the economy has been identified as a relative credit strength. The following relative credit weaknesses have been identified: i) macro-economic stability and sustainability; ii) current account resilience; iii) banking sector oversight; iv) financial imbalances; and v) institutional and political risks.

The QS generates a one-notch downward adjustment and indicates A+ long-term ratings for Malta.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope explicitly factors in ESG sustainability issues during the ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 20% weight in the quantitative model (CVS). Under governance-related factors in the CVS, Malta’s performance is below the EU average as assessed under the World Bank’s Worldwide Governance Indicators. Governance metrics have deteriorated in recent years. Its average World Bank Governance Indicators percentile rank declined by 7.7 places over 2013-19, mostly driven by worsening performance in control of corruption (-19.5 percentile ranks), government effectiveness (-8.9) and rule of law (-7.5). Policymaking in Malta has been effective but recent political events have led to some instability.

Malta’s performance across key social factors is mixed. Employment dynamics have been very strong in recent years with improving rates for participation, unemployment and youth inactivity. Malta also performs well for income inequality and poverty levels compared to other EU countries. Still, the country faces demographic pressures as well as substantial skills mismatches. PISA results consistently show that Malta’s mean performance across all three subjects tested are below EU average. Educational outcomes are strongly tied to socio-economic backgrounds. Around 51% of pupils from the lowest socioeconomic quartile fail to achieve the minimum reading standard (compared to 34.8% at EU level). These negative aspects may constrain the country’s growth potential given its plan to increase the prevalence of higher-value-added sectors and the associated need for a more skilled labour force.

Environmental factors are explicitly considered in the rating process via the environment sub-category under the ESG risk pillar. Malta has achieved substantial improvements in its greenhouse gas emissions in recent years thanks to the completion of an underwater interconnection to mainland Europe which allowed the country to shift from heavy fuel oil to less carbon-intensive natural gas. The country’s service-based economy limits its climate mitigation capacities, which is reflected in its less stringent emissions targets pursuant to the Effort Sharing Regulation. Its physical constraints in terms of natural resources and land, given that it is a small island state, limit its ability to achieve material climate gains while an expanding population and strong growth in economic activity is leading to pressures on emissions. Scope notes that Malta does not intend to meet its target to reduce emissions by 19% domestically because of limited mitigation potential and high mitigation costs. Instead, it will continue its current practice of ensuring compliance with annual targets by purchasing emissions allocations from other EU member states until 2030⁶.

Rating committee
The main points discussed by the rating committee were: i) economic and fiscal performance; ii) impact of Covid-19; iii) growth potential, external environment, financial stability and macro-economic sustainability; and iv) institutional developments and reform progress.

Rating driver references
1. Ministry for Finance and Employment (2021), The Labour Market – Looking Back & the Road Ahead
2. Central Bank of Malta (2021), Economic Update 3/2021
3. European Commission (2020), Country Report Malta 2020
4. Ministry for Finance and Financial Services (2020), Malta: Draft Budgetary Plan 2021
5. Council of Europe (2019), Malta: Fifth Round Mutual Evaluation Report
6. European Commission (2020), Assessment of the final national energy and climate plan of Malta
7. Venice Commission (2020), Opinion No. 993 / 2020

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Rating Methodology: Sovereign Ratings, 9 October 2020), is available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation      YES
With Access to Internal Documents                                   NO
With Access to Management                                             YES
The following material sources of information were used to prepare the Credit Ratings: public domain and the Rated Entity.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Thibault Vasse, Analyst
Person responsible for approval of the Credit Ratings: Alvise Lennkh, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 9 November 2018.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
© 2021 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.