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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 Stable Outlook.

Summary and Outlook

The affirmation of Malta’s A+ rating reflects the country’s: i) strong growth potential; ii) prudent fiscal management, supported by strong growth and reflected in its good record of pre-crisis fiscal consolidation; and iii) robust external position, with a large net international creditor position, further bolstered by euro area membership. The rating is constrained by: i) an externally dependent and resource constrained economy which poses some long-term risks to the stability and sustainability of Malta’s growth model; ii) fiscal risks related to increasing age-related cost pressures, high reliance on corporate income taxes and contingent liabilities; and iii) lingering, albeit improving, institutional and administrative challenges.

The Stable Outlook reflects Scope’s view that the risks Malta faces over the next 12 to 18 months are well balanced.

The rating/Outlook could be upgraded if, individually or collectively: i) continued implementation of structural reform support greater diversification into higher-value added, more sustainable activities, bolstering the resilience of the country’s growth model; and/or ii) post-crisis fiscal consolidation returns public debt-to-GDP to a firm downward trajectory.

Conversely, the rating/Outlook could be downgraded if, individually or collectively: i) there is a structural deterioration in the growth outlook; ii) the fiscal outlook weakens substantially and/or iii) institutional fragilities re-emerge and threaten Malta’s economic attractiveness and competitiveness.

Rating rationale

The first rating driver supporting Malta’s A+ ratings relates to the country’s strong growth potential. Malta’s economy expanded rapidly in the years pre-Covid, posting very strong growth rates of 7.4% on average over 2015-19, the second highest in the EU after Ireland. This was driven by a shift from manufacturing towards faster-growing, higher value-added, export-oriented sectors such as e-gaming, finance and tourism, and inflows of highly skilled workers. Structural shifts in the Maltese economy and successful reform implementation also contributed to Malta’s solid medium-run growth potential, estimated at around 3.5%, the highest among its peers.

Malta has been recovering swiftly from the Covid-19 pandemic despite ongoing headwinds stemming from an uncertain economic environment, slowdown among trading partners, still elevated inflation, and tightening monetary policies. Real growth reached 7.1% in 2022, supported by strong investment and domestic consumption while net exports weighed on economic performance. The tourism sector has particularly performed strongly, with total inbound tourists reaching 1.2m in the first half of 2023, up 44% from the first half of 2022. The growth outlook remains strong, supported by elevated public investments under the National Recovery and Resilience Plan, buoyant domestic demand, and sustained recovery in important sectors such as tourism, e-gaming, information and communication technologies and professional services. Scope projects growth to moderate to 2.7% in 2023 and stabilise at around 3.5% thereafter, placing Malta as one of the top performing EU economies.

The second rating driver for Malta’s A+ rating is its prudent fiscal management, supported by strong economic performance and reflected in its good record of fiscal consolidation. Strong growth and effective fiscal consolidation in the years leading up to the Covid-19 crisis helped Malta achieve one of the largest public debt reductions in the EU (-16pps of GDP over 2015-19), affording the government with sufficient fiscal space to provide large scale support to its economy throughout the Covid-19 and cost-of-living crises. The countercyclical policy response to both crises was swift and effectively preserved the country’s growth potential. The country’s public finances have been recovering gradually, with a budget deficit of 5.3% of GDP in 2022, after 9.3% in 2020 and 7.5% in 2021 respectively. Scope notes that fiscal performance since 2020 has consistently outperformed expectations thanks to strong economic growth and higher tax revenue, reflecting the authorities’ conservative budgeting practices. Spending on measures to support companies and households to mitigate the cost-of-living crisis are set to reach 1.7% of GDP in 2023, half that of the 2023 budget (3.4% of GDP).

The government’s fiscal strategy is slowly turning towards strengthening the fiscal position without jeopardising the public investments needed for the green transition and national defence. The government expects to maintain energy subsidies through 2026 with an average cost of 1.4% of GDP per year, though this is subject to revisions depending on the evolution of commodity prices. The 2023-26 Stability Programme foresees a structural adjustment of 0.7% of GDP in 2024, beyond that which would be required under the revised EU fiscal framework . Still, the budget deficit should narrow only modestly to 5.1% of GDP in 2023, before falling below 3% by 2026. As such, Malta will be among the few EU member states with a deficit above 3% of GDP in 2025.

However, Malta benefits from good growth prospects and a strong record of consolidation, which provide the country with solid foundations to rebuild fiscal buffers in the post-crisis period. Public debt, at 56% of GDP in 2022, is lower than expected thanks to the debt-reducing effects of strong growth and high inflation. Scope foresees these factors to offset the impact of significant budget deficits on the public debt trajectory in coming years, with debt stabilising at 58% of GDP by 2024. Importantly, the interest payment burden will remain moderate and stable at below 1.3% of GDP over the forecast horizon despite the significant increase in the debt stock and markedly higher interest rates since 2019, reflecting Malta’s long average maturity of debt of over eight years.

The third driver underpinning Malta’s A+ rating is its robust external position. The country posted sizeable current account surpluses in the pre-crisis years, averaging 4.8% of GDP over 2015-2019, supporting a largely positive net international investment position of 42% of GDP in September 2022, one of the highest in the EU. The current account balance reached a deficit of 2.7% of GDP in 2022, versus a 1.2% of GDP surplus in 2021, mostly due to a widening in the goods trade deficit amid higher commodity import prices. Malta’s export competitiveness has improved recently, benefitting from relatively low inflation and improvements in unit labour costs relative to euro area peers, underpinned by strong labour productivity growth. Scope expects the current account to improve and turn positive in coming years as exports performance improves on the back of continued recovery in the tourism sector while import price pressures alleviate.

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

First, Malta is a small, open, externally dependent, and resource constrained economy, which can pose long-term risks to the stability and sustainability of the country’s growth model. Exports represented 148% of GDP in Q1 2023 and the economy is strongly interconnected with international financial markets given its large financial services sector. As such, Malta remains vulnerable to external economic shocks, including changes in the international tax regime and tightening financial conditions. Strong economic performance in recent years was supported by fast-growing strategic sectors such as e-gaming, finance, and tourism. This structural shift was achieved thanks to a significant inflow of highly skilled foreign workers which boosted the labour supply and increased labour productivity. Malta’s growth continues to be dependent on sectors reliant on external demand and investments such as tourism, which accounted for over 10% of GDP in 2019. In addition, the country’s significant labour market shortages and skill mismatches mean that it’s long-term growth path relies on possibly volatile and uncertain migration inflows. Moreover, large inflows of foreign workers and a rapidly expanding economy pose long-term sustainability challenges given scarce resources in terms of land, water and energy, and complicate efforts to reduce emissions. Malta is now trying to address these challenges through its recovery and resilience plan with projects aimed at supporting environmental sustainability, improving educational outcomes and the quality of Maltese worker skills, as well as enhancing social inclusion and mobility.

Second, Malta faces important fiscal risks including rising pressures due to age-related costs and elevated contingent liabilities. The European Commission estimates that Malta’s old age dependency ratio will increase by around 33pps over 2019-70, versus an EU average of 25pps². This will translate into a substantial increase in the total fiscal cost of ageing, estimated at 8pps of GDP over 2019-70, versus an EU average of 1.9pps. Additional risks for public finances stem from the elevated stock of government guarantees mainly related to Covid support measures and additional support for state-owned enterprises. Government guarantees amount to 8% of GDP, while the IMF has estimated that the liabilities of state-owned enterprises represented 19% of GDP in 2019³. Finally, Malta is highly reliant on corporate income taxes, representing 17% of total tax revenue in 2021. This results in vulnerability to economic shocks, while favourable tax rules allowing companies to reduce the effective tax rate from 35% to between 0% and 10%⁴, may no longer be sustainable. The EU Minimum Tax Directive which establishes a minimum 15% effective corporate tax rate for large corporations, may weaken Malta’s economic attractiveness and its tax base.

A third constraint to Malta’s A+ rating relate to its lingering, albeit improving, institutional and administrative challenges. Institutional shortcomings have been identified by international institutions, including the EC, IMF and the Council of Europe. The Venice Commission stated that a “comprehensive and holistic reform of Malta’s democratic institutions and system of checks and balances in still urgently needed”, pointing to the need to enhance judicial independence, parliamentary oversight of the government and curtail of the concentration of power⁵. Similarly, further progress is needed to strengthen control of corruption in the country, with Malta effectively addressing only two of the twenty-three recommendations formulated by the Group of States against Corruption as of May 2022⁶. The government is actively pursuing improvements in judiciary independence, judicial proceedings, control of corruption, fraud and financial irregularities through its National Reform Programme, its Recovery and Resilience plan and its National Anti-Fraud and Corruption Strategy. For instance, legislative changes to enhance governance and the rule of law were taken in 2020, while effective action to strengthen supervisory frameworks and enforce oversight of the financial sector, resulted in the removal of Malta from the Financial Action Task Force’s greylist.

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 credit rating of ‘a’ as regards Malta. The ‘a’ indicative rating is further supported by the methodology’s reserve currency adjustment which provides a one notch uplift to the CVS indicative. The ‘a+’ indicative ratings can thereafter 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 following relative credit strengths have been identified: i) growth potential of the economy. Malta’s relative credit weaknesses are: i) macro-economic stability and sustainability; and ii) governance factors.

The combined relative credit weaknesses and strengths identified in the QS generate no notch adjustment to the ratings and indicate a sovereign credit rating of A+ 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 its rating process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 25% weighting under the quantitative model (CVS) as well as in the methodology’s qualitative overlay (QS).

Environmental factors are explicitly considered in the rating process via the environment sub-category under the ESG risk pillar. Malta has achieved one of the greatest reductions in its greenhouse gas emissions intensity, going from above EU average levels in 2005 to one of the lowest levels across the EU in 2021, though this was in part thanks to the energy interconnector with Italy, which shifted domestic emissions related to power generation outside of the country starting in 2015. Oil and natural gas have the highest shares in the country’s total energy supply (43% and 46%, respectively in 2020 according to IRENA). Renewables continue to play a small role in the country’s energy mix, as also outlined in the National Energy and Climate Plan (NECP), where renewables are expected to represent only 11.5% share of energy consumption by 2030, a target assessed as unambitious by the European Commission⁷ though the NECP is currently under revision. The country’s service-based economy, as well as its geography, demographics and expanding GDP, make further gains in emissions reductions more challenging. In addition, Malta has by far the highest expected relative distance of any EU country to its 2030 effort sharing target, though it expects to meet its targets thanks to flexibilities within the EU Effort Sharing Directive which greatly mitigates transition risks. The country’s recovery and resilience plan is expected to contribute substantially to its green transition, with 54% of the plan supporting climate and environmental objective. In addition, the country is exposed to resource risks as a small island-state that imports many of its goods and much of its energy needs. Malta is vulnerable to floods, hail, soil and coastal erosion, and droughts. Still, natural risks are low as reported in the World Risk Report⁸, with Malta ranking in the top ten safest countries when it comes to natural risks and coping capacities.

Malta presents a mixed performance on social risk factors captured under the CVS. The country has a high and increasing employment rate, at 78.6% in 2021, with long-term and youth unemployment rates at 1% and 9.6%, respectively, well below EU averages (2.8% and 16.6%). Although heterogeneous among different social groups, the rate of population at risk of poverty or social exclusion is also lower than the average European share (20.1% versus 21.6% in 2022). Nevertheless, educational outcomes are lagging EU peers, with a high share of low-skilled adults in the EU (33% of those aged 15-64 in 2022), a limited participation of low-skilled adults in learning, and a high share of early school leavers (10% in 2022). Weak educational outcomes are also reflected in the country’s substantial labour shortages and skill mismatches in different sectors such as ICT, tourism, health, and long-term care. Finally, Malta faces important demographic challenges, ranking as one of the EU countries that will see its old age dependency ratio increase the most in coming decades. The European Commission estimates that Malta’s old age dependency ratio will increase by around 33pps over 2019-70, versus an EU average of 25pps.

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 improved since 2019 in control of corruption (+2.9 percentile ranks), voice and accountability (+1.0), and government effectiveness (0.5), but have worsened in regulatory quality (-2.9) and rule of law (-1.9). Malta is currently implementing a series of structural reforms to address its institutional and governance issues, but further action needs to be taken, in line with the country’s reform agenda. Reforms included in Malta’s recovery and resilience plan aim at strengthening the independence and effectiveness of the judiciary, as well as the country’s capacity to tackle corruption and money laundering. On 26 March 2022, Malta held legislative elections where the incumbent Labour party secured a 55% majority, with the next general elections planned for in 2027. Scope therefore expects broad policy continuity over the coming years.

Rating Committee
The main points discussed by the rating committee were: i) growth dynamics and outlook; ii) fiscal performance and outlook; iii) structural reform progress and economic bottlenecks; iv) current account resilience; v) environmental sustainability and climate mitigation strategy; and vi) scorecard assessments.

Rating driver references
1. Maltese Ministry for Finance and Employment, Stability Programme 2023-26
2. European Commission (2021), The 2021 Ageing Report
3. International Monetary Fund (2023), Malta: 2022 Article IV Consultation Staff Report
4. European Commission (2023), Malta Country Report
5. Council of Europe (2022), The honouring of membership obligations to the Council of Europe by Malta
6. Group of States against Corruption (2022), Fifth Evaluation Round: Compliance Report – Malta
7. European Commission (2020), Assessment of the final national energy and climate plan of Malta
8. RUB & IFHV (2023), WorldRiskReport 2022

Methodology
The methodology used for these Credit Ratings and Outlooks, (Sovereign Rating Methodology, 27 September 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies. The model used for these Credit Ratings and/or Outlooks is ( CVS Model Version 2.1), available in Scope Ratings’ list of models, published under https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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   NO
With Access to Internal Documents                                NO
With Access to Management                                          NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
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 is/are UK-endorsed.
Lead analyst: Thibault Vasse, Associate Director
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Executive Director
The Credit Ratings/Outlooks were first released by Scope Ratings on 9 November 2018. The Credit Ratings/Outlooks were last updated on 23 September 2022.

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

Conditions of use / exclusion of liability
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