Fitch Revises Malta’s Outlook to Stable; Affirms at ‘A+’
Link to Fitch Ratings’ Report(s):
Malta – Rating Action Report
Fitch Ratings has revised Malta’s Outlook to Stable from Positive and affirmed the Long-Term Foreign-Currency (LTFC) Issuer Default Rating (IDR) at ‘A+’.
A full list of rating actions is at the end of this rating action commentary.
Under EU credit rating agency (CRA) regulation, the publication of sovereign reviews is subject to restrictions and must take place according to a published schedule, except where it is necessary for CRAs to deviate from this in order to comply with their legal obligations. Fitch interprets this provision as allowing us to publish a rating review in situations where there is a material change in the creditworthiness of the issuer that we believe makes it inappropriate for us to wait until the next scheduled review date to update the rating or Outlook/Watch status. The next scheduled review date for Fitch’s sovereign rating on Malta will be 10 July 2020, but Fitch believes that developments in the country warrant such a deviation from the calendar and our rationale for this is laid out below.
KEY RATING DRIVERS
The revision of the Outlook on Malta’s IDRs reflects the following key rating drivers and their relative weights:
The Outlook revision reflects the significant impact of the global coronavirus pandemic on Malta’s economy and public finances. Fitch forecasts real GDP to contract 5.9% in 2020, reflecting the health crisis shock to the global economy and tourism, and the government’s containment measures, as both firms’ and households’ spending is put on hold. Growth in public consumption will provide some limited cushion, on the back of increased spending in the healthcare sector. Growth is projected to rebound to 3.6% in 2021, but below 2019’s 4.4%.
Fitch expects the tourism sector in Malta will suffer a sharp contraction in 2Q20, before recovering slowly in 2H20. Overall, we believe hotel occupancy in 2020 to be close to 50% of 2019 levels, with the remaining sectors dependent on tourism to be harshly affected as well. Travel and tourism accounted for about 16% of GDP in 2019 (excluding indirect effects), according to the World Travel & Tourism Council.
We see material downside risks to these forecasts. The extent and duration of the restrictions on activity could be greater- and longer-than-expected, or the tourism sector could fail to recover in 2H20, especially if Malta or its trading partners extend their lockdown periods. In that scenario we would expect a larger decline in output in 2020 and a weaker-than-expected recovery in 2021, which could have negative repercussions for growth prospects and public finances over the medium-term.
The government has responded swiftly to health risks associated with coronavirus. The authorities mobilised the healthcare system and implemented comprehensive containment and mitigation measures, including full suspension of inbound flights, social distancing and closure of non-essential shops and services and the lockdown of vulnerable pockets of population.
The impact of the shock on the domestic economy will be partially softened by proposed government relief measures to combat the disease and support the economy. On 18 March, the authorities announced a package amounting to EUR1.8 billion (13.6% of 2019 GDP) which included EUR210 million (1.6%) in direct spending measures, EUR700 million (5.3%) in tax deferrals and EUR900 million (6.8%) in loan guarantees. Additional measures announced on 24 March included further fiscal support aimed at raising wage subsidies, at an estimated cost of EUR61 million (0.5%) per month. Healthcare spending is projected to increase by EUR100 million (0.8%).
Fitch estimates the general government balance to deteriorate to a deficit of 8.2% of GDP in 2020, from a surplus of 0.8% in 2019, based on the operation of automatic stabilisers and the direct budget impact of close to EUR600 million (4.5% of GDP) from the government measures. Lower spending and a rebound in economic activity would partly shrink the deficit in 2021 to 5% of GDP.
We expect general government debt to increase to 55.7% of GDP in 2020, from an estimated 43.4% in 2019. The authorities estimate up to EUR2 billion (15.1% of 2019 GDP) will be borrowed in 2020, in line with Fitch’s expectations. Malta had EUR379 million (2.9% of GDP) in cash buffers at end-3Q19, which we expect will be partly used to help finance the large deficit.
The extent of the increase in public borrowing this year, and the pace at which it will unwind, remains uncertain, and crucially depends on the time it will take for economic activity to return to pre-pandemic levels. While Malta is likely to emerge from this crisis with a higher level of public debt, its recent track record of sound fiscal performance, including consecutive fiscal surpluses between 2016 and 2019, means it is better prepared than some of its peers to face the challenges in consolidating public finances over the medium-term
Malta’s ‘A+’ IDRs also reflect the following key rating drivers:
We expect the labour market will deteriorate markedly this year, with the unemployment rate set to increase to 6.1% in 2020 from 3.4% in 2019, before edging down to 5.1% in 2021. This would match the level from 2013 but would come short of the maximum registered during the global financial crisis in 2009 at 6.9%. We see upside risks to these projections given that the accommodation and food services employ a large share of foreign labour.
In spite of the external shock, Fitch projects Malta to maintain a current account surplus of 2.9% of GDP in 2020, albeit markedly down from 2019 (8.1%), as the contraction in imports would not be sufficient to offset the weaker service exports. Nevertheless, Malta has one of the largest net international investment positions in the EU, estimated at 62.7% of GDP at end-2019 and this is expected to continue increasing in the coming years. Malta will remain a large net external creditor (estimated at 166.1% of GDP at end-2019), distorted by its large banking sector.
Financial soundness indicators are strong and provide buffers to the financial system in the event of a sharper contraction than forecast with high common equity Tier 1 ratio (16.8% at end-3Q19 for core domestic banks), return on equity (11.1%) and return on assets (0.96%). While asset quality is likely to deteriorate, non-performing loans (NPLs) had declined to 3.2% at 3Q19 (core domestic banks). The share of loans to non-residents (16.9% at end-3Q19 for core domestic banks) remains high and a risk factor, but they have stabilised around 15%-20% for the past few years. We expect credit to the private sector to contract 2% in 2020, given the effects of the pandemic on the economy.
Fitch expects economic policy continuity under the new government. Robert Abela was instated as Prime Minister on 13 January 2020, after having won Labour Party’s internal elections for new party leader on 11 January. This follows the resignation of the former Prime Minister, Joseph Muscat, on 1 December 2019, after weeks of protests over developments in the investigation into the 2017 killing of journalist Daphne Caruana Galizia and other corruption-related scandals. Abela was elected to parliament in 2017 and acted as a legal adviser to Muscat.
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, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Malta has a high WBGI ranking at 83.1, despite having deteriorated significantly in 2018, especially in the Control of Corruption and Voice & Accountability sections.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch’s proprietary SRM assigns Malta a score equivalent to a rating of ‘AA-‘ on the LTFC IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final LTFC IDR by applying its QO, relative to rated peers, as follows:
– External Finances: -1 notch, to reflect the small and highly open nature of the Maltese economy, including the large share of tourism in the economic activity, which makes it vulnerable to external shocks, and the large size of recorded foreign direct investment (FDI) inflows together with a high ratio of debt-to-equity, which flatter external-financing metrics.
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 LTFC 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.
Developments that could individually or collectively result in positive rating action/upgrade include:
– General government debt/GDP returning to a firm downward path over the medium-term, for example due to a post-coronavirus-shock fiscal consolidation.
– Confidence that Malta can return to high GDP growth in the medium term, supporting a convergence of GDP per capita with that of higher-rated sovereigns.
– Further progress in addressing key weaknesses in governance, banking supervision and the business environment.
Developments that could individually or collectively result in negative rating action/downgrade include:
– Severe and prolonged economic weakness due to the pandemic, including a larger-than-expected contraction in the tourism sector.
– Persistent increase in general government debt, for example due to a more prolonged period of fiscal loosening, weaker growth prospects or materialisation of contingent liabilities.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Public Finance 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.
Fitch assumes that in case of need the Maltese government would only be pre-disposed to support core domestic banks, while being unlikely to support international banks and non-core domestic banks.
We assume that the global economy develops in line with our Global Economic Outlook published on 2 April, with the global economy to go through a deep but short-lived recession in 2020 due to the pandemic. In particular, eurozone GDP is forecast to decline 4.2% in 2020, before recovering 2.9% in 2021. Fitch notes that there is an unusually high level of uncertainty around these forecasts and that risks are firmly to the downside.
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.
– 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.
– 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 recent political scandals have the capacity to feed into future governance scores; this is highly relevant to the rating and a key rating driver with a high weight.
– 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 are relevant to the rating and a rating driver.
– Malta has an ESG Relevance Score of 4 for Creditors Rights as willingness to service and repay debt is relevant to the rating and a rating driver, as for all sovereigns.
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(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.