Fitch Affirms Malta at 'A+'; Outlook Stable

Fitch Ratings - Frankfurt am Main - 15 Mar 2024: 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 DRIVERSRating Strengths and Weaknesses: Malta's rating is supported by high per-capita income, high potential and actual growth rates and euro area membership. 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 an increase in the moderate public debt burden.Strong Growth Trajectory: Malta's post-pandemic recovery has been very strong, with GDP exceeding 2019 levels by around 17pp as of 4Q23. The economy expanded strongly by 5.6% in 2023, outpacing both our September forecast of 3.5% and eurozone growth of 0.4% by a significant margin. We forecast that growth will moderate to 4.1% in 2024 and 3.7% in 2025, reflecting lower growth contributions from previously booming sectors (including from the large online gaming sector).The recovery in the tourism sector is now complete, with tourist arrivals reaching close to 3 million (more than 8% above 2019 levels), but capacity constraints (including at the national airport) have emerged. Potential growth is strong, with estimates ranging between 3.5% to 4.0%, supported by the continued inflow of foreign workers.Strong Labour Market: Unemployment is forecast to average 2.8% over the forecast horizon, below the pre-pandemic rate of 4.1% in 2019. Employment growth was strong at 4.9% yoy in 3Q23, supported by the continued inflow of foreign workers. Wage pressures remain contained, but weak labour productivity and skill shortages remain an issue for the economy.Continued Government Intervention: The government continues to provide sizeable subsidies to stabilise electricity, fuel and gas prices and has initiated a new scheme to curb the increase in food prices. The government agreed with retailers that as of February, the price of over 450 basic food items would be lowered by 15% (relative to their October 2023 base values) for the next nine months, leading to a reduction in the food price contribution to overall HICP inflation in February.We forecast inflation at 2.9% in 2024 and 2.5% in 2025, as we expect that food and service prices will gradually normalise. Headline inflation in Malta averaged 5.6% in 2023, broadly in line with the 'A' rated median and eurozone average of 5.8% and 5.4%, respectively. HICP inflation is estimated to have fallen to 3.1% in February while core inflation moderated to 2.5%. Nominal wage growth has remained contained, supported by the continued inflow of foreign workers in lower productivity sectors.Energy Subsidies Weigh on Fiscals: Fitch estimates that Malta's fiscal deficit narrowed to 5.0% of GDP in 2023 from 5.6% in 2022, but the deficit remained well above the 'A' median of 3.2%. Sizeable energy subsidies, amounting to 1.3% of GDP, pushed up the 2023 fiscal deficit. We expect the fiscal deficits to decline to 4.1% of GDP in 2024 and 3.5% in 2025, lower than the 4.5% and 4.0% deficits that the government is currently projecting, capturing savings on energy subsidies from lower energy prices.However, the government lacks a clear exit strategy from the current fixed price policy, creating fiscal risks around the future cost of energy subsidies as these are closely tied to the development of international energy prices.Fiscal Uncertainties: The risk remains that tax changes related to the EU's Minimum Tax Directive could negatively affect Malta's attractiveness as an investment destination for multinational companies. The EU directive came into force at the beginning of 2024 but Malta has opted for a six-year transition period to implement a minimum 15% effective tax rate for multinational companies. The government is contemplating broader corporate tax reform in line with EU and OECD rules.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 revenue loss of 0.3% of GDP annually. Demographic pressures In Malta are more contained than in many other EU countries, supported by the sizeable inflow of foreign workers. Aging costs will only start substantially increasing after 2040, according to the European Commission's latest ageing projections.Gradual Rise in Government Debt: Malta's public debt ratio will increase to 54.0% of GDP by in 2024, from an estimated 51.0% in 2023. Stock-flow adjustments will add 2.0% of GDP to the debt burden this year and include a one-off equity investment of EUR215 million for the new national airline, following the winding down of Air Malta.Public debt will continue on a gradual upward path, reaching 55.7% of GDP by end-2027, below the EU and government debt threshold of 60% of GDP. The debt trajectory is highly sensitive to actual growth performance. Despite sizeable deficits, financing risks are low, with ample liquidity in the domestic banking sector and domestic investors having absorbed most government debt to date (only around 18% was held by non-residents as of January 2024).Sound Banking Sector: Bank balance sheets are strong, including strong capitalisation and low leverage and non-performing loans. Liquidity levels are exceptionally strong, with Malta reporting one of the highest liquidity coverage ratios among EU countries (421% according to EBA data). Malta also reported one of the highest capitalisation rates in the EU with a common equity Tier 1 ratio of 20.6%, exceeding the EU average of 15.9%.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 75.4, reflecting its long track record of stable and peaceful political transitions, well established rights for participation in the political process, strong institutional capacity, and effective rule of law.RATING SENSITIVITIESFactors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade-Public Finances: Continued upward trend in general government debt, for example, due to insufficient fiscal consolidation or weaker growth.-Structural Features: Further deterioration in governance or material adverse regulatory and/or taxation changes 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 fiscal consolidation.-Structural Features: Further progress in addressing key weaknesses in governance and economic diversification.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 higher inflation and GDP volatility from the pandemic and energy shocks. 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.COUNTRY CEILINGThe Country Ceiling for Malta is 'AAA', 4 notches above the LT FC IDR and at the upper limit of the rating scale. We view the risk of exchange and capital controls as de minimis.Fitch's Country Ceiling Model produced a starting point uplift of +3 notches above the IDR. Fitch's rating committee applied a further +1 notch qualitative adjustment under the Long-Term Institutional Characteristics pillar, reflecting the sovereign's membership of the eurozone currency union and the associated reserve currency status. The agency views the risk of the imposition of capital or exchange controls within the eurozone as exceptionally low.REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATINGThe principal sources of information used in the analysis are described in the Applicable Criteria.ESG CONSIDERATIONSMalta 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 a track record of 20+ years without a restructuring of public debt captured in our SRM variable, this has a positive impact on the credit profile.The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/topics/esg/products#esg-relevance-scores.Source: https://www.fitchratings.com/research/sovereigns/fitch-affirms-malta-at-a-outlook-stable-15-03-2024