DBRS confirms Malta's A rating

DBRS Ratings Limited has confirmed the Republic of Malta's long-term foreign and local currency issuer ratings at A and its short-term foreign and local currency issuer ratings at R-1 (low). The trend on all ratings remains Stable.

The A rating reflects Malta's Eurozone membership, which ensures reliable access to European markets, fosters strong and credible macroeconomic policies and makes available financial support from European institutions. The country's solid external position also supports Malta's ratings, together with a favourable public debt structure and the robust financial position of households.

However, Malta's public finances remain a source of vulnerability, and its economy is exposed to external shocks, particularly those emanating from within the EU. Furthermore, pressures from ageing costs, if unaddressed, could pose a concern for the pensions system.

The Stable trends reflect DBRS's assessment that risks to the ratings are broadly balanced. The ongoing improvement in the fiscal position and solid economic performance counterbalances some of Malta's fiscal vulnerabilities and the potential impact from a slowdown in the UK economy.

Malta joined the European Union (EU) in 2004 and adopted the Euro in 2008. The expansion of trade and travel links with Europe - and with Malta serving as an access point to Europe - has provided a significant boost to the country's growth prospects. Rising employment generated by trade and tourism have increased national income, while fiscal, monetary and financial policy institutions have strengthened in line with EU and Eurozone rules.

Malta's solid external position is another credit strength. The current account surplus has averaged 3.5% of GDP in 2012-2015 and the country is also a net external creditor, with a net external asset position of 28.7% of GDP on average over the past five years. Moreover, its low reliance on external financing has supported the country's resilience over recent years. The Maltese government meets its financing requirements domestically, and the core domestic banking sector is conservatively funded by domestic retail deposits.

Malta's public debt composition and structure also provide support to its rating. The Maltese Treasury has followed a strategy of lengthening the maturity of government debt in recent years. The average maturity of government bonds was 8.7 years at end-2015, which compares favourably to other European economies.

Moreover, a comparatively wealthy population and stable financial system have been reliable domestic sources of funding.

Maltese households enjoy high levels of savings and moderate indebtedness.

Household net financial assets are sizable at 200% of GDP. Real estate values rose significantly in the decade prior to the global financial crisis, but without a large increase in household financial liabilities. Prudent lending practices prevented Malta from building up the significant financial imbalances that have afflicted other Eurozone countries. Private consumption growth is consequently quite resilient and overall economic performance has been strong.

Some of Malta's credit challenges are associated with the exposure of its public sector and the moderately high level of public debt. The government has extended guarantees to several large state owned enterprises (SOEs), which have faced financial difficulties. The degree of concentration in the domestic financial sector could also be a source of contingent liabilities, though the overall financial condition of the core domestic banks looks strong. The restructuring of some of the SOEs has reduced risks to the public sector balance sheet.

Nevertheless, the public sector remains vulnerable to debt shocks. Although public debt is declining, it remains moderately high, at 63.8% of GDP in 2015.

Malta's tourism sector and other industries that rely on foreign demand also expose the economy to unfavourable external developments. Although tourism benefits from a market of wealthy European economies, it could be adversely affected by an economic downturn in the region. Malta is particularly exposed to a slowdown in the UK economy, as British tourists account for 30% of Malta's total tourists. Shocks to external demand could also have an impact on domestic real estate prices, with adverse implications for household finances. Moreover, the financial and gaming industries could be adversely impacted by competition from other markets.

Finally, pressures from age-related costs present another challenge for Malta.

Healthcare costs and pension liabilities, while still below EU averages, have increased rapidly in recent years and demographic trends appear unfavourable.

Labour-market participation is rising, thanks to major improvements from recent reform efforts, but remains among the lowest in the EU, particularly among women and older workers. Pension reform measures are being implemented. This should help secure the long-term sustainability of the system, but the overall impact of the measures is still to be assessed.

Rating drivers

Continued progress on fiscal consolidation and a meaningful reduction in public indebtedness could put upward pressure on the ratings. Successful implementation of reforms to improve the efficiency of the public sector, boost private sector investment, and increase further labour force participation could also have a positive effect.

On the other hand, the emergence of additional contingent liabilities, from the energy sector or financial sector, could have adverse implications for Malta's ratings. Large or prolonged external shocks could also pose downside risks.