Canadian credit rating agency assigns ‘A’ rating to Malta

Dominion Bond Rating Service, a Canada-based credit rating agency, has assigned long-term foreign and local currency issuer ratings of A to Malta.

In its first ever credit rating of Malta, DBRS has also assigned short-term foreign and local currency issuer ratings of R-1 (low). The trend on all ratings is Stable.

In a statement, DBRS noted that Malta’s “prudent lending practices and stable household finances” saved it from generating the financial imbalances that have plagued other Eurozone periphery countries. However, it warned that Malta’s weak productivity growth combined with high and rising costs poses a challenge for competitiveness, while low labour participation limits fiscal flexibility.

They said that Malta’s progress on fiscal consolidation and a gradual reduction in public indebtedness could put upward pressure on its stable ratings. It added that successful implementation of reforms to improve the efficiency of the public sector, boost private sector investment and increase formal labor force participation could have a positive effect.

“On the other hand, the emergence of additional contingent liabilities, particularly from the energy or financial sector, could have adverse implications for Malta’s ratings,” the credit rating agency warned. “Large or prolonged external shocks could also present downside risks to the ratings.”

While it noted that Malta benefits from a “flexible labour force and favourable tax climate”, it also warned that “educational outcomes are relatively poor, showing weak basic skills attainment and a high rate of early school leaving.” “Nonetheless, with a considerable amount of seasonal employment and open immigration policies, the labor force adjusts quickly,” DBRS said. “Moreover, the younger generation shows higher levels of educational attainment than older generations, and Malta has been able to adapt training programs in response to the needs of key employers.”  They said that multinational corporations are attracted to Malta due to its full imputation tax system that eliminates the double taxation of dividends paid out of company profits, including capital gains, already subject to tax. 

They pointed out that domestic banks remain traditional in terms of their reliance on retail deposit-based funding and property collateral-based lending.

“A lack of space for new construction and relatively high credit costs appear to have helped insulate the islands from overbuilding, and evidence of overvaluation in the real estate market is limited,” DBRS said. “Consequently, the overall financial system fundamentals remain strong and risks to the government’s balance sheet appear contained.

“Non-domestic banking activity may pose reputational risks, but is unlikely to have any material direct impact on the Maltese economy.”

However, they warned that Malta has exhibited relatively weak productivity growth that could undermine its competitiveness as labor costs continue to rise. They pointed out that growth in Malta’s output per worker since 2007 has underperformed most other southern EU countries, while labor costs have risen in excess of 25%- compared to roughly 10% in France, Italy and Spain.

“Structural characteristics, including the small size of firms, lack of innovation, high degree of informality and limited access to credit appear to be primary factors in Malta’s low rate of productivity growth,” DBRS said. “Infrastructure bottlenecks may also be playing a role.”

They said that Malta has a low rate of labour force participation but that government policies to encourage employment, particularly among women and older workers, have had positive but largely transitory effects on growth.

“An apparently high degree of informality may limit further progress and ultimately make long-term pension commitments less affordable,” DBRS said.

On Malta’s public debt, DBRS pointed out that, while it compares favourably to many other European economies, it remains elevated compared to national historical levels.

They added that the average interest cost of public debt is relatively high, though declining.

They noted that the government’s restructuring of state-owned companies, particularly Enemalta, has reduced risks to the public sector balance sheet, and said that the new fiscal framework could lead to a durable debt reduction in the future.

“Nonetheless, the public sector remains exposed to debt and financing shocks, particularly given the high degree of concentration in the domestic financial sector,” DBRS said. 

They also pointed out that Malta’s economic reliance on tourism and industries catering to foreign demand leaves the economy exposed to external shocks.

“Although tourism emanates from a diverse set of wealthy economies, Malta could be adversely affected by a downturn in European economic activity,” DBRS said. “If a sustained erosion in tourist arrivals or other shocks in external demand were to have an impact on domestic real estate prices, this could have a serious impact on household finances and financial stability. “The island economy’s competitive position could also be eroded as stability returns to nearby North African countries, or as domestic costs rise. Similarly, the financial and gaming industries could be adversely affected by competition from other markets, including in advanced countries engaging in tax and regulatory reforms.”

The Finance Ministry welcomed DBRS’ ratings as a reflection of Malta’s economic growth and progress in the reduction of the national deficit and debt.

It also noted DBRS’ statement that competiveness has been undermined since 2007, “contrary to the Opposition’s claims that the previous administration had left a solid economy behind them”.  

Shadow finance minister Mario de Marco noted DBRS’ claims that “membership in the Eurozone plays an integral role in Malta’s economy”.

“It is ironic that the Labour Party, which opposed both European Union membership and the adoption of the Euro, is now seeking to take credit for the positive effects of Malta’s accession to the EU and the Eurozone,” he said.