Fitch Revises Malta's Outlook to Positive; Affirms at 'A'
KEY RATING DRIVERS
The revision of Malta's Outlooks reflects the following key rating drivers and their relative weights:
General government debt fell to 63.8% of GDP in 2015 from 67.1% in 2014 and is forecast to decline to 58% in 2018 (compared with the 'A' median of 43.9% in 2016) due to strong nominal GDP growth and ongoing fiscal consolidation. Recent pension reforms, including the lengthening of the contribution period and measures to incentivise late retirement, will improve the long-term sustainability of the pension system and ease some pressure on public spending.
The fiscal deficit is forecast to narrow to 0.9% of GDP in 2016 and to 0.8% in 2017, below the 'A' median, from 1.5% in 2015. This is on the back of higher expected revenues from robust economic growth, the International Investor Programme, and higher excise duties, more than compensating lower income tax following the implementation of measures providing tax relief on labour. Tighter spending management and strong nominal GDP growth will pull down expenditure/GDP.
Government-guaranteed liabilities remain high at 15.7% of GDP at the end of 1Q16, although they are set to decrease to 11.9% of GDP at end-2017, when the temporary guarantee granted by the state to ElectroGas for the construction of a new power station expires. We view risks from the crystallisation of these guarantees as low as most relate to profitable companies, including the utility company Enemalta, Freeport Group Corporation and Malta Industrial Parks.
The government estimates potential growth at 4.5% in 2015, reflecting the structural rebalancing of the economy from manufacturing towards more added-value and labour-intensive services sectors. The government has implemented a range of structural reforms to improve the country's business environment and competitiveness and foster medium-term growth. In the energy sector, efficiency gains provided by the energy reform and the completion of large-scale energy projects are estimated to add nearly 3pp to real GDP growth by 2020, according to the Ministry for Finance.
Economic growth continued to outperform the eurozone average and peers in 1Q16 at 5.2%. Fitch expects growth to remain buoyant although moderating over 2016-2018 at 3.6%, driven by strong domestic demand. Real disposable income will be supported by rising employment, subdued inflation and wage appreciation. Residential construction and health and education projects will boost investment. The impact of Brexit is likely to be negative but limited, as the decrease in tourist arrivals from the UK will likely be offset by those from elsewhere.
Fitch excludes from its forecasts several large infrastructure projects that could boost investment due to uncertainties over their timeline and scale.
The affirmation of Malta's IDRs also reflects the following key rating drivers:
The banking sector remains well capitalised, liquid and profitable despite moderate credit growth and high concentration, with core domestic banks representing 240% of GDP at-end 2015. Banks are highly exposed to the sovereign through the holding of securities and financing of government-related entities and to the housing market through mortgage exposure and real estate collateral. House prices are rising due to a large influx of foreign workers, measures supporting first-time buyers and low unemployment, but central bank studies show prices are aligned with fundamentals.
Malta's external position compares favourably with 'A' rated peers, with a net international investment position estimated at 37% of GDP at end-2015. We expect the current account surplus to average 4.6% over 2016-2018, boosted by growth in tourism and exports and a decline in imports mirroring a slowdown in investment.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Malta a score equivalent to a rating of AA - on the Long-term 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 rated peers, as follows:
- Public Finances: -1 notch, to reflect the significant stock of contingent liabilities.
- External Finances: -1 notch, to reflect that the euro reserve currency status, for which the SRM provides 2 notches, would likely offer Malta only limited protection in case of a global or domestic financial crisis.
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.
Future developments that could individually or collectively, result in positive rating action include:
-A longer track record of consolidating the public finances that leads to a lower government debt/GDP ratio.
-A significant decline in contingent liabilities or a low likelihood that these contingent liabilities materialise.
-Progress in addressing key weaknesses in the business environment.
Future developments that could individually or collectively, result in negative rating action include:
-Significant slippage from fiscal targets leading to deteriorating public debt dynamics.
-Crystallisation of material contingent liabilities or a shock to the banking sector that requires fiscal support.
Fitch assumes that in case of need, the government of Malta would only be predisposed towards supporting the core domestic banks, which are systemically important, in particular Bank of Valletta (110% of GDP at-end 2015). For HSBC Bank Malta (81% of GDP), Fitch believes that any necessary support would come from its parent company. In Fitch's view, the Maltese government would be very unlikely to support the international banks and would probably not support non-core banks either.