Moody’s retain stable outlook for Malta

Dr. Jean-Philippe Chetcuti | Published on 20 Jan 2011

Ccmalta Default

Malta’s A1 government ratings reflect the country’s high economic resilience and its very high financial robustness according to the latest sovereign credit report on Malta issued by Moody’s Investors Service yesterday.

The outlook on Malta’s government ratings is stable. Yet, Moody’s sees a clear need for Malta to address its structural economic problems if it is to continue its real convergence with core euro zone countries and remain competitive.

The country’s primary challenge is to maintain economic competitiveness over the longer term, building on and securing its success in attracting investment in fields such as remote gaming, financial services, call centres and pharmaceuticals.

“Malta has made substantial progress towards real convergence with the rest of the euro zone,” said Dietmar Hornung, vice-president and senior analyst in Moody’s Sovereign Risk Group and author of the report.

“Although competitiveness in some traditional export industries is decreasing as a result of real income convergence, market liberalisation and EU membership are facilitating new export-oriented activities.”

Key to addressing the competitiveness issue will be making progress on structural reforms associated with the EU’s Lisbon Agenda. “Areas of weakness for Malta include an oversized and inefficient public sector, an over-reliance on public subsidies, insufficient spending on research and development, and a low female participation in the labour force,” added Mr Hornung. “These problems will be exacerbated in coming years due to the ageing population.”

The analyst notes that Malta’s institutional strength benefited from the EU accession process. “Now, the risk of economic disruption from the political cycle is far less than it has been historically, not least because of the heavy constraints on economic policy that are imposed by Malta’s membership of the EU and its adoption of the euro.”

Moody’s also considers that Malta’s susceptibility to event risk is very low. For one thing, its adoption of the euro has effectively eliminated the risk of an external financial crisis. Malta’s banks also weathered the initial stage of the crisis relatively unscathed, but their concentration risk is considerable, given their high exposure to the real estate sector.

Moody’s rates Malta’s government debt A1, which reflects “high” levels of economic and institutional strength, “high” government financial strength and “very low” susceptibility to event risk. Malta has made substantial progress towards real convergence with the rest of the euro zone. Although competitiveness in some traditional export industries is decreasing as a result of real income convergence, market liberalisation and EU membership are facilitating new export-oriented activities.

Malta’s institutional strength has clearly benefited from its accession to the EU in 2004 and to the EMU in 2008 through the related improvement of its economic and social institutions. Political risk has also decreased as the once-wide policy differences between the Nationalist Party (NP) and the Partit Laburista (PL) have narrowed significantly in recent years, culminating with the election of the moderate Joseph Muscat as a “new labour” party leader. Government debt remains highly affordable, thanks to significant progress towards fiscal consolidation prior to EMU accession in January 2008. However, the fiscal situation has deteriorated since then, aggravated by lower revenues due to the economic downturn. Malta’s susceptibility to event risk is considered “very low”, mainly because its adoption of the euro has effectively eliminated the risk of an external financial crisis. The benefits of euro membership hold especially true for a small island economy such as Malta’s. Malta’s banks also weathered the initial stage of the crisis relatively unscathed. However, concentration risk is considerable, and banks are highly exposed to the real estate sector.

The outlook on Malta’s rating is stable, although to preserve government financial strength in the medium to long term, there is a clear need to tackle the economy’s structural problems in particular those related to population ageing given substantial unfunded liabilities. Within the EU, Malta’s A1 government bond ratings are at the same level as the ratings of Czech Republic (A1, stable outlook), Slovakia (A1, stable outlook) and Estonia (A1, negative outlook). Malta’s ratings are one notch below Cyprus (Aa3, stable outlook), and one notch above Poland (A2, stable outlook) and Greece (A2, negative outlook). Malta’s global sovereign peers are Chile (A1, positive outlook), China (A1, positive outlook), Saudi Arabia (A1, positive outlook) and Israel (A1, stable outlook).


As an EU periphery country, preserving competitiveness is essential
Malta’s economic strength is assessed as “high”. The convergence of income to the EU average over the past two decades has been impressive and has continued even during the current global crisis.

During 2005-2007, Malta registered strong economic growth, averaging at almost four per cent. With the global recession, Malta’s small open economy has suffered, primarily through the trade channel: exports have decreased and Malta’s sizeable tourism industry has been hit by a lower number of visitors from Germany and the UK.

Increasing job uncertainty and a negative wealth effect (caused by declining housing prices) have been weighing on private consumption. The government’s stimulus in the form of infrastructure projects and subsidies to enterprises amounted to 1.5 per cent of GDP in 2009, limiting the 2009 GDP contraction to a relatively modest 2.2 per cent.

The recovery measures included public infrastructure investment and support for manufacturing, tourism and SMEs. In addition, there was a government-led initiative under which banks grant a one-year interest moratorium to ailing hotels.

In 2010, real growth is expected to turn modestly positive.

Consumption will benefit from low inflation, and investment is expected to be boosted by the construction of a major information and communication technology (ICT) business park. Unemployment has risen in the current crisis to around seven per cent from 5.9 per cent in 2008.

The wage-setting process is marked by a mandatory indexation of wages (cost of living adjustment; COLA) which defines the increase in the minimum wage, based on CPI inflation.

In times of relatively high inflation, COLA hampers necessary cost adjustments and affects the country’s competitiveness. Over 2009, subsidies to utilities were reduced, and tariffs now more adequately reflect the real costs. These costs are relatively high since the power sector is state-owned, and deregulation is difficult as the market is too small for meaningful competition. Since there are very limited water resources (only 20 per cent is pumped from the ground), seawater is transformed into potable water. This transformation is energy-intensive and costly.

The textile sector has left the island and the electronic sector is also turning into a sunset industry. Semiconductors, which account for around five per cent of GDP and 50 per cent of manufacturing exports, are subject to competition from Asia and potentially volatile fluctuations in global electronics prices. Although ST Electronics is still the biggest manufacturing employer, it has reduced its workforce by about 25 per cent since 2006 (currently 2,500 employees). Malta has been successful in attracting new industries to offset ST’s shrinking workforce.

The economy benefits from its English-speaking, highly-skilled work force (both Maltese and English are official languages). Malta has gained competitiveness in fields such as remote gaming (1,000 employees), financial services, call centres, and pharmaceuticals. Furthermore, Lufthansa has opened a big facility to service aeroplanes.

Tourism remains a key economic factor. Its importance to the Maltese economy has been stable since the early 1980s. Tourism represents 12 per cent of Maltese GDP (24 per cent including multiplier effects).

It accounts for 20 per cent of government revenue, and one-third of the work force depends on tourism (10,000 full-time employees plus 10,000 tourism-related employees).

The most important markets are the UK, Germany and Italy. Malta’s challenge is to compete with low-cost Mediterranean destinations like Cyprus, Spain and North Africa. Malta’s banking sector is one of the largest in the EU in relation to GDP, and has been an ordinal winner in the current crisis.

Malta is home to 91 hedge funds and numerous administrations of funds and insurances. A favourable tax regime, a flexible regulator, and the fact that Malta is on the “White List” of the OECD bolster Malta’s position. HSBC has opened a call centre in Malta, which employs 500 people, servicing the UK on a 24-hour basis. However, the growth outlook for Malta is subject to a number of risks. The most significant of these is the rate of growth in the rest of the EU (the primary market for Maltese exports of goods and services) and the potential effects of higher oil prices, as Malta is dependent on oil imports for virtually all of its energy needs. Malta’s economy is also relatively small and undiversified, which increases the risk of sector-specific shocks. Over the longer term, the primary challenge will be to maintain economic competitiveness. Key to addressing the competitiveness issue will be making progress on structural reforms associated with the EU’s Lisbon Agenda. Areas of weakness for Malta include an oversized and inefficient public sector, a low level of spending on research and development, and a low level of female employment.

The country’s institutions have benefited from EU/EMU accession
Malta’s institutional strength is “high”. The country’s institutions have benefited from the EU accession process that led to Malta’s EU membership in May 2004. Furthermore, Moody’s views the adoption of the euro in January 2008 as a positive for institutional strength, as membership of the euro zone and the requirements of the Stability and Growth Pact provide Malta with a strong policy anchor. Malta’s electorate remains almost evenly split between the two main political parties, the PN and the PL (formerly MLP, Malta Labour Party). Although the PN has held a majority of seats in Parliament for all but two of the past 22 years, the size of the majority has remained slim.

The elections to the European Parliament in June 2009 resulted in a clear PL victory, raising the possibility that the PL could be poised to win a majority in the next parliamentary election (although it is a long way off – it is due by 2013). The ideological differences between the two parties have diminished considerably following EU accession, which has improved policy predictability. The ramifications of a potential PL victory in the parliamentary election for Malta’s economic policies would likely be far less dramatic today than they were the last time the Labour Party took office in 1996. At that time, the MLP halted the country’s EU accession process, among other disruptive actions, which led to a steep increase in public debt.

The PL is no longer opposed to the EU and now promises to respect the Stability and Growth Pact criteria for fiscal performance with a view to further reducing Malta’s large public debt burden. The PL’s opposition to government policy currently centres on allegations of corruption, bureaucratic incompetence, and wasteful expenditure. The risk of economic disruption from the political cycle is seemingly far less than it has been historically, not least because of the heavy constraints on economic policy that are imposed by Malta’s membership of the EU and its adoption of the euro.

Subsidies and public wages are high compared to rating peers

Malta’s government financial strength is classified as “high”. General government debt to GDP is at 70 per cent – lower than the euro zone average, which is set to exceed 80 per cent this year. Our constructive view of Malta’s government financial strength is confirmed by the ratio of interest payments to revenue – a key indicator for assessing a country’s debt affordability – which is currently at eight per cent, only marginally higher than the euro zone’s 6.8 per cent.

However, the PN government is struggling to stabilise Malta’s fiscal position. The general government budget deficit has been widening, partly due to a one-off transaction related to early retirement schemes for shipyard workers, but also as a result of a considerable shortfall in revenue. In particular, tax receipts on property transactions have declined. The government implemented a cut in energy and water subsidies, an increase in fuel taxes and the liquidation of shipyards to prevent the 2009 budget deficit rising above 4.5 per cent of GDP.

In June 2009, the European Commission initiated a formal excessive deficit procedure against Malta for breaching the three per cent of GDP budget deficit threshold. Fiscal consolidation will be challenging, since subsidies, State aid, public wages and entitlement spending are all high compared to its rating peers. The room for manoeuvre is limited, as 65 per cent of the revenue flows are cyclically sensitive and 70 per cent of the expenditures are fixed commitments (pensions, benefits, health care, and interest payments).

Additional fiscal risks are represented by the government’s renewed pledge to reduce income taxes further, to continue to provide free universal healthcare and to fund improvements in higher secondary and tertiary education. Over the longer term, Malta – like most developed countries – faces sizable age-related spending pressures, particularly in regards to pensions.

The retirement age of Malta’s pay-as-you-go system is being gradually raised (currently at 60 years for women and 61 years for men), and a capital-based second pillar is to be established. Malta’s health system is a burden on government finances as well: hospitals are free of charge, as is medication for those with low incomes.

Malta’s energy utilities need governmental subsidies as big corporations and hotels do not pay the full bill. Moreover, Malta’s higher education institutions (including the university) are free, which means their R&D is not appropriately funded. Malta’s 2009 gross debt issuance (approximately EUR500m) was utilised to refinance EUR208m of outstanding debt, fund the budget deficit and reduce the outstanding stock of Treasury bills by EUR113m.

So far, the Treasury’s policy has been that of relying almost exclusively on issuing bonds in the domestic market. Non-residents hold less than one per cent of Treasury bills and less than three per cent of Treasury bonds. However, the authorities are working on facilities and legislation to tap international markets in the coming years.


Malta’s banking industry weathered the global crisis relatively unscathed

Malta’s susceptibility to event risk is “very low,” meaning economic, financial or political risks that are likely to induce a multi-notch downward migration of Malta’s A1 rating in the foreseeable future. This assessment reflects our view that both government refinancing risks and contingent liabilities in the context of a balance of payments crisis have been considerably reduced, respectively eliminated by Malta’s accession to the euro zone.

Political disruptions are also considered highly unlikely now that the two political parties are more closely aligned regarding the EU and the economic policy framework. Financial event risk is also assessed as “very low”. Malta’s banking industry weathered the global crisis relatively unscathed. None of the commercial banks was directly affected by the spike in defaults in structured products and the global liquidity shock. No governmental funds have been necessary to support the banking system. The central bank’s stress tests confirm the view that the banking system is resilient. Non-performing-loan ratios are low, loan-to-value ratios do not exceed 80 per cent, and capital ratios remain adequate. However, concentration risk in the loan portfolios needs to be monitored as Maltese banks have high exposure to the real estate sector.

Since the housing market peaked in 2006, prices have turned softer, but are still relatively stable due to the island’s scarcity effect. According to the central bank, housing prices declined by three per cent in 2009. Overall, a decrease by 15 per cent to 20 per cent from the peak is expected. There is some housing market segmentation, as prices at the higher end are relatively stable.

To conclude, although the vulnerability of the financial system has increased due to the ongoing decline in property prices, Malta’s banking industry has shown considerable resilience in the current crisis, which is reflected in a “very low” susceptibility to event risk. This resilience is a function of the banks’ relatively conservative asset portfolios and their low dependence on wholesale refinancing.



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