NEWS | Wednesday, 26 September 2007

Moody’s confirms Malta’s A2 sovereign credit rating, ‘positive’ outlook

International rating agency Moody’s has confirmed its A2 rating for Malta’s long-term foreign and local currency bonds with a positive outlook, however it warned that the country’s lack of flexibility and high exposure to external shocks like the oil crisis might slow down its economic growth.
The sovereign ratings were upgraded from A3 in July 2007 following the European Union (EU)’s final decision to allow Malta to adopt the euro on 1 January next year.
In its annual assessment of Malta’s economic and financial situation published earlier this month, the international credit rating agency said it viewed the eventual adoption of the euro as a credit positive because it will all but eliminate the risk of a currency crisis and thereby isolate Malta’s economy from external financial shocks.
“Furthermore, membership of the eurozone and the requirements of the Stability and Growth Pact will continue to provide Malta with a strong policy anchor. July’s positive rating action is buttressed by Malta’s strengthening economic fundamentals,” the international credit rating agency said.
It explained that in recent years, Malta has successfully implemented a programme of fiscal consolidation that has substantially narrowed the government’s deficit and reversed the previous upward trend in the public debt burden.

“Malta’s economy has staged a domestically led recovery from its recession in 2003. Real GDP expanded by around 3 per cent in both 2005 and 2006 and is expected to maintain a similar pace over the next two years amid low inflation,” Moody’s said.
The recovery has largely been driven by private consumption and investment, which have been spurred by historically low interest rates, expanding credit, and capital inflows associated with Malta’s 2004 accession to the EU. A pick-up in electronics and pharmaceutical exports also contributed in 2006.
In 2007 and 2008, growth will continue to be primarily domestically driven with private consumption stimulated by a 2007 income tax cut and healthy employment growth in the services sectors.
“Although Malta’s real growth rate in 2006 was close to the weighted average for the 27 members of the European Union (EU), of 3 per cent, it remained the lowest among the twelve new EU member states (NMS). This discrepancy is partly due to the fact that Malta’s economy is at a later stage of development than most other NMS,” Moody’s explained.
It said GDP per capita in Malta averaged €18,200 in 2006 in purchasing power terms according to Eurostat, the fourth highest level among the NMS and 77 per cent of the EU average.
Yet Malta’s low real growth rate “also reflects a number of impediments to growth in Malta including relatively inflexible product and labour markets and other structural limitations,” Moody’s said.
The international credit rating agency warned that the growth outlook for Malta is subject to a number of risks. “Most important are the potential effects of higher oil prices - with Malta dependent on oil imports for virtually all of its energy needs - and the rate of growth in the rest of the EU - the primary market for Maltese exports of goods and services.”
Malta’s economy is also relatively small and undiversified, which increases the risk of sector-specific shocks. “For example, tourism, which accounts for around 20 per cent of GDP, remains vulnerable to increasing competition from cheaper Mediterranean destinations, while semiconductors, which account for around 5 per cent of GDP and 50 per cent of exports, are subject to competition from Asia and potentially volatile fluctuations in global electronics prices.”
Moody’s also warned in its latest report about Malta that “a potential correction in local real estate prices, which have risen strongly in recent years, could also prove detrimental”.
Over the longer term and following the planned adoption of the euro in 2008, Moody’s said the country’s primary challenge will be to maintain economic competitiveness. “Key to addressing this issue will be making progress on structural reforms associated with the EU’s Lisbon Agenda.”
According to a recent assessment by the UK-based Centre for European Reform (Lisbon Scorecard VII), Malta’s performance against the Lisbon criteria in 2006 compared poorly with other EU members.
“Areas of weakness for Malta include an oversized and inefficient public sector, a low level of spending on research and development, slow progress in liberalizing the energy sector, a low level of female employment, and a high drop-out rate among university students.
“The government’s National Reform Programme, prepared in 2005, outlines a strategy towards addressing these weaknesses but implementation will be key to any success in these areas,” the international credit rating agency warned.
Commenting on the political scenario, Moody’s explained how Malta’s electorate remains nearly evenly split between the two main political parties, the Nationalist Party (NP) and the Malta Labour Party (MLP).
“The most recent parliamentary election in April 2003 saw the NP win 35 seats versus 30 seats for the MLP, which is a relatively large margin by historical standards.
“However, the tide may be turning - the MLP has prevailed in all four local elections since the 2003 parliamentary elections, the most recent being in March 2007 and opinion polls currently show the MLP to be marginally ahead of its rival.
“There is therefore a significant possibility that the MLP could win the upcoming parliamentary elections (which are due by August 2008 at the latest) for the first time since 1996.
“The ramifications of a potential MLP victory for Malta’s economic policies would likely be far less dramatic today than they were the last time the MLP took office,” it said.
In 1996, according to Moody’s, considerable disruption followed the MLP’s cancellation of a recently implemented VAT, a sharp hike in utility charges, and the freezing of Malta’s accession process to the EU with the result that the public finances deteriorated sharply.
“However, policy differences between the MLP and NP have narrowed significantly since Malta’s accession to the EU in 2004. The MLP now states that it would maintain Malta’s membership of the EU and the eurozone and would continue to respect the Maastricht criteria for fiscal performance with a view to further reducing Malta’s large public debt burden.
“The MLP’s opposition to government policy currently centres around allegations of corruption, bureaucratic incompetence, and wasteful expenditure. Whether the MLP would prove to be as fiscally conservative if it won power remains to be seen,” Moody’s explained.
Commenting on Government finance and debt, the international credit rating agency explained that “the ongoing consolidation of the public finances has led to a significant reduction of the fiscal deficit over the past three years that has facilitated a gradual decline in the weighty public debt burden since its peak in 2004”.
The fiscal deficit narrowed to 2.6 per cent of GDP in 2006 from 3.1 per cent in 2005, and the European Commission projects that it will narrow further to 1.6 per cent in 2008. Hence the deficit is projected to remain comfortably below the Maastricht criterion for EU members of 3 per cent of GDP.
Moody’s noted that “this consolidation has partly been effected by one-off measures, which generated net revenues equivalent to 1.7 per cent of GDP in 2005 and 0.7 per cent of GDP in 2006.
“Nevertheless, the structural fiscal balance (the cyclically-adjusted fiscal balance net of one-off measures) has also strengthened, from a deficit of 3.8 per cent of GDP in 2005 to 2.7 per cent of GDP in 2006.” The structural deficit is expected to narrow to 1.6 per cent of GDP in 2008.
Structural fiscal reforms in recent years mentioned by Moody’s included an increase in the standard rate of VAT in 2004, a clampdown on benefit fraud, a gradual reduction in the number of public sector workers, and the restructuring of some loss-making public enterprises.
“Despite a reduction in personal income tax rates at the beginning of 2007, tax revenues have grown strongly so far this year on the back of robust economic growth,” it added.
Moody’s warned that “the bright outlook for the public finances is clearly vulnerable to risks, the most significant of which are the rate of economic growth and the trajectory of oil prices.
“Furthermore, the political cycle could yet lead to a loosening of policy in the 2008 budget given that parliamentary elections are due by mid-2008 and that the ruling party continues to trail in opinion polls,” it said.
Over the longer term, Malta, like most developed countries, faces sizable age-related spending pressures, particularly in regards to pensions, healthcare, and social security costs as the age profile of the population increases.
“While the government is cognizant of this issue, it has yet to respond vigorously to the challenge. The government finally succeeded in passing the first stage of a planned package of pension reforms in 2006.
“This will raise the pension age for both men and women to 65 from the current level of 61 for men and 60 for women.
“However, this will happen only very gradually – in phases over a period of 20 years – and the European Commission judges that the reforms will provide little relief to the budget over the long term (although the government disputes this judgement),” Moody’s said.
The international credit rating agency added that “the government has yet to seriously tackle the problem of rising healthcare costs despite promises of reform. The healthcare system in Malta remains free at the point of service”.
Given the projected maintenance of a healthy growth rate and a further reduction in the fiscal deficit, the European Commission projects that the government’s gross debt burden will continue to ease gradually.
The general government’s gross direct debt declined to 66.5 per cent of GDP at end-2006 from a peak of 73.9 per cent at end-2004 and is forecast to ease to around 64 per cent of GDP in 2008.
“Nevertheless, this level continues to exceed the EU average (62 per cent at end-2006) and is the highest among the NMS,” the international credit rating agency noted.
However, the European Commission’s projection does not include the effects of privatisation, which could potentially result in an accelerated decline in the debt ratio. The government recently agreed to sell its remaining stakes in Maltapost and Tug Malta, while according to Moody’s, “additional targets for privatisation include stakes in Bank of Valletta and the Kordin Grain Terminal”.
The international credit rating agency noted that the structure of the government’s gross direct debt is “relatively benign”, with around 95 per cent denominated in local currency and 85 per cent in long-term maturities.
“In addition to its direct debt, the government has a significant amount of guaranteed debt, which amounted to 12 per cent of GDP at end-2006, although we expect this level also to decline gradually,” Moody’s said.

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