Moody's Investors Service said today that it had downgraded Malta's foreign-currency and local-currency government bond ratings to A2 from A1 and revised the outlook to negative.
Moody's said the key drivers for today's rating action are:
"1) Lower medium-term economic growth rates, driven by a decline in potential output growth as a result of the 2008-09 financial crisis, thereby leaving the economy more vulnerable to further economic shocks.
"2) The country has exhibited weak debt metrics for some time and the anticipated improvement in the government's balance sheet at the time of EMU accession has not materialised.
"3) The expectation that even if debt ratios stabilize in the coming years, they are likely to remain above levels commensurate with an A1 rating over the medium-term."
Malta's country ceilings for bonds and bank deposits are unaffected by today's rating action and remain at Aaa, in line with the euro area's ceilings.
MALTA FREEPORT DOWNGRADED TOO
In a related rating action, Moody's also downgraded Malta Freeport Co.'s foreign-currency and local-currency debt ratings to A2 from A1 given its status as a government guaranteed entity
"The main driver underlying Malta's one-notch downgrade to A2 and negative outlook is Moody's view that the global recession of 2008-09 will leave the country with a legacy of slower medium-term economic growth. Specifically, the Maltese government estimates that potential output growth will decline to 2.3% from well over 3% before the crisis because of a decline in fixed capital investments, which led to lower capital formation during 2009-10, and lower total factor productivity growth," Moody's said.
The main driver underlying Malta's one-notch downgrade to A2 and negative outlook is Moody's view that the global recession of 2008-09 will leave the country with a legacy of slower medium-term economic growth- "
"However, the IMF projects an even lower medium-term growth rate of 2.0%. For some time, Malta's debt metrics have been unfavourable relative to other A1-rated sovereigns. Nevertheless, the government's bond ratings were upgraded at the time of EMU accession based on an expected acceleration of growth and an improvement in the government's balance sheet. These benefits have not materialized, and as a result of the financial crisis, government debt ratios further weakened, negating convergence with A1 peers.
"The deteriorating global economic outlook and continued instability inthe euro area heighten the risk of a new economic shock throughout Europe as fears of contagion intensify."
"Moody's assesses the probability of contagion from such a shock to be moderate and the likely impact to be low given the limited impact of the 2008-09 crisis on the performance of the Maltese economy.
"However, Moody's believes that Malta's real economy is susceptible to contagion from the euro area debt crisis given the country's small open economy and its reliance on external demand and tourism. The impact of such a possible shock would arise from second-round effects given that the primary blow would be felt by core European countries, which represent Malta's main trading partners and tourist markets.
"The combination of these factors has led Moody's to assess Malta's creditworthiness to be still in line with an A category rating, but more appropriately positioned at an A2 rather than an A1 rating and to assign a negative outlook.
"As a result of lower potential growth and the relative weakness in keycredit metrics, even if Malta's debt metrics stabilize over the medium-term, they will no longer be commensurate with an A1 rating and do not compare well with those of other A1 peers such as the Czech Republic, Estonia and Korea."
The agency said a further bout of weakness related to the deteriorating external environment could reduce the government's room for manoeuvre in terms of meeting deficit reduction targets, thus potentially leading to a further weakening of the government's balance sheet.
In the future, it said, Malta may face problems related to structural rigidities in the fiscal accounts and the government's reliance on continuous one-off measures to consolidate the government deficit. Nevertheless, demand for the government's debt is likely to remain stable over time as it is held predominantly by strong, domestic financial institutions, acting as a buffer that supports the government's positioning within the A rating category.
WHAT COULD CHANGE THE RATING
Moody's said it would change the negative outlook to stable in the event that the economy proves resilient in the face of a large economic shock, and debt metrics improve to levels consistent with an A2 rating.
Substantial structural reforms focused on enhancing competitiveness and boosting potential output growth rates would also be credit-positive.
Malta's creditworthiness could weaken further in the event of the government's failure to consolidate the fiscal balance towards deficit targets- "
Conversely, Malta's creditworthiness could weaken further in the event of the government's failure to consolidate the fiscal balance towards deficit targets, leading to a sustained deterioration in fiscal policy credibility and debt dynamics.
Furthermore, Malta's rating could also be undermined by a rapid deterioration in the balance sheets of its financial institutions, potentially stemming from financial shocks or a deteriorating economic outlook, thereby limiting their ability to provide funding at moderate rates to cover the government's financing needs.