Moody’s has downgraded Malta’s foreign-currency and local-currency government bond ratings to A2 from A1 and revised the outlook to negative.
One of the key reasons for this decision, it said, was lower medium-term economic growth rates. This was 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.
Secondly, “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”.
A third reason was the expectation that, even if debt ratios stabilised in the coming years, they were 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 the rating action and remain at Aaa, in line with the euro area’s ceilings.
Moody’s has also downgraded Malta Freeport’s foreign-currency and local-currency debt ratings to A2 from A1 given its status as a government guaranteed entity.
Explaining its decision to downgrade the island one notch and adopt a negative outlook, Moody’s said its view was that the global recession would 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 per cent from well over three per cent 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.
“However, the IMF projected an even lower medium-term growth rate of two per cent. 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 materialised, and as a result of the financial crisis, government debt ratios further weakened, negating convergence with A1 peers.”
Moody’s said the deteriorating global economic outlook and continued instability in the euro area heightened the risk of a new economic shock throughout Europe as fears of contagion intensified.
The probability of contagion from such a shock was moderate and the likely impact 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, it said, would arise from second-round effects given that the primary blow would be felt by core European countries, which represented Malta’s main trading partners and tourist markets.
While Malta’s creditworthiness was still in line with an A category rating, A2 was more appropriate than an A1 rating, along with the assignment of a negative outlook.
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 might 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.
Still, demand for the government’s debt was likely to remain stable over time as it was held predominantly by strong, domestic financial institutions, acting as a buffer that supported the government’s positioning within the A rating category.
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.
On the other hand, Malta’s creditworthiness could weaken further in the event of the government’s failure to consolidate the fiscal balance towards deficit targets.
The 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.