Fitch Affirms Malta at 'A'; Outlook Stable

LONDON, March 14 (Fitch) Fitch Ratings has affirmed Malta's Long-term foreign and local currency Issuer Default Rating (IDRs) at 'A'. The Outlooks are Stable. The issue ratings on Malta's unsecured foreign and local currency bonds have also been affirmed at 'A'. The agency has also affirmed Malta's Short-term foreign-currency IDR at 'F1' and the Country Ceiling at 'AAA'. KEY RATING DRIVERS The affirmation and the Stable Outlook reflect the following key rating drivers: The Maltese economy is on the road to recovery. In 2013 the economy grew by 2.4%, better than 2012 (0.9%) and higher than the eurozone average (negative 0.4%), but still some way short of the 'A' median of 3.3% over five years. Fitch expects Malta's GDP growth to continue outperforming the eurozone average in 2014-15. At 6.5% the unemployment rate is in line with the 'A' median and well below the eurozone average, while the employment rate has risen, underpinned by the increasing female labour market participation rate. Public finances remain a sovereign rating weakness. However, while public debt/GDP continues to exceed the 'A' median, positive budget outturns for 2013 indicate that the general government deficit (GGD) is converging to the rating median (2.6%). Fitch estimates the GGD declined to 3% of GDP in 2013, from 3.3% of GDP a year earlier. Recent data points to significant growth in both indirect and direct tax receipts in the 11 months to November 2013. Positive labour market dynamics and corporate profitability have underpinned growth in income tax receipts, despite changes to the income tax brackets. Stronger revenues contrast with rising expenditure, reflecting significant underlying pressures in the Maltese economy. Fitch estimates general government expenditures increased to 44.2% of GDP in 2013 from 43.4% of GDP in 2012. Significant increases in compensation of employees, social benefits' expenditures and capital expenditure have only been partially offset by expenditure reduction at ministerial level. However, total expenditures relative to GDP remain well below the eurozone average. The 2014 budget does not address these expenditure pressures and, as a result, Fitch expects government expenditure relative to GDP to increase further. Nevertheless, the budget, which includes mainly revenue-based measures, should result in GGD declining to 2.8% of GDP this year. Enemalta, the public energy utility, poses the main risk to 2014 fiscal outturns. Fitch notes the authorities' decision to reduce energy tariffs from March 2014, while simultaneously cutting energy production costs at Enemalta. However, the latter is subject to execution risk and the plan could negatively impact Enemalta's profitability, should cost savings fail to materialise. This in turn would have an impact on the budget and be rating negative. The agency believes that in the longer term it may be be difficult for the government to achieve and sustain continued primary budget surpluses thereby placing public debt on a downward trajectory without some adjustment on the expenditure side. Long-term fiscal policy will be heavily influenced by spending pressures on pensions and healthcare related to an ageing population. Public debt sensitivity analysis has marginally improved from the previous review. Fitch forecasts that general government gross debt (GGGD) will peak at 73% of GDP in 2014 (74% in 2014-15 previously) and decline only marginally in the medium term, reaching 70% of GDP by 2020. Contingent liabilities pose additional risks to creditworthiness. Government-guaranteed liabilities stood at 17.6% of GDP in 2013 and 60% of them related to Enemalta. This implies that total public debt stood at around 90% of GDP in 2013. Furthermore, government payment arrears amount to around 10% of GDP (in 2012), the second highest level within the eurozone. The Maltese sovereign credit profile benefits from a deep pool of domestic savings. Public debt is predominantly held by domestic investors and financing capacity is underpinned by a liquid banking sector. Malta also has a robust net external creditor position relative to rating peers and positive international investment position. The banking sector provides most of Malta's net creditor position, but the sovereign also enjoys modest net external creditor status. The government has a strong parliamentary majority, which bodes well for political stability. It also has a strong mandate to reform the energy sector and Enemalta. On healthcare and pensions (two critical areas for the long-term sustainability of public finances) progress has been slow. RATING SENSITIVITIES The Outlook is Stable. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a rating change. However, future developments that could individually or collectively, result in a downgrade include: - Significant slippage from fiscal targets leading to a deterioration in the public debt dynamics. - Crystallisation of material amounts of contingent liabilities on Malta's balance sheets, arising from a range of potential sources, including domestic government liabilities, a shock to the banking sector or eurozone bail-out packages. Fitch notes that on 11 March, Shanghai Electric Power Company agreed to acquire a 33% stake in Enemalta. While full details are not yet available, this deal reportedly has the potential to enhance the utility's profitability over the medium term and reduce its debt. A successful restructuring of the company would allay concerns around crystallisation of contingent liabilities. The agreement should be presented to the Maltese parliament in September 2014. The main factors that individually or collectively could trigger positive rating action are: - An improved track record in consolidating the public finances that leads to a significantly lower public debt level. - A significant decline in contingent liabilities. KEY ASSUMPTIONS Fitch assumes that Malta's economic growth rate will be around 2.5% in 2014-15. This is also dependent on the soft recovery in the eurozone staying on track. In its debt sensitivity analysis, Fitch does not assume any crystallisation of material amounts of contingent liabilities. Fitch assumes the gradual progress in deepening fiscal and financial integration at the eurozone level will continue; key macroeconomic imbalances within the currency union will be slowly unwound; and eurozone governments will tighten fiscal policy over the medium term. It also assumes that the risk of fragmentation of the eurozone remains low. Fitch assumes that the banking sector's performance remains resilient. Moreover we assume that in case of need, the government of Malta would only be predisposed towards supporting the core domestic banks, which are systemically important. The largest bank is Bank of Valletta, which accounts for 107% of GDP.Country CeilingsAdditional Disclosure Solicitation StatusALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. 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