Moody’s Investors Service has today affirmed Malta’s A3 government bond rating. The outlook remains negative.

The key drivers for today’s affirmation are:

1) The government’s successful consolidation strategy, which brought the 2011 fiscal imbalance below the 3% of GDP ceiling under the excessive deficit procedure.

2) The expectation that debt ratios will stabilise in 2013, curbing further deterioration of key credit metrics that are already weaker than ‘A’ category medians.

3) The continued presence of significant macroeconomic and fiscal downside risks.

In a related rating action, Moody’s has today also affirmed the foreign- and local-currency debt ratings of Malta Freeport Co. at A3, given its status as a government-guaranteed entity.

RATIONALE FOR RATINGS AFFIRMATION

The first driver of Moody’s affirmation of Malta’s government bond rating is the success of the government’s 2010 consolidation strategy. Following the 2010 recovery, the favourable macroeconomic momentum carried over into 2011 with real output expanding 2.1%, and remaining near potential growth.

The benign economic environment was supportive of the authorities’ consolidation strategy to bring the fiscal imbalance below 3% of GDP in 2011, as mandated by the European Commission’s excessive deficit procedure.

With higher receipts from value added taxes and lower capital transfers and current transfers payable, the government successfully achieved its goal of reducing the fiscal deficit from 3.7% of GDP in 2010 to 2.7% by the end of 2011. The government’s medium-term budgetary framework, as laid out under the latest stability programme presented to the European Commission in April, foresees continued fiscal tightening through 2014.

Moody’s expects that Malta’s debt ratios will stabilise in 2013, which will in turn curb further deterioration of key credit metrics that are already weaker relative to ‘A’ category medians. Moody’s forecasts continued positive real output growth for 2012, but well below potential coming in at a very subdued 0.5% and a gradual recovery in 2013 growth, with real GDP expanding 1.1%.

Although the general government deficit should remain below 3% of GDP, Moody’s believes that the fiscal imbalance will increase to 2.9% in 2012, before declining to 2.6% in 2013. These forecasts imply a continued, but slowing, increase in the sovereign’s debt ratios. The rating agency expects general government debt to rise to 73.7% of GDP in 2012 and 74.5% of GDP in 2013 before trending downward. Although Moody’s expects that debt will stabilise in 2013, earlier than in other ‘A’ category peers, Malta’s debt ratios will remain well above peer medians.

Nevertheless, Moody’s notes the continued presence of significant macroeconomic and fiscal downside risks. Further plans for fiscal consolidation target a deficit of 2.2% of GDP in 2012 and 1.8% in 2013.

The consolidation strategy is mostly underpinned by additional revenue raising measures, and appears to be optimistic given the weaker economic environment at home and abroad, additional expenditure related to the restructuring of Air Malta, utility subsidies and the current stage of the political cycle, with the deficit traditionally widening in pre-election periods. Given these factors and a susceptibility to stop-and-go policies, Moody’s believes that there remains a risk of fiscal slippage in 2012.

Should instability due to the euro area debt crisis hamper macroeconomic performance, negative debt dynamics could persist beyond 2013 despite a narrowing of the deficit. Such ongoing dynamics could lead to a significant further deterioration in the sovereign’s key credit metrics and as such underpin Moody’s decision to maintain a negative outlook.

WHAT COULD MOVE THE RATING UP/DOWN

The negative outlook on Malta’s sovereign rating could be changed to stable in the event of a sustained improvement in investor sentiment across the euro area. Although unlikely in the foreseeable future, the government’s ratings could move upward in the event of a significant improvement in the government’s balance sheet, leading to greater convergence with ‘A’ category medians. Substantial structural reforms focused on enhancing competitiveness and boosting potential output growth rates would also be credit positive.

Conversely, Moody’s would view as negative material fiscal slippage that jeopardises debt sustainability. Downward pressure on the rating could develop if Malta’s economic growth prospects deteriorate significantly, thereby obstructing fiscal consolidation and leading to a significant further deterioration in the sovereign’s key credit metrics. The rating could also be downgraded if the financial system were to undergo a large negative shock that hinders its ability to provide funding to the sovereign.

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