By David Curmi
On the 11th August, Fitch, one of the top three international rating agencies upgraded Malta’s sovereign credit rating to A+ from A. This is good news and generally reflects the strength of the local economy coupled with improving dynamics on the Debt-to-GDP ratio, now forecast by Fitch to move down to 50% by 2019.
But what in reality does this mean for local investors? A credit rating is a measure that indicates the ability of an issuer of debt (Malta government in this case) to repay its debts. The higher the credit rating - AAA being the highest - the stronger the entity that is borrowing money and therefore the higher the capacity or ability of the entity to pay its interest and redemption obligations. Additionally a higher rating would also normally command a lower rate of interest. Conversely countries or companies that have a lower rating are required by the market to pay higher rates of interest to compensate investors for the extra risk they are taking. In the table attached, I have ranked the eurozone countries by strength of their rating, Germany at the top and Greece at the bottom. As you go down the list you also notice two aspects, firstly how well Malta is doing when compared to some of our larger and wealthier neighbours, secondly, and generally speaking, the yield that you are able to obtain on 10-year bonds issued by these countries rises as the rating decreases. This is a reflection of the higher level of risk of these countries.
In truth though, the yield difference between an A+ rating and an A rating is not that large and certainly in the context of an average non-institutional investor is probably immaterial. Yet having ratings is important as it gives a strong indication of the quality of the issuer and allows comparisons across issuers of debt securities allowing investors to get some semblance of relative value. In this respect Malta has greatly benefitted from two aspects in recent years. Firstly, entry into the EU and the euro has helped to anchor our rates to those of central Europe. As a standalone country our interest rates would be much higher than they are currently – not such a bad thing for savers but not a good thing for the economy. Secondly, the policy of the ECB, and in particular Mario Draghi to do whatever it takes to protect the euro has lead to a major convergence of yields downwards for all eurozone countries, especially as the ECB embarked on its Quantitative Easing program. This has happened whilst at the same time ratings of countries in the eurozone have generally deteriorated over recent years. Look at the rating of Spain and Italy. Just before the financial crisis of 2007/08 exploded, these countries were rated AAA and AA- respectively.
It is important now that the government of Malta is able to keep Malta on this upward rating trajectory most especially as almost 50% of government debt is due for renewal in the next 5 years. Currently the government is still paying an average of approximately 4.1% on its issued outstanding debt. Maintaining or improving our country rating is going to be one important factor in determining the ultimate cost of interest that new bonds issued by the government will command.
Other factors may however supersede this. And this is where a welcome relief from the parchedness of the desert heat may arise for investors in such bonds. As the recovery in Europe continues to spread its tentacles, the need for the ECB to continue providing cash to the economy is reducing. At some point in the not-so-distant future the ECB will stop or reduce their level of participation in buying up government bonds, and may, soon after, commence the long road to raising interest rates. This will be a most welcome development for income seekers who have suffered in silence for many a long year.
It is not inconceivable therefore that even as our rating strength increases, the yield on government bonds also increases. This is not a direct reflection on government’s inability to settle its debts but more a reflection of the ECB's actions, since all roads lead to Rome in this respect.
Incidentally in recent weeks the government announced it will be launching its first ever Old Aged Pensions bond. The bond, offering 3% interest for a period of 5 years will NOT be listed on the Malta Stock Exchange and there will be serious restrictions on its transferability. Notwithstanding this, they will still be great value for anybody born in 1955 or earlier, especially when you compare to the 0.16% that is available on 5 year Malta government bonds listed on the MSE. Think of them as a five year fixed deposit account that you cannot withdraw monies from, with even better quality as the issuer is the government and not a bank.
Hope you have a good rest of the summer.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business