The local currency rating could only be sustained if the November budget contained "convincing" measures and showed serious resolve to reduce the government's deficit, international ratings agency Fitch has warned.
The economic slowdown had left "in tatters" the government's aim of reducing the budget deficit to 4.5 per cent of GDP this year, Fitch said. It was now likely to be above seven per cent and higher than last year's 6.2 per cent.
Fitch affirmed Malta's long-term foreign currency rating at A, short-term at F1, and long-term local currency at AA minus. These ratings apply to senior unsecured debt of the government. The outlook for the long-term ratings remains stable.
Fitch's report comes three weeks after Standard&Poor's lowered Malta's local currency sovereign credit ratings, citing as the main reason the government's failure to control its deficit.
A surge in government spending at the start of the year did not help, according to Fitch, with government consumption of goods and services 15 per cent higher in the first quarter than a year earlier.
Efforts to cut the government payroll were making slow progress. The government still employed 23 per cent of the workforce, while the public sector as a whole consisted of 35 per cent of the workforce, Fitch said.
It said government debt was likely to exceed 70 per cent of GDP by December, the highest among the EU accession countries, and the credit outlook would depend critically on whether the government could take steps to curb public spending.
The weakness in continental European economies had continued to hit Malta hard, Fitch noted.
Until 2000, Malta had enjoyed annual growth of five per cent for more than a decade. Since then output has barely changed, though there have been signs of recovery in the key tourism and micro-electronic sectors.
Investment has also dipped below 20 per cent of GDP from over 25 per cent. Fitch estimated that output in the economy as a whole may now be nearly 10 per cent below potential.
The referendum and general election results in the spring did remove the considerable doubts there had been over Malta's EU membership, Fitch said. A huge upturn in business sentiment ensued, especially in export-oriented sectors, but a substantial recovery in output, tourism and investment depended on a return to health of the euro area.
On a positive note, Fitch noted that the external financial position was healthier and last year's 3.9 per cent current account deficit should narrow further this year.
The scheme encouraging residents to declare or repatriate savings held abroad has helped boost the official reserves to over six months' current external receipts and the country's net external creditor position has become even stronger. The government has little external debt.
Malta was likely to join the exchange rate mechanism II after acceding to the EU next May, though the government had yet to announce this, Fitch said.
The country had a long history of exchange rate stability and low inflation so holding the exchange rate stable should pose no problems.
The euro already accounted for 70 per cent of the currency basket to which the lira was currently pegged. But without substantial budgetary cuts, Malta would be unable to qualify for EMU, Fitch said.