(Adds Government statement)
Fitch Ratings has downgraded Malta's long-term foreign and local currency issuer default ratings from A+ to A.
The agency gave the country a stable outlook and affirmed its ceiling at 'AAA' and short-term foreign currency rating at 'F1'.
In a statement, it said the downgrade reflects significant fiscal slippage.
"Malta's general Government deficit was 3.3 per cent of GDP in 2012, well above both the Government's target (2.2 per cent) and Fitch's September 2012 forecast (2.6 per cent of GDP).
"This slippage has carried over to 2013, when Fitch forecasts a deficit of 3.6 per cent of GDP, compared with 2.7 per cent in the original 2013 budget.
"The European Commission has re-opened the excessive deficit procedure against Malta, with the deadline for correcting the excessive deficit set for 2014."
In its previous rating review in September last year, Fitch identified material fiscal slippage in 2012 as a negative rating trigger.
Fitch also said that public debt dynamics were worsening.
"Fitch now forecasts that general Government gross debt will peak at 74 per cent of GDP in 2014-15 (two years later than previously expected) and decline only marginally in the medium term, remaining above 73 per cent of GDP by 2020.
"A debt ratio that is higher for longer reduces the fiscal space to absorb future adverse shocks."
Fitch said that, in its view, the authorities' response to the 2012 fiscal deterioration has been slow.
"The 2013 budget is moderately expansionary, rather than starting consolidation.
"Although the newly-elected government has committed to fiscal consolidation and pledged to exit EDP by 2014, as yet there has been no clarity around the fiscal measures underpinning the adjustment.
"The April 2013 Stability Programme Update suggests the fiscal adjustment will be based solely on revenue growth. Despite Fitch's forecast for positive GDP growth in 2014-15, the agency believes it will be difficult for the Government to reduce the general Government deficit and put public debt on a downward trajectory without some adjustment on the expenditure side."
The agency said that contingent liabilities are rising and this posed additional risks to creditworthiness.
"Government-guaranteed liabilities had risen to 17.6 per cent of GDP in 2012 from 11 per cent in 2006, and 60 per cent of them relate to Enemalta, the public energy utility company.
"This implies that total public debt (including guarantees) stood at 90 per cent of GDP in 2012. Furthermore, Government payment arrears, including the healthcare sector, amount to some 9.8 per cent of GDP (in 2012)."
However, the agency lists the pensions system as the main long-term threat to public finances.
"Since the March 2013 elections, there has been no concrete policy announcement in this area, despite several years of consultations on the review and recommendations of the Pensions Working Group.
"Demographic projections by the EU Commission suggest that the system is not sustainable without reform. Long-term fiscal policy will be heavily influenced by spending pressures on pensions and healthcare related to an ageing population."
The agency noted that the Maltese sovereign credit profile benefits from a deep pool of domestic savings. Public debt, it said, was predominantly held by domestic investors and financing capacity wasunderpinned by a liquid banking sector.
The new Government, it said, had a strong Parliamentary majority, which boded well for political stability.
The Government had a strong mandate to reform the energy sector and Enemalta. But, on healthcare and pensions, the Government had not yet articulated a detailed plan.
It noted that GDP growth outperformed the eurozone average in recent years and that the labour market proved resilient, as did the banking sector.
Problems highlighted by Fitch being addressed - Government
In a statement, the Government noted that Fitch was downgrading Malta because of the excessive deficit and said this was a problem it inherited and was addressing.
The Government was confident it would reach its deficit targets next year and this would go down to under three per cent.
An important message from Fitch, it said, was that the Maltese economy was progressing and creating employment. It acknowledged the agency’s warning about the need for more fiscal discipline and control of public finances and said these were problems it was addressing.
In this context, the Government was working for the country to retain a stable economy while increasing economic growth to continue creating employment by improving the country’s competitiveness.
The Government was also working to address the cost of energy and Enemalta’s problems.
It said it was confident that its policies on the economy and public finances would continue to give the desired results.