S&P warns on New Zealand ratings, currency skids

Reserve Bank of New Zealand dollar notes are pictured in Singapore June 22, 2006.

WELLINGTON (Reuters) - Standard & Poor's on Monday warned New Zealand's foreign currency rating could be downgraded if the country continues to pile up more foreign debt, sending its currency reeling by a full U.S. cent.

The ratings agency said it was revising New Zealand's foreign currency outlook to negative from stable, citing a widening current account deficit and credit risks in its banking sector. An actual cut in the AA+/A-1+ rating could well lead to an increase in borrowing costs for the country and its banks.

"The outlook revision on the foreign currency ratings reflect our recognition of the risks stemming from New Zealand's projected widening external imbalances in the context of the country's weakened fiscal flexibility," said S&P sovereign ratings credit analyst, Kyran Curry.

"New Zealand's vulnerability to external shocks, arising from its open and relatively undiversified economy, also raises risks to the country's economic recovery and credit quality."

The agency said increased fiscal savings by the National-led government would be crucial in avoiding a downgrade.

Curry said the negative outlook meant there was around a one-in-three chance of the rating actually being downgraded. He also emphasised that there would be no change anytime soon and this was a change in the medium-term view which covered the next two to three years.

Still, S&P's warning took the market by surprise and knocked the New Zealand dollar down a cent to $0.7750, while pushing government bond yields higher.

"At this stage it's still early days, but the onus is now on the government to ensure the fiscal position is turned around not only quicker but the return to surplus occurs sooner," said Khoon Goh, a senior economist at ANZ-National Bank.

"The focus will surely be on the December half-year update, to ensure the credit rating is not downgraded."

The government is due to release its semi annual economic and fiscal on Dec. 14, and recently has been cautiong that its growth outlook could be lowered.

S&P did stress that New Zealand's weaknesses were mitigated by fiscal and monetary policy flexibility, strong institutions, economic resilience, and an actively traded currency.

Last week Finance Minister Bill English foreshadowed a deterioration in the government accounts, saying a weak domestic economy would likely mean lower growth for the year to March 2011, and higher budget deficits in the short term.

A month ago English said New Zealand's credit ratings appeared safe, with the three main ratings agencies approving of the government's fiscal strategy.

In October, Fitch reaffirmed New Zealand at AA+ with a negative outlook, while in September Moody's maintained New Zealand at AAA with a stable outlook. In September S&P had maintained New Zealand's AA+/A-1+ rating with a stable outlook in the wake of the earthquake which devastated the South Island city of Christchurch.

(Reporting by Wayne Cole; Editing by Ed Davies)