SCENARIOS-New Zealand faces risk of credit rating cuts

WELLINGTON, March 4 (Reuters) - New Zealand is bracing for its worst recession on record and credit ratings firm Standard & Poor's has warned that the country's sovereign AA plus rating is at risk of a downgrade if fiscal imbalances are not addressed.

S&P has lowered New Zealand's foreign currency rating outlook to negative from stable in January partly because of a current account deficit of 8.6 percent of gross domestic product, and a forecast blowout in government finances and ballooning debt.

S&P said it wants to see how the government plans to stabilise its finances, which are moving deeply into deficit after years of large surpluses as spending increases and tax revenues fall amid a deepening recession.

Fellow ratings firms Moody's Investors Service and Fitch Ratings have also remarked about the large imbalances but said New Zealand's ratings -- Aaa and AA-plus, respectively -- are safe for the time being.

NEW ZEALAND DOLLAR NZD= WILL FALL

The kiwi, which is freely floating, will fall sharply in reaction to a downgrade as investors flee to better quality assets.

The New Zealand dollar has borne the brunt of the adjustment in its external deficit, with the currency falling 15 percent against the U.S. dollar so far this year, and around a third below its 23-year post-float high of March last year.

In extreme circumstances, the Reserve Bank of New Zealand might intervene to prop up the currency, if it decides that markets have become "disorderly".

DEBT PREMIUM WILL INCREASE

Investors will seek higher premiums to lend to New Zealand.

Reflecting rising worries, New Zealand's 5-year credit default swaps NZGV5YUSAR=MP (CDS) -- insurance-like contracts that protect against defaults and restructuring -- have risen to 140 basis points, compared with 20 basis points in normal times.

GOVERNMENT SECURITIES

Foreign investors could shy away from New Zealand denominated debt in the event of a rating downgrade.

The proportion of New Zealand government securities held by foreigners had dipped in December RBNZ12 and foreign holdings could fall further as a weakening kiwi and the prospect of interest rate cuts dim the allure of New Zealand's assets.

The last time its foreign currency rating was downgraded was in 1998 and after the cut, foreign ownership of New Zealand government bonds fell by 10 percentage points.

OFFICIAL OPTIONS

The government might sell assets, cut spending and/or increase taxes to reduce deficits and balance its books. The New Zealand government did this in the early 1990s, but the economy posted only slight growth for a long period.

Alternatively, the government might seek to stimulate the economy as it now doing in the expectation that a quick return to growth is the best method to restore its finances. (Compiled by Mantik Kusjanto; Editing by Jan Dahinten)