UPDATE 1-Moody's cuts El Salvador credit rating to Ba2

(Updates with more detail, background, adds byline)

By Daniel Bases

NEW YORK, March 24 (Reuters) - Moody's Investors Service cut its long-term foreign currency credit rating on El Salvador one notch to Ba2 from Ba1 on Thursday, citing continued deterioration in its financial strength and reduced fiscal flexibility.

The outlook on the country's credit rating was changed to stable from negative.

"Government debt affordability metrics -- in particular debt to revenues -- are no longer consistent with a Ba1 rating in light of the country's limited growth prospects," Moody's said in its statement.

El Salvador's dollarized economy means it has limited ability to implement monetary policy to meet changing economic conditions.

"Additionally, the rating reflects vulnerabilities inherent in El Salvador's close economic ties with the U.S., including its heavy reliance on remittances from the U.S., that have been highlighted by the recent recession," the firm said.

Moody's decision brings it equal to the BB rating from Fitch ratings. Standard & Poor's rates El Salvador one notch below Moody's at BB-minus.

"The Ba2 rating incorporates El Salvador's low economic strength which reflects the small size of the economy, its narrow focus, modest growth prospects, and the country's low income level," Moody's wrote in a statement.

The government's economic strength continued to deteriorate in 2010, albeit at a slower pace, Moody's said, as a result of its continuing fiscal deficit and sluggish economy.

These conditions limit its ability to engage in counter-cyclical fiscal policies, such as borrowing or spending savings to bolster the economy in case of economic shocks.

"If the government is unable to achieve its fiscal consolidation targets, or economic growth falls below the government's optimistic forecasts, the resulting increases in debt could jeopardize fiscal sustainability," Moody's said.

In February, the government reached an agreement with the International Monetary Fund on a 2011 economic program under an existing $790 million IMF loan. The IMF board is expected to approve the plan in late March.

The plan focuses on supporting economic growth and social investment while gradually cutting spending in order to lower the public debt in the hope of creating a more resilient financial system.

The IMF predicts El Salvador's economic growth could reach 2.5 percent, due to the global economic recovery and domestic demand.

Government debt is likely to stabilize at under 52 percent of gross domestic product by the end of 2011, the IMF said.

"While the authorities' willingness and ability to successfully implement stated policy objectives has historically set El Salvador apart from many of its neighbors in Central America, Moody's believes that the government will be challenged to maintain this track record going forward," the firm said. (Reporting by Daniel Bases and Pam Niimi; Editing by Andrew Hay)