UPDATE 2-Sequestration manageable for U.S. public sector-Fitch

Fri Mar 1, 2013 2:18pm EST

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WASHINGTON, March 1 (Reuters) - U.S. state and local governments will be able to weather the across-the-board federal spending cuts known as sequestration, even those in areas with a large federal government presence, Fitch Ratings said on Friday.

The credit rating agency said that "any credit impact will be isolated and no near-term rating actions are anticipated."

The imminent cuts, meant to trim $85 billion from U.S. spending by Sept. 30, do not affect the largest sources of federal funds for states - Medicaid and highway funds - and the reductions will likely total less than 1 percent of overall state and local revenues, Fitch said.

"Some smaller localities that are heavily dependent on federal activity will be more vulnerable to the economic and revenue impact of the sequester than states and larger, more diverse municipalities," it said.

Mostly, lower federal spending on salaries and services will drag on budgets as the local economies slow, and the reductions in direct grants will have a smaller impact, Fitch said.

Governors and mayors from across the country pressed Congress this week to find an alternative to the automatic cuts. But a deal seemed out of reach in the remaining hours before the spending cuts are due to take effect.

Reducing the federal debt has been a top priority for many in Congress and the tussle over spending is expected to continue as the U.S. government comes up again against its debt ceiling and a temporary funding law - known as the continuing resolution - expires at the end of the month.

"We continue to believe that broader cuts that the federal government may implement as it confronts deficit reduction are the larger concern for public finance credits," Fitch said.

Fitch is the last of the three major rating agencies to sound off on the impact of sequestration. On Thursday, Moody's Investors Service said the cuts would be a credit negative for issuers, but the impact would be felt gradually.

Standard & Poor's Ratings Services took a position closer to Fitch's that sequestration would only have minor consequences for the credit quality of those borrowing in the $3.7 trillion municipal bond market.

The budgets of cities and states are finally improving after the 2007-09 recession and many civic officials are worried that federal actions such as sequestration may jeopardize their recovery.

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