Moody's cuts California rating on budget crisis

NEW YORK (Reuters) - California's financial crisis deepened on Tuesday after Moody's Investors Service downgraded its ratings on about $72 billion of debt closer to junk status, citing a growing risk of the state's ability to make priority payments amid a budget crisis.

Moody's cut California's general obligation debt by two notches, to Baa1, or three notches above speculative, or "junk," status and said its rating remains on a watchlist for a further possible downgrade.

California less than two weeks ago began to issue IOUs to pay some bills in a bid to conserve cash as it struggles to balance its budget.

Moody's said its downgrade "reflects the increased risk to the legally or constitutionally required payments ("priority payments") as the state deadlock continues and the controller has begun to make certain payments that are not legally or constitutionally required to be paid on time ("non-priority payments") with IOUs."

Without a solution to the state's $26 billion budget gap, the risk to these priority payments -- and eventually debt service payments -- is increasing, Moody's said in a statement.

The action came as California's Republican Governor Arnold Schwarzenegger and state lawmakers were set to resume talks on a budget agreement. The state started its fiscal year on July 1 without a balanced budget agreement.

Fitch Ratings downgraded its credit rating on California on July 6, lowering it to BBB, just two notches above junk.

(Reporting by Ciara Linnane; Editing by Leslie Adler)