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SAN JUAN (Reuters) - Moody's Investors Service on Thursday slashed Puerto Rico's credit rating by two notches to Baa3, just slightly above the non-investment grade, with a negative outlook.
The decision, which affects $38 billion of outstanding debt, is linked to the U.S. commonwealth's weak economic outlook and to the lack of meaningful pension reforms, the Wall Street credit ratings agency said.
The downgrade comes as the U.S. $3.7 trillion municipal bond market, where Puerto Rico is a big borrower, sizes up the incoming administration of Governor-Elect Alejandro Garcia Padilla, who ousted Republican Governor Luis Fortuno in a close election last month.
Fortuno was seen as a pro-business reformer whose painful economic initiatives seemed to be starting to bear fruit.
A clear lack of growth drivers, a decline in population and unemployment that at 13.8 percent is nearly double that of the United States, are factors that Moody's listed to explain its rating assessment.
Puerto Rico's spending budget for fiscal 2013 is $9.08 billion, down 2 percent from the year before, mostly due to continuing declines in payroll spending. Revenue is projected to be $8.75 billion, just 0.9 percent more than fiscal 2012, with the shortfall being covered with bond proceeds.
"The budget gap does not include expenditures for approximately $745 million of debt service payments which are expected to be refinanced during fiscal 2013", Moody's noted.
The rating agency also added that the commonwealth recently cut its forecast for economic growth for fiscal 2013 from 1.1 percent to 0.6 percent "indicating that the projected deficit for the fiscal year ending June 30th will grow".
Puerto Rico's next-tax supported debt stand at $14,000 per capita "significantly higher than any U.S. state and also reflective of the relatively low per capital incomes in the commonwealth".
With around 330,000 active and retired members, Puerto Rico's two main pension plans count on a weak system of funding which "could also challenge its finances and economy".
At the same time, Moody's lowered the bonds of Puerto Rico's Public Finance Corporation, its Aqueduct & Sewer Authority and certain Highways & Transportation Authority bonds to Ba1, the highest non-investment-grade, or junk, rating.
Puerto Rico's 30-year yield spread over top-rated bonds on the municipal market traded at 248 basis points, a record high for 2012, according to Municipal Market Data.
The announcement of the downgrade came first from Juan Carlos Battle, the president of the Government Development Bank, which acts as Puerto Rico's financial adviser.
"We are not pleased by the action taken by Moody's today and we are in disagreement that they did not give time to the incoming administration to present its fiscal team and work plan to address these issues," Battle said.
"We also disagree with the interpretation of many of the aspects of the government's present fiscal situation."
Reporting by Juan Voyton; editing by Gary Crosse and Bob Burgdorfer