By Yali N’Diaye

WASHINGTON (MNI) – Rating agency Standards & Poor’s Thursday
followed Moody’s in welcoming structural reforms to address California’s
budget shortfall proposed by new Governor Jerry Brown, but given the
uncertain path to adoption, neither agency has changed their ratings on
the state.

The proposal could “make progress” in improving “the state’s
structural misalignment between revenues and expenditures,” Standard &
Poor’s said in a report.

Moody’s agreed in an article earlier this week that the “proposed
budget is more reliant on recurring solutions than recent budgets have
been, and would therefore narrow the state’s structural budget imbalance
in the future.”

And “This would be credit positive.”

So clearly, the rating agencies welcome the commitment.

That said, the path to adoption proves difficult, bringing
uncertainty to the final outcome.

“We believe that the path from proposal to adoption is narrow and
time sensitive, and will likely require multiple levels of political
support in only a few months’ time,” Standard & Poor’s stressed.

As a result, the proposal had no immediate impact on the rating or
the outlook.

Moody’s also noted that “because the proposed revenue increases
depend on voter approval in a June special election, it is not a done
deal,” and refrained from taking any rating action following
California’s announcement.

But that alone — as opposed to a downgrade — could be considered
positive for California, whose ratings have been deeply affected by the
financial and economic crisis.

The State is currently rated A1 by Moody’s with a stable outlook,
and A- with a negative outlook by Standard & Poor’s.

Still, there are significant hurdles on the road to enactment,
given the political achievements that have to be made, the scale of the
proposed reforms and the limited time allowed.

“The scale of the governmental and fiscal reforms proposed may
prove difficult given the timeline with which lawmakers have to work,”
Standard & Poor’s said Thursday.

“The governor has proposed that the legislature pass the spending
cuts in March, and then bring the extension of the taxes to the voters
in a special election in June,” Moody’s said. It added, “The Legislative
Analyst’s Office (LAO) has indicated that the spending cuts may require
approval by two-thirds of each house of the legislature, rather than a
simple majority. It is uncertain whether that can be achieved.”

Besides, “it is unclear whether voters would agree to extend the
higher taxes, as they voted against the tax extensions just last year.”

Additionally, the 2011 budget counts on savings stemming from lower
spending and operational efficiencies that may be difficult to achieve.

In that regard, some of the assumptions, according to Moody’s,
“appear optimistic.”

Standard & Poor’s, on the other hand, underlined “cautious economic
growth assumptions, that may be somewhat conservative.”

So, “If the economy and employment growth outperform those assumed
in the proposed budget, we believe there could be the possibility for
favorable revenue variance.”

January 10, Governor Brown proposed closing California’s structural
budget gap, which without action would widen to $17.2 billion to $21.5
billion per year through 2014-15.

The current year deficit — $8.2 billion and estimated to hit $17.2
billion by 2012 — would be resolved by the proposal and create $1
billion in reserves.

The most recent tone adopted by rating agencies regarding their
assessment of municipal issuers has turned slightly more positive
compared to a year ago.

Wednesday, Fitch Ratings said the outlook trend for the muni sector
is “mostly stable,” although it is “negative in a small number of
revenue supported sectors.”

However, the continued real estate downturn, increasing
pension-related fixed costs and the downshifting of state
responsibilities to local governments remain key risks.

In a report titled ‘Navigating a Risk-Laden Recovery,’ Fitch said,
“In the U.S., local and state governments are currently experiencing
financial stress at a level not seen for decades.”

“However, Fitch believes that, as a class of debt, municipal
tax-backed credit remains resilient and that while the incidence of
default may increase from very low historical levels, defaults will
continue to be isolated situations.”

It will be interesting to see the outcome of Standard & Poor’s
review of Illinois, which also recently announced drastic steps.

“We have not put out an update on the recent budget adjustments but
hope to do so soon,” analyst Robin Prunty told Market News
International. “We are evaluating the revenue actions in addition to the
other changes and how that affects the current rating and the
CreditWatch status.”

Moody’s already said this week, “Illinois’ sweeping fiscal actions
last week — including a $7 billion tax hike, authorization of a $3.7
billion pension bond, and a spending growth cap — constitute important
steps in the state’s efforts to balance its budget.”

“If Illinois succeeds in adhering to the discipline of its new
four-year plan, this would be credit positive,” Moody’s added.

** Market News International Washington Bureau: 202-371-2121 **

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