* Fitch Ratings cuts NZ outlook to negative
* Cites worries over large c/a deficit and external debt
* NZ dollar drops around half a cent (Adds analysts' comments, updates market reaction)
By Gyles Beckford
WELLINGTON, July 16 (Reuters) - Ratings agency Fitch downgraded New Zealand's sovereign outlook to negative on Thursday, citing a lofty current account deficit and high foreign debt levels, sparking a sharp slide in the kiwi dollar.
The timing of the move was surprising given New Zealand had in May secured an upgrade from Standard & Poor's after the government tightened its budget with spending cuts and plans to control borrowing.
Analysts said the Fitch move reinforced views that interest rates will remain at record low levels well into next year.
"This decision should refocus investors toward New Zealand's weighty current account deficit," said TD Securities senior strategist Annette Beacher.
"This decision should also refocus the government towards fiscal consolidation sooner rather than later, leaving the cash rate much lower for longer."
Prime Minister John Key said this week that New Zealanders have built up foreign liabilities of NZ$177 billion ($113 billion), amounting to about 98 percent of the country's gross domestic product.
"(This) is one of the highest proportions in the OECD, and constitutes a large part of New Zealand's economic vulnerability," Key said.
The New Zealand dollar, which had earlier tested two-week highs, fell 1 percent or half a cent after the Fitch statement, before settling around $0.6400.
The kiwi has risen almost 30 percent since early March as appetite for risky investments improved amid signs a global economic recovery was taking root.
The interest rate market showed limited reaction the move.
LARGE CURRENT ACCOUNT DEFICIT
Fitch affirmed its AA-plus rating, which is one notch below the top rating, but said the rating outlook implied a greater than 50 percent chance the rating would be downgraded over the next 12-24 months.
"New Zealand could fall into a low-growth trap as foreigners demand higher returns as an incentive to continue lending to New Zealand so it can consume more than it produces, gradually eroding New Zealand's fundamental credit strengths, including strong public finances, and rendering it more vulnerable to future adverse shocks," it said in a statement.
"It seems reasonably appropriate to me. The surprise in terms of rating was S&P moving away from negative to stable," said UBS economist Robin Clements.
"This sort of shift is appropriate in the sense that we do run a pretty high current account deficit and internationally have pretty high debt," Clements added.
S&P raised Zealand's AA-plus rating outlook to stable in May, after downgrading it in January. Moody's Investors Service has kept New Zealand's credit ratings outlook stable.
New Zealand relies heavily on foreign borrowing to fund its large current account deficit, which stood at 8.5 percent of gross domestic product in the first quarter, because of stubbornly low levels of household savings.
A ratings downgrade would deter investment in the country at a time when it needs to attract capital to finance the deficit that is almost twice as much as triple-A rated neighbouring Australia.
Central bank Governor Alan Bollard said last month the economy was near its low point and should start growing by the end of the year, but strength in the New Zealand dollar could derail a recovery.
Bollard also said the medium-term risk was that New Zealand households resume their 'borrow and spend' habits before paying back some of their existing debt.
New Zealand has been in recession since the start of 2008, prompting the Reserve Bank to cut interest rates by a total of 5.75 percentage points since last July. In the latest Reuters poll 14 of 16 economists expected the bank to remain on hold at its next policy review on July 30. (Additional reporting by Mantik Kusjanto and Umesh Desai) (Editing by Kazunori Takada)