By Wayne Cole
* S&P revises down New Zealand outlook to negative
* May cut rating if country's external finances worsen
* NZ$ slides in reaction, yields shoved higher
(Adds finance minister's reaction)
WELLINGTON, Nov 22 (Reuters) - Standard & Poor's warned on Monday that New Zealand's foreign currency rating could be downgraded if the country continues to pile up more foreign debt, sending its currency reeling by a full U.S. cent.
The ratings agency said it was revising New Zealand's foreign currency outlook to negative from stable, citing a widening current account deficit and credit risks in its banking sector. An actual cut in the AA+/A-1+ rating could well lead to an increase in borrowing costs for the country and its banks.
"The outlook revision on the foreign currency ratings reflects our recognition of the risks stemming from New Zealand's projected widening external imbalances in the context of the country's weakened fiscal flexibility," said S&P sovereign ratings credit analyst Kyran Curry.
Curry said the negative outlook meant there was around a one-in-three chance of the rating actually being downgraded. He also emphasised that there would be no change anytime soon and this was a change in the medium-term view which covered the next two to three years.
The agency said increased fiscal savings by the National-led government would be crucial in avoiding a downgrade.
That was a point acknowledged by New Zealand Finance Minister Bill English, who said it underlined the importance of cutting back on foreign debt. The country has net foreign liabilities of more than NZ$160 billion.
"This is a long-standing problem for New Zealand and has left us vulnerable as a country," English said, adding that the government was taking steps to reduce this external vulnerability and was committed to returning the budget to surplus by 2016.
Indeed, English was confident that action already under way on the budget and debt would be enough to avoid a downgrade.
THE SOONER THE BETTER
Investors, however, were not so optimistic and knocked the New Zealand dollar down over a cent to $0.7733 , while pushing government bond yields higher.
"At this stage it's still early days, but the onus is now on the government to ensure the fiscal position is turned around not only quicker but the return to surplus occurs sooner," said Khoon Goh, a senior economist at ANZ-National Bank.
"The focus will surely be on the December half-year update, to ensure the credit rating is not downgraded."
The government is due to release its semi annual economic and fiscal on Dec. 14, and has been warning that its growth outlook could be lowered [ID:nWEL004221].
New Zealand's economic recovery has struggled to gain traction, with unemployment stubbornly high and households and companies cautious about spending. A surge in the local dollar since September also threatens to make exports less competitive.
While the country's current account deficit has narrowed in the past couple of years to just under 3 percent of gross domestic product (GDP), this was mainly due to sluggish domestic demand.
As the economy recovers, the deficit was likely to expand again toward 6 or 7 percent of GDP, said S&P.
Just a month ago, English said New Zealand's credit ratings appeared safe, with the three main ratings agencies approving of the government's fiscal strategy. [ID:nWLF004857]
In October, Fitch reaffirmed New Zealand at AA+ with a negative outlook, while in September Moody's maintained New Zealand at AAA with a stable outlook.
S&P itself had maintained New Zealand's AA+/A-1+ rating with a stable outlook back in September, when an earthquake which devastated the South Island city of Christchurch put a fresh strain on government finances. (Editing by Kim Coghill) (If you have a query or comment on this story, send an email to news.feedback.asia@thomsonreuters.com)