(Adds finance ministry statement paragraphs 14-15)
By Daniel Flynn and Lefteris Papadimas
ATHENS, Jan 14 (Reuters) - Standard & Poor's cut its credit rating on Greece's sovereign debt on Wednesday due to a rising public deficit and deteriorating economic outlook, stoking fears of downgrades to euro zone states as the global crisis bites.
The news sent Greek bond spreads sharply wider and helped drive the euro to below $1.31 versus the dollar, amid concern S&P downgrades to euro zone economies like Spain could follow.
S&P cut Greece's sovereign rating, already the lowest in the 16-nation euro zone, to A-/A-2 with a stable outlook from A-/A-1, citing the government's repeated failure to pare back its fiscal deficit despite years of solid economic growth.
Greece was one of four euro zone countries warned by S&P in recent days of a possible ratings cut as the credit crunch and rising unemployment worsened their economic outlook. Ireland, Spain and Portugal were the other countries to be warned.
"The ongoing global financial and economic crisis has in our opinion exacerbated an underlying loss of competitiveness in the Greek economy," S&P credit analyst Marko Mrsnik said.
"The ongoing slowdown in credit growth will likely lead to a deceleration in domestic demand, thus increasing the risk of a recession and a possibly protracted adjustment."
S&P, which only put Greece on creditwatch on Friday, said the country was entering the downturn with a fiscal deficit of around 3.5 percent of gross domestic product (GDP), after repeated government failures to reduce a hefty public sector wage and pension bill. It forecast Greece's public deficit would rise to over 4 percent of GDP this year -- double the government's budget forecast -- and was unlikely to improve significantly before 2012 unless policies were overhauled.
OTHERS MAY FOLLOW
Calyon rate strategist David Keeble said the move made it seem more likely other countries put on watch by S&P may be cut.
"The short gap between the watch and the downgrade for Greece does suggest that they had already decided they would cut them," he said. "If Spain and Portugal make it through this week without a ratings cut, I guess the market will assume there is a greater chance without a downgrade."
Spreads of Greek 10-year government bonds over benchmark German Bunds widened by about 10 basis points to a session high of 246.9 basis points, shy of Tuesday's peak of 247 basis points. The euro fell as low as $1.3094, a new one-month low.
The head of Greece's public debt agency said the downgrade had been expected amid the global downturn and would not have a lasting effect on bond spreads or demand for Greek debt.
"The Standard and Poor's downgrade was expected as the global crisis hits the euro zone periphery especially hard," Spyros Papanicolaou told Reuters.
Finance Minister Yannis Papathanassiou, who was promoted from deputy minister in a reshuffle last week, said the government retained its long-term target of cutting the fiscal deficit but was constrained by the global downturn.
"In these tough international circumstances, our first priority is not to balance the budget, ignoring the social effects," he said in a statement. "Many countries in the euro zone will exceed by far the deficit limit of 3 percent of GDP."
Although Greece's economic growth ended 2008 at a solid 3.2 percent, according to government estimates, its current account deficit is running at around 14 percent of GDP and above-average inflation has persistently eroded its competitiveness. Government debt equates to around 94 percent of Greece's 260 billion euro GDP. S&P forecast it could top 100 percent by 2011.
The key sectors of shipping and tourism, which account for over a quarter of the economy, have been hard hit by a slump in foreign demand. Public calls for higher social spending and the rising cost of debt servicing would outweigh any improvements to the efficiency of the Greek tax system, S&P said. For the text of the S&P statement please click on [ID:nWLA4998] For debt agency chief interview please click on [ID:nLE380961] (Additional reporting by Kirsten Donovan in London; Editing by Victoria Main)