By Mantik Kusjanto
WELLINGTON/NEW YORK (Reuters) - New Zealand suffered two ratings downgrades within hours on Friday when Standard & Poor's and Fitch cut the country's ranking by one notch over concerns about its growing foreign debt.
Fitch moved first, marking New Zealand's first downgrade in 13 years and sparking a sharp slide in the New Zealand dollar.
Although bond yields are near record lows, the higher risk rating will add to funding costs and could delay when the Reserve Bank of New Zealand (RBNZ) resumes raising rates, analysts said.
"It is likely to delay any official moves from the RBNZ and the risks are certainly becoming even more skewed toward a later start than our March expectations," Goldman Sachs economist Philip Borkin said.
S&P and Fitch cut New Zealand's sovereign rating to double A from double A-plus, a level on par with Kuwait and Abu Dhabi. The rating is lower than Australia's triple A rating but above Japan's double A-minus.
Both agencies classified the outlook for New Zealand as "stable."
New Zealand Finance Minister Bill English blamed the downgrades in part on sensitivity over the euro zone's debt crisis, saying the government was cutting spending to get back to budget surplus by the 2014/15 fiscal year.
"The timing is a little bit surprising given that New Zealand has made key progress in improving its imbalances, it's the outlook where you cannot disagree with them," Borkin said.
New Zealand's current account deficit narrowed to 3.7 percent of GDP in June from as high as 8.9 percent at the end of 2008.
Foreign debt has fallen to 70 percent of GDP from 84.6 percent in March 2009, which compares to 60 percent in Australia.
But both ratings agencies said they expected external debt to grow. Fitch, which had New Zealand on negative watch since 2009, forecast the current account deficit would grow to 5.5 percent of GDP by 2013.
"New Zealand's high level of net external debt is an outlier among rated peers -- a key vulnerability that is likely to persist as the current account deficit is projected to widen again," said Andrew Colquhoun, Fitch's head of Asia-Pacific Sovereigns.
The New Zealand dollar fell 1.5 percent after the two downgrades to a session low of $0.7638, most of decline coming after Fitch announced its downgrade. The currency later recovered to settle around $0.7660.
Economists said they expected the rating cuts to increase New Zealand's borrowing costs marginally since global bond yields are being capped by concerns about economic downturns in Europe and the United States.
"We expect the impact of New Zealand's international borrowing costs will be a marginal increase, perhaps 5-10 basis points, more so at the long-end of the curve," said Deutsche Bank chief economist Darren Gibbs.
New Zealand's government yield curve steepened, with the front end rising 6.5 basis points and the long end up 13.5 bps. But the rise also followed higher yields elsewhere.
Global economic concerns have weighed on yields for the past two quarters. The 10-year bond yield of 4.455 percent is just above a record low of 4.228 percent on Monday.
The central bank has held its policy rate at 2.5 percent for the past four reviews to help the economy rebound from the impact of two major earthquakes since September. At its last review on Sept 15, the central bank said it will not raise rates until global market volatility subsides.
After the downgrades, financial markets pricing imply benign rate outlook, with only 30 basis points of tightening in the next year, little changed from the previous day.
S&P said New Zealand's strengths were its fiscal and monetary policy flexibility, economic resilience, public policy stability and a sound financial sector.
But those strengths were moderated by high external imbalances, which were accompanied by high household and agriculture sector debt, dependence on commodity income as well as emerging fiscal pressures associated with an aging population.
"New Zealand's external position will deteriorate further at a time when the country's fiscal settings have been weakened by earthquake-related spending pressures and fiscal stimulus to support growth," said S&P credit analyst Kyran Curry.
English said New Zealand's vulnerability to external shocks was less than it was back in 2008 when, ironically, the credit rating was higher.
"We have been working to reduce the vulnerability as much as possible over the last two or three years and we have made quite considerable progress," English said in a television interview.
"Because of the problem with Italy and Spain, rating agencies are becoming much more hypersensitive to debt."
The other major rating agency, Moody's, has New Zealand at triple-A with a stable outlook, but it focuses more on the level of government indebtedness, which at the end of May stood at a net 20.4 percent of GDP.
The last time New Zealand's credit rating was downgraded was in 1998, when Moody's cut its rating to Aa2 from Aa1.
New Zealand's rating cut is the latest in a series of downgrades among high-rated developed countries -- including the United States, Japan and Italy -- which suffer from a growing debt burden and weak economic growth.
"While these are volatile times, we are expecting global investors to be able to put this news in context and continue to support the NZ government bond market," said Christian Hawkesby, head of fixed income at Harbour Asset Management.
The current account deficit narrowed earlier this year to a 21-year-low of 2.5 percent of GDP, but is expected to keep swelling as a pick up in the economy fuels imports and higher profits for foreign investors.
Public finances, which have traditionally been a rating strength, have also deteriorated in the past three years.
The government's plans to return to a budget surplus in the 2014/15 fiscal year may be delayed by the reconstruction costs for the Christchurch earthquake in February, Fitch said.
(Additional reporting by Gyles Beckford, Walter Brandimarte, Chris Sanders and Wanfeng Zhou; Editing by Richard Borsuk)
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