Moody's Investors Service warned California that its credit rating, which is already at the bottom among U.S. states, may be hacked several levels.
California is struggling hard to patch up a $24.3 billion budget gap.
At present, California's full faith and credit pledge is rated A2 by Moody's, which is five steps above high-yield, high-risk status, or junk.
In case California's credit rating is hacked further, it would increase the state's borrowing cost and raise the yield paid to investors on its bonds. Standard & Poor's has been scrutinizing California for a possible reduction in its credit rating.
According to Moody's California's leasing debt and other state-related debt are also under review, which could further affect $72 billion of debt.
Although, California's deficit is escalating to more than 20 % of the general fund, yet lawmakers are showing their inability to agree on how to close the budget gap.
Moody's said in a report, "If the Legislature does not take action quickly, the state's cash situation will deteriorate to the point where the controller will have to delay most non-priority payments in July."
Moody's further stated that lack of action could result in a multi-notch downgrade.
Earlier, Republican Governor Arnold Schwarzenegger said he would not support any increase in tax as Democrats anticipated a budget that would raise $2 billion from cigarette consumers and oil companies to help the state getting out of the financial problem.
Mounting unemployment rate is also posing a great problem to the state. Its unemployment rate soared to 11.5 % in May from 6.8 % in the previous year.
The investors would definitely be scared off by warnings made by the rating agencies.
But some investors looking for risk premium may be attracted by California's intimidated finances.
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