The State of Connecticut (Aa3 negative) is grappling with challenges to its financial sustainability as growing expenses from unfunded pension liabilities, retiree health care costs, and bonded debt place pressure on the state's credit quality, Moody's Investors Service says in a new report.

"Connecticut's fixed costs command roughly 30% of the state's $18.9 billion non-federal governmental revenues, which is the highest percentage of all 50 states," Marcia Van Wagner, a Moody's Vice President – Senior Credit Officer says.

Governor Dannel Malloy has proposed an executive budget featuring extensive structural changes that would shift and reorder state aid to local governments. Bloomberg News

The report "Connecticut (State of): Weak Economy, High Fixed Costs Test Connecticut's Fiscal Management," says these costs will expand to more than $7 billion by fiscal 2019, equaling nearly 35% of the state's general fund budget by fiscal 2019.

Moody's says the high wealth of Connecticut is a paramount credit strength. However, its economy has entered a ""new normal," with employment still below pre-financial crisis levels and income growth lagging the nation's.

"The state's finance sector has faltered, having shed 11% of its jobs since 2007, and the non-financial sectors have failed to compensate, with manufacturing in decline and lackluster growth in the service sector," Van Wagner says.

Moreover, economic growth has been hampered by population loss. Connecticut is one of only four states to lose population since 2013 every year, a credit negative. To address fiscal sustainability, Governor Dannel Malloy has proposed an executive budget featuring extensive structural changes that would shift and reorder state aid to local governments and demand significant cost savings from collective bargaining agreements for state employees.

A program of this magnitude would cut $1.36 billion from the budget in fiscal 2018 as the budget pegs labor savings at $700 million, which could consist of a wage freeze and benefit changes.

Additionally, the relationship between the state and municipalities would change significantly if the governor's proposal to shift one-third of the cost of contributing to the Teachers' Retirement System to local governments is passed. This would be combined with a restructuring of K-12 education aid and packaged with a new local government option to levy property tax on certain tax-exempt properties.

Large recurring actions of this magnitude would help the state stabilize its finances and would be credit positive.

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