SAN FRANCISCO — Citing the risk that continuing budget gridlock could impact the state’s ability to pay its creditors, Moody’s Investors Service downgraded California to Baa1 from A2 late Tuesday afternoon, while keeping the rating on watch list for possible downgrade.

The downgrade stems from the inability of the state’s leadership to agree on actions to close a $26 billion budget deficit, combined with the state having already begun issuing IOUs to some creditors, according to a Moody’s news release.

Controller John Chiang began issuing IOUs to lower-priority creditors July 2, but has said that without budget corrections, by October California will be short of cash for all legally protected classes of creditors that the state currently pays with cash.

“Moody’s believes that as the days and weeks go by without enacted solutions to the current cash crisis and the $26 billion budget gap, the risk to priority payments, and eventually debt service payments, is increasing,” the news release said. “The downgrade incorporates the risk we believe exists at the current time, as well as the state’s inability to solve the current difficulties in a timely fashion.”

After a series of meetings over the weekend, Gov. Arnold Schwarzenegger and the top four legislative leaders were scheduled to reconvene again Tuesday night.

Moody’s issued connected two-notch downgrades to lease-revenue and other appropriation-backed state debt, most of which was dropped to Baa2 from A1.

A series of judgment certificates of participation was dropped to Baa3 from Baa1, and Moody’s downgraded bonds issued for three “regional centers” that serve the disabled to a speculative-grade Ba1 from Baa2.

“Bonds that are secured by non-priority payments (such as those issued by the state’s regional centers or any others around which the payment status is unclear, such as those secured by judgments) may have increased downward pressure on the ratings in the near future if no action is taken by the state to solve the cash crisis and non-priority payments continue to be paid with IOUs,” Moody’s said.

Overall, the actions affect approximately $72 billion of rated debt.

Fitch Ratings dropped California GOs to BBB last week. Standard & Poor’s affirmed its A rating July 1. All three agencies have California on a negative watch.

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