Moody's Investors Service yesterday sharply lowered its rating on bonds issued by the city of Melrose, Mass., to Ba from A.

The rating agency attributed the steep downgrading of the city's $3.4 million in general obligation bonds to "weak liquidity, unreasonable budget assumption," and an accumulated deficit of $3.1 million, nearly 10% of the city's $32 million budget for the fiscal year ending June 30.

"It's a really drastic cut," conceded Joan Dougherty, a vice president and manager of New England regional ratings at Moody's, adding that the rating change came from "our policy of updating ratings to make sure they're as current as possible."

Since 1990, when the rating agency last looked at the finances of Melrose, an affluent Boston suburb with a population of 28,000, "they've had very fast deterioration in their finances," Ms. Dougherty said. She added, however, that the rating downgrade was not the most severe on record at Moody's. Hampshire County, Mass., for example, tumbled to Baa from Aa in January 1991, she noted.

For the coming fiscal year, Melrose faces a budget gap of more than $4 million, including its accumulated deficit. Ms. Dougherty said the rating change should not indicate that the city faces the prospect of default onits outstanding bonds or on its short-term debt, which includes $5.1 million of revenue anticipation notes coming due at the end of next month and $4.6 million of bond anticipation notes, most of which are maturing in August.

Like other cities and towns in Massachusetts. Melrose has seen state aid dwindle. For Melrose, aid that was $12.4 million in fiscal 1989 fell to $9 million in the current budget year. In addition, the constraints of Proposition 2 1/2, the 1980 product of a statewide taxpayer revolt, have made raising local taxes more difficult.

Under Proposition 2 1/2, which shifted the burden of revenue raising from the locals to the state government over the last decade, a majority of citizens has to approve a referendum for higher taxes. Local tax increases are limited to 2.5% each year without such consent. The city is scheduling a referendum for September, according to Richard D. Lyons, the newly elected Melrose mayor.

In a statement yesterday, Moody's warned city officials against using the proposed override, which calls for just under $4 million in additional taxing power, to avoid spending cuts. "It should be noted that an override request for a much smaller level was defeated recently," the rating agency said.

"If the override request is defeated by the voters and should the current administration fail to enact appropriate expenditure reductions -- steps which are clearly needed to restore the city's financial stability -- further credit deterioration is likely," Moody's said in the statement.

But Mr. Lyons, an independent and former marketing executive for Bay State Health Care and Blue Cross-Blue Shield, said he was undaunted by the rating agency's gloomy prognostications.

"Moody's is wrong," Mr. Lyons said. "I feel confident that because of the marketing ability that we have, we will pass the override."

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