(Adds Treasury reaction, paragraph 2)
By Ed Stoddard
JOHANNESBURG, June 9 (Reuters) - Ratings agency Moody's downgraded South Africa's credit rating on Friday but kept it at investment grade with a negative outlook, citing a recent abrupt cabinet reshuffle and reduced growth prospects for an economy mired in recession.
South Africa's National Treasury said after the announcement that "reigniting" investor confidence was its urgent priority and that "policy transparency and continuity remain on top of government's agenda."
Moody's is the only major ratings agency to retain South Africa's investment grade status after Fitch and S&P Global Ratings downgraded the credit rating of Africa's most industrialised economy to speculative or "junk status."
But Moody's lowering by a notch from Baa2 to Baa3, the bottom of the investment grade table, will be a cause for concern in Pretoria as the Treasury strives to convince investors it is serious about governance and fiscal discipline.
"Recent events, particularly but not exclusively the abrupt March Cabinet reshuffle, illustrate a gradual erosion of institutional strength," Moody's said, referring to the sacking of highly respected former finance minister Pravin Gordhan.
Moody's said "reduced growth prospects" were another driver behind its decision. South Africa sank into recession for the first time in eight years in the first quarter, led by weakness in consumer sectors such as wholesale, retail trade and accommodation.
The ratings agency also cited a " ... continued erosion of fiscal strength. Lower levels of growth and heightened uncertainty about policy direction and policymakers' commitment to structural reforms have increased the risk of a weakening of the government balance sheet."
South Africa relies heavily on foreign money to cover its large budget and current account deficits but could struggle to attract investment if political tensions linger on and economic growth does not return.
Investors fear policy steps to spur on the economy and keep debt in check are taking a backseat to corruption scandals and the jostling for positions as President Jacob Zuma's ruling African National Congress (ANC) prepares for a major policy conference and the election of new leaders later this year.
South African debt has already been dropped from one the widely used global bond indexes, the JPMorgan Emerging Market Bond Index Global, and risks being excluded from the larger Citi's World Government Bond Index, if both Moody's and S&P's cut the rand-debt rating to "junk".
South Africa's long-term local-currency bond and deposit ceilings were also lowered to A2 from A1, and the long-term and short-term foreign-currency bond ceilings lowered to A3/P-2 from A2/P-1, respectively. (Editing by David Gregorio)