SAN FRANCISCO, Nov 20 (Reuters) - California could end its next fiscal year with a $5.6 billion reserve as its finances improve and if its current fiscal policies do not change, providing it with the means to build a strong reserve and tackle unfunded pension obligations, the state's budget watchdog agency said on Wednesday.
"The state's budgetary condition is stronger than at any point in the past decade," the Legislative Analyst's office said in a fiscal outlook report. "The state's structural deficit - in which ongoing spending commitments were greater than projected revenues - is no more."
"We assume continued economic growth in future years," the office added. "In such a scenario, we project that, under current laws and policies, state General Fund revenues will grow faster than expenditures through 2017-18, when the state's projected operating surpluses reach $9.6 billion."
The office cautioned its forecast assumes ongoing economic growth and "slow but steady, growth in stock prices."
California's economy is slowly recovering from the recession and its finances have greatly improved due to austerity measures taken in recent years and new revenue from tax increases approved by voters last year.
Much of that new revenue is expected to come from higher personal-income tax rates on the wealthy and on their capital gains income.
California's improved finances gives the state's leaders room to increase spending beyond raising education spending, but the Legislative Analyst's Office recommended they prepare the state's finances for the next economic downturn by setting aside money to establish an $8 billion reserve by 2016-2017, and to pay down unfunded retirement liabilities at the state's pension funds for teachers and university employees.
"Continuing to improve the state's fiscal health will require a balanced strategy of building reserves, retiring budgetary liabilities, and paying for past commitments," the office's report said.
The report comes as Governor Jerry Brown's office begins to prepare its initial budget plan for the state's next fiscal year, which he will present to lawmakers in January.
Brown's finance department last week said the state's general fund revenue for October was $317 million above forecast for the month in the state's current budget, while revenue since the start of the current fiscal year in July was $485 million ahead of expectation.