California started issuing IOUs yesterday as one of the largest economies in the world crashed into insolvency and the Governor, Arnold Schwarzenegger, declared a fiscal state of emergency.

The state’s controller of finances, John Chiang, will issue promissory notes to businesses and local authorities after law-makers failed to resolve the crisis over the state’s $24.3 billion (£15 billion) budget deficit.

Nearly 30,000 IOUs totalling more than $53 million were expected to be sent out yesterday after the start of the new fiscal year. This is the first time since 1992 that California has resorted to IOUs, formally known as registered warrants, to stay afloat.

California has been hit by sharply falling tax revenues and rising costs because of the recession. Unemployment rates are among the highest in the country.

Although the IOUs will be repaid with interest, they cannot be cashed until October unless banks agree to honour them sooner. Mr Chiang said that he planned to pay $3.4 billion in bills this month with IOUs if a budget is not agreed. Hardest hit will be small businesses that provide goods and services to the state, and taxpayers expecting state refunds.

The move is almost certain to damage further the state’s credit rating, already the worst of any of the 50 US states, saddling taxpayers with billions of dollars in higher interest payments on state bonds that have yet to be sold.

State offices will be closed a further three days a month to conserve cash. The partial government shutdown will also lead to a third enforced day off for 235,000 state employees, bringing their total pay cut this year to about 14 per cent. The state legislature remained in deadlock, unable to agree by a two-thirds majority on tax measures to deal with the projected deficit.

“California needed the legislature to act boldly and with conviction. Their response was not a solution to California’s budget problem but an invitation to actually a bigger financial crisis,” Mr Schwarzenegger said.

On Tuesday, as the previous fiscal year was drawing to a close, Senate republicans rejected three Bills designed to save $5 billion, including $3.3 billion in education funding cuts that had to be enacted. Passing those Bills would have given the legislature time to work out a broader solution to the deficit.

The IOUs will also be sent to California counties, which must find other ways to fund a wide array of social programmes, from alcohol abuse and mental health treatment to services for the elderly and disabled. California’s universities were evaluating ways to assist students whose grants will not be funded to pay education expenses.

Bank of America announced that it would cash the state’s promissory notes for its customers until July 10, but it was unclear whether some of California’s largest banks would accept the notes as payment.

Mr Schwarzenegger and state officials have asked other banks to honour the IOUs. “We will make those payments,” he said. “We are responsible.”

The legislature has 45 days to pass a budget plan. After that, lawmakers would be barred from working on any other policies until they produced a budget.

“Each day we wait, the problem is getting bigger, the deficit is getting bigger, because right now we are spending money that we don’t have,” Mr Schwarzenegger said.

Other states, including Illinois and Pennsylvania, are also struggling with budget crises but their deficits are dwarfed by California’s.

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