It also noted it "maintained the state's negative outlook."
The downgrade by Moody's comes nearly a week after Illinois lawmakers reached the end of their session without coming to agreement on a way to fix the state's nearly $100 billion pension crisis.
Later in the day, Illinois Governor Pat Quinn called the legislature into a special session later in June to address the pension crisis.
Earlier in the week, the credit-rating agency Fitch Ratings dropped its rating of Illinois debt from "A" to "A-" due to lawmakers' failure to decide on a solution on pension obligations.
Moody's on Thursday indicated that its action also stemmed from the pension debt crisis, writing in a statement announcing the downgrade: "The Illinois General Assembly on May 31 concluded its session without addressing the severe pension liabilities that are the state's greatest credit challenge. Our rating now assumes the government will not take action to reduce the state's pension liabilities any time soon."
In its statement, Moody's noted among the state's strengths the diversity and size of its economy, its powers to determine revenue and spending, and provisions prioritizing debt service over other spending. It also named challenges facing the state, including a "sever pension funding shortfall," chronically deferring payments "to manage operating fund cash," and what it characterized as "long-term weak management practices" stemming from under-funded pensions and delaying payment of bills.
Moody's described the pension liability faced by Illinois as the "most severe" of any U.S. state. It reported that it had calculated the state's "adjusted net pension liability" was 238 percent of revenues. Connecticut, the state with the second-largest pension load, came in at 187 percent of revenues.
Lower ratings generally imply that higher interest rates will be applied to loans borrowed by a state.
Standard & Poor's reported Thursday it's keeping its A- rating for Illinois after predicting earlier there'd be no pension solution by May.
The Associated Press contributed to this report.