Fitch Ratings downgrades US: A stern criticism of political standoffs

Fitch, on Tuesday, became the second major agency, after Standard & Poor's in 2011, to strip the US of its prized triple-A credit rating. Here's a look at what led to this and its possible impact:

Why did Fitch Ratings downgrade the US?

It said the rating downgrade of the US reflected “the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to 'AA'- and 'AAA-rated peers over the last two decades.” The factors it cited are:

Erosion of governance

There has been a steady deterioration in standards of governance over the past 20 years, including on fiscal and debt matters. It said, “The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management.”

Two months ago, American lawmakers were haggling over the government borrowing limit and the two sides seemed so far apart that the process threatened to tip the world's largest economy into a technical default. The government, according to Fitch, also lacks a “medium-term fiscal framework” and has a “complex budgeting process”.

Rising general government deficits 

The general government (GG) deficit will rise to 6.3 per cent of GDP in 2023, from 3.7 per cent in 2022, reflecting “cyclically weaker federal revenues, new spending initiatives, and a higher interest burden”. State and local governments are expected to run an overall deficit of 0.6 per cent of GDP this year.

General government debt to rise

Lower deficits and high nominal GDP growth reduced the debt-to-GDP ratio over the past two years from the pandemic high of 122.3 per cent in 2020. But at 112.9 per cent this year, it is still well above the pre-pandemic 2019 level of 100.1 per cent. The GG debt-to-GDP ratio is projected to rise over the forecast period, reaching 118.4 per cent by 2025.

Medium-term fiscal challenges unaddressed 

Higher interest rates and the rising debt stock will increase the interest service burden, while an aging population and rising health-care costs will raise spending on the elderly absent fiscal policy reforms.

Economy to slip into recession

According to the agency, tighter credit conditions, weakening business investment, and a slowdown in consumption will push the US economy into a mild recession in Q4CY23 and Q1CY24. It sees annual real GDP growth slowing to 1.2 per cent this year from 2.1 per cent in 2022 and overall growth of  0.5 per cent in 2024.

Fed tightening

The Fed raised interest rates by 25 bps in March, May, and July 2023. Fitch expects one more hike to 5.5 per cent-5.75 per cent by September. The resilience of the economy and the labor ma­r­ket are complicating the goal of bringing inflation towards its 2 per cent target.

What implications the move may have?

The rating cut by Fitch may increase the borrowing cost for the government, and, in turn, expand the fiscal deficit, ahead of the US presidential election in 2024. As ratings by the agency are widely followed globally for investments, the latest move may impact confidence in the US economy and make it a bit difficult for businesses to raise capital. Also, as witnes­sed globally, the downgrade could lead to increased volatility in the financial markets.

Will the rating cut hurt the reputation of the US economy?

According to analysts, the move shows the harm caused to the US by repeated rounds of contentious debate over the debt ceiling. “This basically tells you the US government's spending is a problem,” said Steven Ricchiuto, US chief economist at Mizuho Securities USA. A Moody’s Analytics report had said that a downgrade of Treasury debt would set off a cascade of credit implications and downgrades on the debt of many other institutions.

What happened in 2011 when S&P cut the top AAA rating by a notch?

In view of a debt ceiling crisis in 2011, Standard & Poor's cited political polarisation and insufficient steps to right the nation's fiscal outlook. Its US credit rating is still AA+ — the second highest. After that downgrade, US stocks tumbled and the impact of the rating cut was then felt across global stock markets.