Fitch's decision to downgrade the United States' Long-Term Foreign-Currency IDR to 'AA+' underscores concerns about fiscal deterioration, escalating debt burden, and governance challenges.
source: expedia.com
Fitch Ratings has on 01 August 2023 made a significant rating decision, downgrading the United States of America's Long-Term Foreign-Currency Issuer Default Rating (IDR) from 'AAA' to 'AA+'. However, the Rating Watch Negative has been removed, and a Stable Outlook has been assigned. It's important to note that the Country Ceiling has been reaffirmed at 'AAA'.
The primary drivers behind this rating downgrade are the anticipated fiscal deterioration over the next three years, the mounting general government debt burden, and the erosion of governance in comparison to 'AA' and 'AAA' rated peers, which has been evident over the past two decades through repeated debt limit standoffs and last-minute resolutions.
Fitch's analysis points to a gradual decline in governance standards over the last 20 years, particularly concerning fiscal and debt matters. Despite a bipartisan agreement in June to suspend the debt limit until January 2025, the recurrent political standoffs and last-minute resolutions surrounding the debt limit have cast doubts on the government's ability to manage fiscal affairs effectively. Additionally, the absence of a medium-term fiscal framework, a complex budgeting process, economic shocks, tax cuts, and new spending initiatives have all contributed to a series of debt increases over the past decade. Addressing medium-term challenges related to the escalating social security and Medicare costs resulting from an aging population has also seen limited progress.
Another concerning aspect is the rise in general government deficits. Fitch expects the general government (GG) deficit to surge to 6.3 percent of GDP in 2023, up from 3.7 percent in 2022, due to weaker federal revenues, new spending initiatives, and a higher interest burden. Moreover, state and local governments are anticipated to register an overall deficit of 0.6 percent of GDP this year after running a small surplus in 2022. While the Fiscal Responsibility Act's non-defense discretionary spending cuts offer some improvement to the medium-term fiscal outlook, the cumulative savings of USD1.5 trillion (3.9 percent of GDP) projected by 2033, according to the Congressional Budget Office, are only modest. Fitch does not expect substantial fiscal consolidation measures before the November 2024 elections.
General government debt, while having reduced over the last two years, remains high at 112.9 percent of GDP in 2023, compared to the pre-pandemic 2019 level of 100.1 percent. Fitch projects that the debt-to-GDP ratio will continue to rise, reaching 118.4 percent by 2025, far exceeding the 'AAA' median of 39.3 percent of GDP and the 'AA' median of 44.7 percent of GDP. Fitch's long-term projections indicate further debt-to-GDP increases, rendering the U.S. fiscal position increasingly vulnerable to future economic shocks.
Despite the downgrade, Fitch acknowledges several exceptional strengths that underpin the United States' ratings. These include its large, advanced, well-diversified, and high-income economy, supported by a dynamic business environment. Significantly, the U.S. dollar remains the world's preeminent reserve currency, offering the government extraordinary financing flexibility.
The economic outlook, however, appears less favorable, with Fitch's projections suggesting that the U.S. economy may slide into a mild recession in the fourth quarter of 2023 and the first quarter of 2024. The agency anticipates a slowdown in GDP growth, and lingering effects on the labor market may negatively affect medium-term potential growth.
Adding further complexity to the economic landscape, the Federal Reserve has tightened its monetary policy by raising interest rates several times in 2023. Fitch expects another hike to 5.5% - 5.75% by September. While the economy and labor market show resilience, the Fed faces challenges in bringing inflation down to its 2 percent target. The Fed's decision to continue reducing holdings of mortgage-backed securities and U.S. Treasuries has further tightened financial conditions.
Fitch also takes into account Environmental, Social, and Governance (ESG) considerations. The U.S. has an ESG Relevance Score of '5' for Political Stability and Rights, reflecting well-established political participation rights, albeit with a percentile rank below 50, negatively impacting the credit profile. However, the U.S. scores '5[+]' for Rule of Law, Institutional & Regulatory Quality, and Control of Corruption, indicating strong institutional capacity, effective rule of law, and a positive impact on the credit profile.
In conclusion, Fitch's decision to downgrade the United States' Long-Term Foreign-Currency IDR to 'AA+' underscores concerns about fiscal deterioration, escalating debt burden, and governance challenges. As the U.S. grapples with medium-term fiscal imbalances, corrective measures become imperative to stabilize the economy and improve its fiscal trajectory. The impact of this rating downgrade on financial markets and investor sentiment remains to be observed, given the United States' historical role as a pillar of the global financial system.
