Though the US economy is stable and still strong, it would still have to bear the brunt of downgraded ratings by agencies like Fitch and Moody

International rating agency Fitch has downgraded the United States' long-term foreign-currency issuer default rating (IDR) from AAA to AA+ on August 1, 2023. The Fitch states, “The rating downgrade of the United States reflects 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 that has manifested in repeated debt limit standoffs and last-minute resolutions.”

It is worth mentioning that in the past, debt ceiling standoff has arisen again and again by the US government, and the

US Parliament had been giving solutions for the same, by increasing the debt limit at the last moment. In such a situation, an atmosphere of tussle was also seen many times between the US President and the US Parliament.

This is indicative of the fact that USA’s fiscal position is not very good and the government has to repeatedly approach the US Parliament to raise the debt ceiling, to enable the US administration to meet its fiscal requirements. In the past, many times we have witnessed, shutdowns of the US government due to lack of funds. The trigger for a downgrade in the US rating by Fitch comes from the likelihood of worsening the fiscal situation of America in the next three years; and the threat of increasing debt burden on the government.

The Fitch rating agency says that the US government's standards in treasury and debt-related matters have steadily declined over the past 20 years. Since there have been repeated political deadlocks over the debt ceiling, there has been a loss of credibility in fiscal management. The government also lacks a medium-term fiscal framework compared to similar countries, having a rating between AA and AAA.

Fitch also says that the US government debt has increased significantly over the past decade due to a series of economic shocks and tax cuts and new spending initiatives. Due to the ever-increasing number of elderly people in America, the expenditure on Social Security and Medicare is increasing continuously and there is no specific effort to deal with it.

The general government fiscal deficit was equal to 3.7 per cent of GDP in the year 2022, which is expected to increase to 6.3 per cent in 2023. The debt on state and local governments is also increasing. Whatever little improvement has been achieved due to the Fiscal Responsibility Act is woefully inadequate and there is little chance of any significant fiscal consolidation efforts until the 2024 elections.

It is noteworthy that about 12 years ago, on August 5, 2011, the rating agency named Standard and Poor's reduced the rating of America in the same way. This was the first time that the US federal government was rated below AAA.

The rating downgrade came just four days after the US Congress raised the debt ceiling then. Although the rating agencies named Fitch and Moody's did not downgrade their ratings then. The US government's rating has remained AAA since 2011, and it’s for the first time since then that the US federal government has been downgraded by Fitch.

In the meanwhile, we see that another rating agency Moody’s has downgraded many US banks. The agency has cut down the credit rating of 10 small and midsized banks and placed 6 big lenders on notice for a future downgrade.

The reason given for this action is a rise in funding cost (that is, an increase in interest rates) and profitability pressures.

Implications of a rating downgrade

America is economically the most powerful country in the world, and its economy is also very wide and full of diversity. The business environment there is also very dynamic. With such structural strength, the US dollar is the world's most popular and prestigious reserve currency. The countries of the world still want to keep their foreign exchange reserves in dollars only. Thanks to all these advantages, despite the rating downgrade, there does not seem to be a situation that America will default in repaying its loans. The world's faith in America continues unabated, but still, it needs to be understood what could be the implications of the downgrade of America's rating on the American economy.

The first impact of any country's rating downgrade is on the interest rates. Domestically, a downgrade would likely lead to higher interest rates, as investors would demand a higher risk premium to hold US debt. This would make it more expensive for the government to borrow money, which could lead to cuts in spending or tax increases. The US government will now need to pay a higher interest rate than before to borrow.Secondly, interest rates on loans issued by the US government must provide a global benchmark. This is because debt issued by the US government is considered one of the most secured loans in the world. In such a situation, if even the most secured loans will now have higher interest rates, then after this downgrading of Fitch, an increase in interest rates can be seen globally, or interest rates on borrowing by some other country may now become the benchmark. But, its likelihood is very meagre, as the US is the largest single borrower in the world.

Thirdly, It could also lead to a decline in the value of the dollar, which would make imports by the US more expensive. Internationally, a downgrade would damage the US's reputation as a haven for investment. This could lead to capital outflows, as investors seek to park their money in countries with higher credit ratings. It could also make it more difficult for the US to borrow money from foreign governments and institutions.

Fourthly, a downgrade could also hurt the US economy. It could lead to a decline in consumer confidence, which would reduce spending. It could also lead to a decline in business investment, as businesses become more uncertain about the future. This could further increase the recessionary tendencies.

Fifthly, the common man would find it difficult to pay their EMIs, as homeowners or vehicle owners, with adjustable-rate mortgages could see their interest rates go up, which could make it more difficult to afford their monthly payments.

Sixthly, we see another rating agency downgrading the banks and other lending institutions, again due to an increase in interest rates in the past; and with this downgrade by Fitch, may further aggravate the situation for these lending institutions, as interest rates may go upwards after the downgrade in rating. It’s not clear how the US administration will deal with the implications of this downgrade. But, this downgrade is no good sign for USA’s economic and corporate life.

(The writer is a Professor, at PGDAV College, University of Delhi. Views expressed are personal)