Fitch Comments on US Debt Agreement – Warns of Downgrade

Fitch Ratings says in a comment that the US Debt agreement was reached as expected, and that the risk of sovereign default remains extremely low. However, the rating agency points out that the nations debt profile will not be “consistent with retaining its triple-A rating” by the end of 2012.

“On current trends Fitch projects that U.S. government debt, including debt incurred by state and local governments as well as the federal government, will reach 100% of GDP by the end of 2012, and will continue to rise over the medium term.”

Fitch Ratings

“While the agreement is clearly a step in the right direction, the United States, as in much of Europe, must also confront tough choices on tax and spending against a weak economic back drop if the budget deficit and government debt is to be cut to safer levels over the medium term,” Fitch says.

“The increase in the debt ceiling and agreement on the broad parameters of a deficit-reduction plan support Fitch’s judgment that, despite the intensity and theatre of political discourse in the United States, there is the political will and capacity to ultimately do the right thing.”

In Fitch’s opinion, the agreement is an important first step but not the end of the process towards putting in place a credible plan to reduce the budget deficit to a level that would secure the United States’ ‘AAA’ status over the medium-term.

Fitch said in its June 8 comment, ‘Potential Rating Implications of a Failure to Raise the US Debt Ceiling, that if the ceiling was not raised by the date projected by the Treasury (Aug. 2), then the U.S. sovereign rating would be placed on Rating Watch Negative.

“While this has been averted – albeit at the last possible moment – Fitch now expects to conclude its scheduled review of the US sovereign rating by the end of August.”

The review will focus on the US sovereign credit fundamentals relative to ‘AAA’ peers and medium-term economic and fiscal prospects in light of Sunday’s agreement on cuts of nearly USD1 trillion over 10 years on discretionary spending and the establishment of a bipartisan, bicameral Congressional committee that will identify an additional USD1.5 trillion of additional deficit reduction by year-end.

The agreement passed by Congress provides for an initial increase of the debt limit of USD400 billion and introduces procedures that would allow the limit to be raised further in two additional steps, for a cumulative increase of between $2.1 trillion and $2.4 trillion by end-2011.

“The fundamental economic and financial underpinning of the United States’ ‘AAA’ status remains strong despite the heated political debate over the role of government and how best to reduce the outsized federal budget deficit. Corporate sector balance sheets and profitability are healthy, underlying productivity growth is still relatively strong, and the U.S. dollar remains unchallenged as the global reserve currency. Financial sector and household balance sheets are being repaired, though the process will be prolonged and costly in terms of a relatively weak recovery in economic activity and employment.”

Recent revisions to estimates of gross domestic product reveal that the recession associated with the 2008-09 financial crisis was even deeper and the recovery somewhat weaker than previously estimated, underscoring Fitch’s assessment that most of the federal budget deficit is structural in nature.

“Even if, as Fitch currently forecasts, the recovery regains some momentum in the second half of this year and over the medium term can sustain an annual rate of growth of around 2.5%, significant revisions to tax and spending policies will be required to materially reduce the budget deficit.”

Market and refinancing risks are minimized by monetary and exchange rate flexibility, the status of the US dollar as the global reserve currency, and the size and liquidity of the US Treasury market that is without parallel.

“Moreover, the interest burden of federal debt is projected to remain moderate by historical standards and broadly in line with ‘AAA’ peers.”

“Nonetheless, at a time of heightened concerns regarding the creditworthiness of sovereign governments in mature industrialized economies, it is essential that a credible multi-year deficit reduction plan is articulated and implemented. On current trends Fitch projects that US government debt, including debt incurred by state and local governments as well as the federal government, will reach 100% of GDP by the end of 2012, and will continue to rise over the medium term – a profile that is not consistent with the United States retaining its ‘AAA’ sovereign rating,” the rating agency concludes.

Press Release.

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