Tuesday, 29 Jan 2013

The retreat by Republicans from threats to push the United States into a debt crisis has stayed the hand of at least one credit ratings agency, but that does not mean the United States is suddenly safe.

The country has retained its top triple-A rating from Moody's Investors Service and Fitch Ratings, despite rising debt levels. It was downgraded by one notch in 2011 by Standard & Poor's after a chaotic debt ceiling battle. On Monday, Fitch said the recent debt ceiling extension eliminates the immediate risk to the rating.

But going forward, the emerging signs of lawmakers working together are not likely to be enough to head off more downgrades of U.S. government debt, which is used as a benchmark for borrowing costs and considered the safest of safe havens.

There is no exact formula for what will trigger a downgrade, but statements and reports released by the agencies give some clues. Specifically, the U.S. debt-to-GDP ratio, currently at about 68 percent, is better than triple-A rated nations such as Canada, but far worse than Australia or Norway.

"The negotiations for the medium-term deficit and debt trajectory are the most important things in our ratings," said Steven Hess, lead U.S. sovereign credit analyst at Moody's Investors Service.

"We're looking for a convincing downward trajectory in the debt ratios and we don't think that that's yet there."

The U.S. government has jumped from crisis to crisis in recent years, beginning with the 2011 debt ceiling battle, followed by the threat of the "fiscal cliff" of major tax increases and spending cuts that emerged late last year. It was also thought that Republicans would force drastic spending cuts by refusing to raise the debt limit, until recently merely a procedural matter.

However, even with the parties in Washington behaving, that is still not enough until debt levels are addressed.

Moody's has said specific measures to trim the debt-to-GDP ratio over time would likely get the U.S. Aaa rating affirmed and remove the danger of a downgrade. Budget deals that do not do that, or do it too slowly, will imperil the credit rating.

The agency said it will probably resolve the country's negative outlook by the end of this year, whether the budget questions get ironed out or not.

The other potential risk is that, instead of a stalemate, the warring parties in Washington delay tough decisions in much the same way they have put them off in the past, said Nikola Swann, a director of sovereign ratings at Standard & Poor's.

Short delays are one thing, Swann said, "but when you start talking about years and years of delay, this eventually raises the question, will this ever be implemented?"

NUMBERS GAME

The most recent deal, a three-month extension of the debt ceiling while the Senate sets out a budget, does little to resolve either of the major risks to the U.S. rating - rising debt and political dysfunction.

All three of the major rating agencies have negative outlooks on the U.S. rating. Hess said Moody's does not have a "particular number" when it comes to a debt-to-GDP ratio.

Moody's said in a September report that the Aaa rating would likelier be safe if the federal debt-to-GDP ratio peaked in 2014 and then was projected to fall below 60 percent by the early 2020s as a result of a budget deal. But if the ratio is projected to increase to about 90 percent in that time frame, "a downgrade of the rating would become more probable."

For some context, in 2011, U.S. public debt rose to 67.8 percent of GDP, according to the CIA World Factbook, and the path of this key measure is uncertain. Australia is currently at 26.7 percent, but Canada is at 87.4 percent.

Nevertheless, the U.S. economy is at least growing steadily, if not briskly. The International Monetary Fund estimates GDP growth of 2 percent this year and 3 percent next. Economic growth generally helps reduce debt-to-GDP ratios because tax revenues increase and more goods are produced. Should growth disappoint, a lower rate of expansion in coming years would make "growing out of debt" harder.

By contrast, triple-A rated United Kingdom is flirting with its third recession in five years and Germany, the euro zone's workhorse, is only projected to grow 0.6 percent in 2013 and 1.4 percent in 2014.

While Moody's is agnostic on the mix of revenue-raising and spending cuts, at least one round of belt-tightening could come soon with automatic spending cuts set to roll out in March.

The so-called sequester could work like a crash diet - slimming, but with the potential for a sharp, swift shock. Whether that would be good or bad for the rating is unknown.

"Is the sequester going into effect an indication of success or failure of the political system?" asked Stan Collender, a budget expert with Qorvis Communications. "It easily could be considered success because, hey, the deficit is being reduced."

The relative calm that has descended on Washington might be just a temporary ceasefire. Squabbling led S&P to cut the United States to AA-plus on Aug. 5, 2011, and all three agencies have made it clear that reliable policy remains important to maintaining high credit ratings.

"Having last-minute agreements which set up the prospect of another man-made ... fiscal crisis of one form or another six months later, we don't think is a characteristic associated with a triple-A rated sovereign government," said David Riley, managing director for sovereign ratings at Fitch.

Editor's Note: Billionaires Dump Stocks. Prepare for the Unthinkable.

© Thomson Reuters 2013 All rights reserved