Credit rating agency Standard & Poor’s (S&P) downgraded to “negative” today its outlook on the United States sovereign debt, citing the risk that the government will be unable to curb rising debt and the growing deficit.
According to the New York-based credit rating agency:
Because the U.S. has, relative to its AAA peers, what we consider to be very large budget deficits and rising government indebtedness, and the path to addressing these is not clear to us, we have revised our outlook on the long-term rating to negative from stable.
US deficit grew to 11% of GDP
The credit rating agency points to the growing US deficit, which “ballooned” to more than 11% of gross domestic product (GDP) in 2009 from around 2%-5% during the past decade.
The downgrade also stems from what S&P sees is a risk that policy makers might fail to agree on how to address the country’s budget and finances, leaving the US fiscally weaker relative to other AAA-rated countries.
Debate on fiscal policy
President Barack Obama and the Democrats are currently in the middle of heated debates with congressional Republicans over how to address the fiscal problem. The White House proposed a mix of tax increases and spending cuts, while Republicans are asking for reductions in both spending and taxes which would supposedly help boost the flagging US economy.
On April 8, the Obama administration narrowly averted a government shutdown when it struck a deal with the Republicans regarding the current year’s budget.
The debate has now shifted to the cap on government debt which the government will breach by May this year. Democrats are asking to raise the $14.29 trillion debt ceiling while Republicans are demanding more budget cuts before they agree to lifting the cap. If the ceiling is not raised, the US government might default on the interest payments of some of its debts.
“AAA” bond rating at risk
S&P also warned that if no credible and clear plans are finalized and implemented by 2013, it will lower the US sovereign bond rating, currently rated “AAA.”
AAA is the highest rating on an issued bond which a borrowing entity like the government uses to lower its borrowing cost, that is, the high bond rating can be used to borrow at reduced interest rates.
We believe there is a material risk that US policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013. If an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the US fiscal profile meaningfully weaker than that of peer ‘AAA’ sovereigns.
Impact of credit rating downgrade
Should S&P push through with lowering the AAA long-term rating of the United States, this would leave Germany and France as the only countries with a higher rating, threatening the dominance of the US as a global economic powerhouse.
Riskier US debt would also result to higher bond yields which would lead to increased borrowing costs in the form of higher mortgage rates, credit card interest rates, and business and personal loan interest rates.
The S&P outlook downgrade on April 18 sent stocks sharply lower. The Dow Jones shed 1.14% of its value, closing at 12,201.59.