Fitch, one of three major independent credit rating agencies downgraded the US government’s credit rating from top-level AAA to AA+.
Investors generally use credit ratings as a benchmark for evaluating and judging how risky it could be to lend to the government. US Federal Government is usually considered a highly secure investment because of the size and stability of the economy.
The rating has been downgraded following concerns over the state of the country’s finances and its debt burden. Fitch cited the worsening political polarisation around spending and tax policy as one of the key reasons for the downgrade.
Since 2001, the revenue generated from collecting taxes has rarely covered enough of the costs of everything the U.S. government pays for, from roadways to wars. When federal income falls short, the government fills the gap by borrowing money from investors. That gap has gotten a lot bigger in recent years as the U.S. has spent trillions fighting COVID-19, contending with financial crises and funding several wars.
As of August 1, the US Treasury owed US$32.6 trillion, both to bondholders and other parts of the federal government.
That’s part of the reason that Fitch cut the US government’s long-term creditworthiness by one notch, from AAA, its highest rating to AA+. Fitch also cited an “erosion of governance,” specifically pointing to recent efforts by conservatives to prevent the U.S. from raising its debt ceiling.
“In Fitch’s view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025,” a statement by the credit rating agency Fitch.
US Treasury Secretary Janet Yellen criticised the move by citing that the ratings were arbitrary and based on outdated data.
The US dollar was seen to move lower against the Australian dollar and other major currencies after the announcement of the rating downgrade.
In May, Fitch had already placed its AAA rating of US sovereign debt on watch for a possibility of downgrade, because of the downside risks and a growing debt burden.
S&P had also stripped the US of its AAA rating in 2011 because of the rising level of debt. After the S&P downgrade, US stocks tumbled and the impact was felt across global stock markets. The downgrade in 2011 followed a similar debt ceiling standoff.
To cover its growing borrowing costs, the federal government has few options – none good.
It can borrow more money, which is seen as riskier – like taking out one loan to pay off another – and could result in an even lower credit rating and a continuous spiral of rising borrowing costs. Or it could hike tax rates or cut spending, both of which have political consequences and could be hard to accomplish given the degree of polarisation in Congress.
Furthermore, research has shown that higher government debt is generally associated with lower long-term economic growth, which reinforces the problem by reducing revenue and thus requiring more debt.
So, while Fitch’s downgrade doesn’t signal an imminent financial crisis, it does serve as a warning as Congress engages in its fiscal fights. The impact of reduced credit ratings could lead the US to pay higher interest rates on its notes, bills, and bonds.
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