Economic Update: August 2023

Fitch downgrades US Long term rating to AA from AAA

• Fitch Ratings has downgraded the United States of America’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘AA+’ from ‘AAA’.
• While Fitch notes that several structural strengths underpin the United States’ ratings, including its large, advanced, well-diversified and high-income economy, supported by a dynamic business environment. Critically, the U.S. dollar is the world’s preeminent reserve currency, which gives the government extraordinary financing flexibility.
• Rating Agency gave following rating drivers for the action.
  • Erosion of Governance: In Fitch’s view, there has been a steady deterioration in standards of governance as can be seen in repeated debt-limit political standoffs and last-minute resolutions.
  • Rising General Government Deficits: Fitch expects fiscal deterioration over the next three years with the government deficit to rise to 6.3% of GDP in 2023, from 3.7% in 2022, reflecting cyclically weaker federal revenues, new spending initiatives and a higher interest burden.
  • General Government Debt to Rise: Lower deficits and high nominal GDP growth has increased the debt-to-GDP ratio to 112.9% this year, well above the pre-pandemic 2019 level of 100.1%. The debt-to-GDP ratio is projected to rise over the forecast period, reaching to 118.4% by 2025.
  • Economy to Slip into Recession: Tighter credit conditions, weakening business investment, and a slowdown in consumption will push the U.S. economy into a mild recession in 4Q23 and 1Q24, according to Fitch projections.
  • Fed Tightening: The Fed raised interest rates by 25bp in March, May and July 2023. Fitch expects one further hike to 5.5% to 5.75% by September.

Impact:

• The Rating downgrade, even though anticipated by market, led to a selloff in the US markets as Dow closed 348 points, or 1%, lower in the next day trading session. The S&P 500 fell 1.4% and the NASDAQ dropped 2.2%. Mortgage rates rose on the announcement of downgrade and the yield on 10 year US treasuries climbed.
• The impact of news on India is unlikely as the macroeconomic picture of India is favorable due to strong growth momentum, moderating inflation, growing domestic demand and good corporate earnings in recent times.
• On the other hand, a case is made for increase in India’s current sovereign rating (currently BBB-, lowest in investment grade rating) as India is fastest growing major economy and third largest economy from purchasing power parity.

Credit Rating Agencies:

• A credit rating agency (CRA) is a company that assigns credit ratings, which rate a debtor’s ability to pay back debt by making timely principal and interest payments and the likelihood of default.
• Ratings play an important role in the borrowing costs of companies as banks and financial institution consider credit ratings to determine the interest costs.
• The global bond markets rely on credit rating agencies to issue ratings on debts. Big Three credit-rating agencies —S&P, Moody’s and Fitch, though non-government, are given special status by the US market regulators.
• In India seven rating agencies are recognized by market regulator SEBI: Crisil (backed by S&P), ICRA (Backed by Moody’s), India Ratings (backed by Fitch), CARE, Acuité, Brickwork* and Infomerics.