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THROUGH THE LENS

United States Downgraded to AA+ by Fitch

The Event

• Fitch Rating downgraded its US debt rating to AA+ from AAA

• The Rating downgrade reflects the expected fiscal deterioration over the next three years, a high and growing government debt burden, and erosion of governance.

• Treasury Secretary Janet Yellen quickly responded to the downgrade, calling it “arbitrary” and “outdated.”

Possible Impact

• We believe that the Fitch rating downgrade is unlikely to lead to major impact in debt, currency and commodity markets. As the previous rating downgrade for US debt came in 2011 by S&P, which had then led to steep stock market declines and rising bond yields.

• Currently we have seen some correction in equity markets globally due to risk off sentiment and minimal impact on bond yields, currency and commodity markets.

• This recent rating downgrade could lead to rise in US Treasury yields and decline in risk assets.

• The Dollar and Gold could strengthen as investors shift assets towards safe havens.

• This could also weigh on emerging-market assets due to rise in US yields.

Rationale for Rating Downgrade by Fitch Ratings

• Rising general government deficits – The general government (GG) deficit is expected 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. Additionally, state and local governments are expected to run an overall deficit of 0.6% of GDP (surplus of 0.2% of GDP in 2022).

• General government debt to rise- Lower deficits and high nominal GDP growth reduced the debt-to-GDP ratio over the last two years from the pandemic high of 122.3% in 2020; however, at 112.9% this year it is still well above the pre-pandemic 2019 level of 100.1%. The GG debt-to-GDP ratio is projected to rise to 118.4% by 2025. The debt ratio is over two-and-ahalf times higher than the 'AAA' median of 39.3% of GDP and 'AA' median of 44.7% of GDP.

• Erosion of governance - There has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters. The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management. In addition, the government lacks a medium-term fiscal framework, unlike most peers, and has a complex budgeting process.

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