Explainer | Moody’s Ratings downgrades the US to Aa1: Why it matters

Late on May 16 (May 17 morning in India), Moody's Ratings announced it downgraded the Government of United States of America’s long-term issuer and senior unsecured ratings to Aa1 from Aaa and changed the outlook to stable from negative. The recent move by the rating giant has overreaching significance across the world.

For one, this means that even ratings agencies are looking at the mounting US debt. Debt ratios and interest payments ratios do not align with sovereigns at the same level.

Moreover, in the past decade, US administrations under Joe Biden and Donald Trump (twice) and the US Congress were in a deadlock—they could never agree on significant measures to cut the massive annual fiscal deficits and rising interest costs.

Moody’s noted: “We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration.”

The ratings agency also sees that the massive fiscal deficits could lead to more government debt and, in turn, lead to a higher interest burden.

“Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat,” Moody’s reasoned.

It doesn’t look good for the US. In fact, Moody’s sees the fiscal performance of the US to likely “deteriorate relative to its own past and compared to other highly-rated sovereigns.”

In fact, veteran market guru and Berkshire Hathaway chairperson Warren Buffett, two weeks ago, called US fiscal deficit “unsustainable”.

“We are operating at a fiscal deficit now that is unsustainable over a very long period of time,” Buffett said. He even invoked the famous economist Herbert Stein, who in a May 1985 column in The Wall Street Journal wrote about the US fiscal deficit: “What economists know seems to consist entirely of a list of things that cannot go on forever, and this may be one of them. But if it can’t go on forever it will stop. And if we never do anything that we can’t go on doing forever we will never do very much.” 

While downgrading credit ratings, Moody’s lifted the outlook to stable from negative. Therefore, there is a sliver of hope. “The US retains exceptional credit strengths such as the size, resilience and dynamism of its economy and the role of the US dollar as global reserve currency,” added Moody’s.

The Federal Reserve’s independent nature and the marked “constitutional separation of powers among the three branches of government” means that we will continue to see effective monetary policy despite some policy uncertainty.

However, the US administration needs to pull up its big-boy pants if it has to arrest the continuous mounting of fiscal deficits. Tax cuts meant a marked reduction in federal revenue, adding fuel to the fire. ”Without adjustments to taxation and spending, we expect budget flexibility to remain limited, with mandatory spending, including interest expense, projected to rise to around 78 per cent of total spending by 2035 from about 73 per cent in 2024,” Moody’s stated.

If the 2017 Tax Cuts and Jobs Act is extended, it could add around $4 trillion to the federal fiscal primary deficit over the next decade—and this is excluding interest payments.

“While we recognize the US’ significant economic and financial strengths, we believe these no longer fully counterbalance the decline in fiscal metrics,” Moody’s said, defending the downgrade.

While a broader political blame game could follow, this ratings downgrade could affect American citizens by hitting too close to home. With the US financial system heavily connected to the Treasury yields, this could mean a jump in home mortgage and student loan rates.

Moreover, private investors could take a cautious approach, lifting costs of all lending, including homes, cars/automobiles, and credit cards—a major tool for everyday US residents.

Business