Editorial     

Published: August 15, 2023
Updated: August 15, 2023

Taking US downgrade in our stride

Over a fortnight ago, New York headquartered Fitch Ratings sent shockwaves through the financial world when it unexpectedly downgraded the United State’s credit rating from AAA to Aa+. A stunned US government and its economic advisors criticized and questioned the Fitch move, but independent observers were not surprised as they thought the downgrade was inevitable, though delayed. It’s worth recalling that 12 years ago – in 2011, to be exact — Standard & Poor had downgraded the US credit rating from AAA to AA+. Objective observers strongly feel that Fitch’s implicit downgrade is justified by a consistent deterioration in debt-limit resolution governance, forecasts of a rising fiscal deficit (to 6.3 per cent in 2023), a high debt-to-GDP ratio (of 118 per cent in 2025) and medium-term challenges related to a slowing economy. In fact, three months ago – in May 2023, to be exact – Fitch had clearly indicated the possibility of an eventual change by putting the US credit on ‘Rating Watch Negative’.

This eventuality will have serious consequences in the short term. It is feared that the cost of paper will go up. Little wonder, following the Fitch announcement, the US bond yield displayed volatility with a positive inclination. The 10-year bond yield initially rose by 20 bps to 4.20 per cent but settled at 4.04 per cent by the week-end due to expectations of a moderation in the forthcoming inflation announcement. Currently, bond yields remain at historically high levels and these elevated prices are expected to persist, impacting both corporate and economic growth in the short- to medium term.

The impact of the downgrade on the US economy will be limited because of the dollar’s continuing status as the most reliable and most liquid currency. However, the US equity market will be impacted adversely on withdrawal of short-term funds. Though the US stock market has put up a gratifying show this year with S&P 500 moving up by 16.5 per cent year-to-date, sustaining this positive momentum will be quite challenging. With the Fitch announcement, the value of the greenback has turned cautious. It is feared that if the trend continues, it can have a negative implication on the equity market and can even have a cascading effect on equities and currencies in emerging markets.

The downgrade can lead to a number of consequences, perhaps the most obvious being an increase in the country’s borrowing costs due to a perceived greater risk of default. As a result, the US government may end up having to pay more interest on its new debt issues, further deepening its debt burden.

Having surpassed a record $25 trillion in outstanding treasuries, the government pays nearly $1 trillion in interest, or roughly a third of what it collects in taxes. Meanwhile, the Treasury Department just announced that it expects to issue over $1 trillion in new debt in the third quarter. The downgrade could also lead to currency devaluation if foreign investors opt to sell off their holdings.

Anything major happening in the US economy impacts world markets. Interestingly, when US benchmark equity index Dow Jones was up by 0.20 per cent after the Fitch downgrade news, the Indian BSE index slipped one per cent to below the 66,000 level while other Asian markets including Hong Kong, South Korea, Tokyo and even Australia all fell up to 2 per cent, with technology stocks suffering the most.

As far as India is concerned, with the Fitch announcement downgrading the US economy, FIIs (Foreign Institutional Investors) turned sellers in the Indian market. But the selling was not that heavy as in other emerging markets. This is due to the fact that the Indian economy is gaining strength even in an environment of global economic slowdown.

Analysts agree that the Fitch rating is likely to cause only a minor kneejerk reaction in the Indian market as rating changes often come with certain repercussions. The Indian market will forget the US downgrade and may focus on other fundamental factors such as corporate earnings, crude oil prices, the RBI policy on interest rates and fund flows.