Fitch Calls for Credible Medium Term Deficit Reduction Plan

Following the enactment of the American Tax Relief Act a few weeks ago, two top credit rating agencies--Moody's and Standard & Poor's--announced a wait-and-see approach on the U.S. credit rating.  This came as a result of the fiscal cliff deal containing inadequate savings to put the debt on a sustainable fiscal path, lack of decision on the debt ceiling, and a two month delay of the sequester.

Today, the third major credit rating agency, Fitch Ratings, has added its voice by calling on Congress to raise the debt limit to avoid a downgrade, while at the same time, urging them to seize the opportunity to put in place credible medium-term deficit reduction measures. In a statement, Fitch comments first on the possibility of breaching the debt ceiling: 

The extraordinary measures now being enacted since 31 December 2012, together with around $43 billion in Treasury deposits, are expected to allow the federal government to continue to fund itself until end-February, though this estimate is provisional and sensitive to volatile monthly budget flows. It is highly uncertain what would happen if Congress did not raise the debt ceiling before the Treasury's borrowing authority and available cash balances were exhausted.

With no legal authorization for net debt issuance, the Treasury would be forced to immediately eliminate the deficit - a fiscal contraction twice as great as the recently avoided 'fiscal cliff' - by delaying payments on commitments as they fall due. It is not assured that the Treasury would or legally could prioritize debt service over its myriad of other obligations, including social security payments, tax rebates and payments to contractors and employees. Arrears on such obligations would not constitute a default event from a sovereign rating perspective but very likely prompt a downgrade even as debt obligations continued to be met.

However, even if Congress avoids this terrible possibility, failure to address the deficit would still leave the U.S. credit rating in jeopardy.

The U.S. 'AAA' status is underpinned by the country's relative economic dynamism and potential, diminishing financial sector risks, respect for the rule of law and property rights, as well as the exceptional financing flexibility that accrues from the global benchmark status of U.S. Treasury securities and the dollar. These fundamental credit strengths are being eroded by the large, albeit steadily declining, structural budget deficit and high and rising public debt.

In the absence of an agreed and credible medium-term deficit reduction plan that would be consistent with sustaining the economic recovery and restoring confidence in the long-run sustainability of U.S. public finances, the current Negative Outlook on the 'AAA' rating is likely to be resolved with a downgrade later this year even if another debt ceiling crisis is averted.

While lawmakers successfully avoided much of the economic harm in the fiscal cliff, Washington must do more and reach a deal containing significant deficit reduction, along with a resolution of the sequester and the debt ceiling or risk downgrades. With all three credit agencies conditioning possible downgrades, we hope this will push Congress and the President to act during this next round of negotiations.

The full statement from Fitch can be found here.