June 13, 2024

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Defaulting on US debt could hurt the nation’s credit rating

Defaulting on US debt could hurt the nation’s credit rating

If the United States government defaults on its debt for even a few hours next week, it could have long-term consequences for the nation’s future. Three major ratings companies – S&P Global Ratings, Moody’s and Fitch Ratings – play a big role in how damaging these consequences could be.

Because the financial repercussions of a default would be severe, the agencies predict that lawmakers will reach an agreement before the government runs out of cash to pay its bills, which could happen as early as next month. But if the government ends up defaulting on debt, the three companies have pledged to downgrade the US as a borrower, and they may be reluctant to bring it back to its previous level, even if a deal is struck soon after that. shortening.

On Wednesday evening, Fitch released its first shots across the government’s bow, putting the US rating on watch for a downgrade, a move that “reflects the growing political partisanship impeding a decision to raise or suspend a debt limit.” agency analysts warned.

The US has never intentionally defaulted on its debt in modern times, Moody’s warned, but even a brief default would change the perception of the debt-limit brink as political theater and turn it into a real risk to the government’s creditworthiness.

“Our view is that we will need to permanently reverse that in the rating,” said William Foster, principal US analyst at the ratings agency. If the Treasury Department missed a single interest payment, the agency said, its credit rating would be downgraded by a notch. For the US to regain its previous higher rating, according to Foster, lawmakers would have to significantly change the debt limit or remove it entirely.

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Credit ratings, which range from D or C (for S&P and Moody’s scales) to AAA or Aaa for the more primitive borrower, are embedded in financial contracts around the world, sometimes dictating the quality of debt pension funds and other investors can hold or the types of assets they can hold. They can act as collateral to secure transactions. The ratings also indicate the health of a country’s finances, as countries with a lower rating tend to face higher borrowing costs.

For the US, the debt-limit stalemate that led to a default “would not be consistent with the highest possible rating,” Foster said. “But if that rule is removed, if it is fixed in a way that is no longer a major concern in terms of creating a default scenario, that would be the context for a reconsideration of the credit profile and possibly bring it back to Aaa.”

Standard & Poor’s downgraded the United States’ credit rating by one notch during a debt-limit bout in 2011, despite eventually striking a deal and avoiding default. The agency has maintained the rating at that slightly lower level, AA+, since then.

“The most powerful thing about the 2011 decision is the political situation and that you have a very clear path to default. It’s still there,” said John Chambers, who was part of the S&P team that downgraded the government at the time. “The current debate validates the decision. S&P cut the rating and leave it as is.

A similar move by Fitch or Moody’s would drop the US from the small club of the world’s most highly-rated debt issuers. (Many investors still consider the US triple A rating, since that is its rating from two of the three jurisdictions.) Singapore and Canada.

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Even without default, the standing of the United States may be affected. Mr. Foster said that passing the so-called X-date — when the government runs out of cash to pay all its bills, which could come as soon as June 1, according to the Treasury Department — could be enough to reduce Moody’s “forecast” for the country’s rating, referring to the opinion on the likely direction of the borrower rating, similar to the move Fitch made on Wednesday.

Even a temporary deal to suspend the debt limit for a short period may not be enough to mollify the ratings firms. A Fitch Ratings spokesperson said the short-term deal, rather than a deal to raise the debt ceiling in the long term, would “just buy time”.

“Developments in the coming days will be the focus of Fitch’s rating assessment,” the spokesperson said.

The United States benefits from its central role in the global economy, with the dollar being the dominant currency in global trade and US government debt the largest debt market in the world. Doubts about creditworthiness can scare away foreign investors and governments, the main holders of American debt, threatening the nation’s ability to finance itself on as favorable terms as it has in the past, and perhaps even erode its international standing.

“This is not good for the United States,” Indonesian Finance Minister Sri Mulyani Indrawati told a recent meeting of global financial leaders.

Mr. Foster declined to comment on whether he had briefed the US government on Modi’s plans for its assessment of the country’s credit rating as the standoff over debt limits continues.

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“We can’t talk about our discussions with issuers, including governments, but we can say that we have ongoing discussions throughout the year, sometimes more high-frequency discussions depending on what’s happening in a particular country at a time,” Foster said. “We always have an open channel with those governments, including the United States.”