Global credit rating agency Fitch has downgraded US Sovereign rating from AAA to AA+ citing expected fiscal deterioration over next three years, a high and growing general government debt burden and steady deterioration in governance over the last 20 years. As expected, the White House and the US treasury have been highly critical of this downgrade. “We strongly disagree with this decision. The ratings model used by Fitch declined under President Trump and then improved under President Biden, and it defies reality to downgrade the United States at a moment when President Biden has delivered the strongest recovery of any major economy in the world.,” White House Press Secretary Karine Jean-Pierre said in a statement. While the US stock markets ignored the downgrade, the domestic stock markets tanked over 1 per cent on Wednesday as investors turned cautious following the credit rating downgrade of the United States by Fitch Ratings, and continued outflows from foreign portfolio investors. The BSE Sensex shed 676.53 points, or 1.02 per cent, to close at 65,782.78. The 30-share index fell by 1,028 points during intraday trades. The broader Nifty ended at 19,526.55, down 207 points, or 1.05 per cent. What’s Fitch explanation? The rating downgrade of the US reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to ‘AA’ and ‘AAA'-rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions, according to Fitch. In Fitch’s view, there has been a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters, notwithstanding the June bipartisan agreement to suspend the debt limit until January 2025. 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, Fitch says. These factors, along with several economic shocks as well as tax cuts and new spending initiatives, have contributed to successive debt increases over the last decade. Additionally, there has been only limited progress in tackling medium-term challenges related to rising social security and Medicare costs due to an aging population, Fitch says. Is this the United States’ first downgrade? In 2011, Standard & Poor’s (S&P) downgraded, for the first time in 70 years, the US rating from AAA to AA+, saying the budget deal brokered in Washington didn’t do enough to address the gloomy outlook for US finances. S&P downgraded US debt after the 2011 debt ceiling deal, primarily viewing the deal as insufficient in stabilising longer-term US debt stability. S&P has not changed its US rating since then. How will this impact markets? US benchmark stock index Dow Jones was up by 0.20 per cent on Tuesday (August 1) despite the news about the Fitch downgrade. However, Dow Futures is down by 0.37 per cent on Wednesday. On the other hand, the Sensex fell by over one per cent to below the 66,000 level on weak global cues. Hong Kong, Tokyo, Australia, Korea and other Asian markets fell by up to 2 per cent following the downgrade by Fitch. Stocks of tech firms which depend on the US and Western markets for business were impacted the most. However, US investors are worried about foreign holders selling their US Treasuries. The selling of US Treasuries could lead to a further increase in US Treasury yields, which can limit stock market rallies. Fitch signalled a possible downgrade in May before the debt ceiling agreement is reached. However, the timing might have surprised the market. Anything happening in the US always impacts the world market. “However, we believe that the impact should be short-lived as one rating agency S&P has already downgraded the US to AA+ beforehand. This time the impact should be for a couple of days and the market may focus on other fundamental factors. The impact on the Indian market should also be short-lived and other factors such as earnings, crude prices and RBI policy and fund flows will be the key to the market. Having said that market is heated the world over and may find a reason to correct it,” said Mukesh Kochar, National Head-Wealth, AUM Capital. Is the US moving towards recession? Tighter credit conditions, weakening business investment, and a slowdown in consumption will push the US economy into a mild recession in Q4 of FY23 and Q1 of 2024, according to Fitch projections. The agency sees US annual real GDP growth slowing to 1.2 per cent this year from 2.1 per cent in 2022 and overall growth of just 0.5 per cent in 2024. This will be bad news for other countries and global investors as the US is the largest economy in the world and the performance of other economies depends to some extent on the US. When will Fed cut rates? The US Federal Reserve raised interest rates by 25 bps in March, May and July 2023. Fitch expects one further hike to 5.5 per cent to 5.75 per cent by September. The resilience of the economy and the labour market are complicating the Fed’s goal of bringing inflation towards its 2 per cent target. While headline inflation fell to 3 per cent in June, core PCE inflation, the Fed’s key price index, remained stubbornly high at 4.1 per cent year-on-year. “This will likely preclude cuts in the Federal Funds Rate until March 2024,” Fitch says. On the domestic front, while the full effects of the interest rate tightening are yet to be felt, the Reserve Bank of India (RBI) has already indicated that its next monetary policy action on August 10 will depend on domestic data points, especially retail inflation and growth data. Analysts expect the RBI to hold the Repo rates steady at 6.50 per cent. When the Fed is tightening, interest rates tend to rise more for emerging markets, including India, which see a sharp currency depreciation. While it is not necessary that the RBI will blindly follow the Fed and other central banks in hiking rates, interest rates in India have, in fact, moved in tandem with rates in the US
