Jan 15 - Fitch Ratings’ expectation is that Congress will raise the debt ceiling and that the risk of a U.S. sovereign default remains extremely low. Nonetheless, and in line with our previous guidance, failure to raise the debt ceiling in a timely manner will prompt a formal review of the U.S. sovereign ratings.
On 31 December 2012, U.S. federal government debt reached the statutory debt limit of USD16.394trn and consequently the Treasury has begun to implement extraordinary measures that will create an estimated USD200bn of additional headroom under the debt ceiling. A repeat of the August 2011 ‘debt ceiling crisis’ would oblige Fitch to review its current assessment of the reliability and predictability of the institutional policy framework and prospects for reaching agreement on a credible medium-term deficit reduction plan.
In Fitch’s opinion, the debt ceiling is an ineffective and potentially dangerous mechanism for enforcing fiscal discipline. It does not prevent tax and spending decisions that will incur debt issuance in excess of the ceiling while the sanction of not raising the ceiling risks a sovereign default and renders such a threat incredible.
The statutory limitation on federal debt is a long-standing feature of the U.S. fiscal framework and applies to nearly all Treasury debt, whether held by the public or in government accounts. Protracted debate prior to increasing the debt ceiling is not an exceptional event, but against the backdrop of unprecedentedly large peacetime budget deficits and outstanding debt, any delay in raising the limit would pose ever increasing risks to the ability of the federal government to honour its obligations in a timely fashion. The last time Congress approved an increase in the debt ceiling in August 2011, the federal government came perilously close to being in a situation where, in the words of the Treasury Secretary, it would be unable “to meet our commitments securely”.
The extraordinary measures now being enacted since 31 December 2012, together with around USD43bn 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 authorisation 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 prioritise 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.
In addition to the debt ceiling, there is uncertainty over whether USD54bn of spending cuts (sequester) deferred by two months under the agreement reached just-in-time to avoid the so-called fiscal cliff on 1 January will come into effect in fiscal year (FY) 2013 and a further USD96bn of reductions in outlays in FY14. And on 27 March, the federal government spending authority expires and, unless renewed, will result in a government ‘shutdown’. Recent history suggests that short term fixes will be agreed, albeit only just before each deadline is breached, that do little more than postpone key decisions and perpetuate the uncertainty over tax and spending policies and fail to place U.S. public finances on a medium-term sustainable path.
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.