Moody’s warns USA over growing deficit

Posted on: February 4, 2010 in: Uncategorized with 0 comments

A remarkable story in today’s news.

The US deficit is so bad that Moody’s, the credit rating agency, is warning that the US’ soveriegn credit rating could come under pressure if the deficit continues to grow on its current path. Since World War II, the US has been the gold standard for safety. No matter what, it could always sell its treasury (government-issued) bonds to the world. That status looks to be under threat. A drop in its credit rating would push up its cost of borrowing.

Here’s the Moody’s announcement:
Announcement: United States of America, Government of
Moody’s: US Budget First Step, Not Solution, to Debt Sustainability

New York, February 02, 2010 — The US government budget presented on February 1 was a small start to the big task of returning to a sustainable debt trajectory, but further measures will be necessary if that task is to be accomplished, Moody’s Investors Service says in an issuer comment.

Unless further measures are taken to reduce the budget deficit further or the economy rebounds more vigorously than expected, the federal financial picture as presented in the projections for the next decade will at some point put pressure on the Aaa government bond rating.

“Freezing part of discretionary spending for a three-year period beginning in the next fiscal year is a positive step from a rating perspective, says Moody’s Senior Credit Officer Steven Hess. “However, the deficits projected in the budget do not stabilize debt levels in relation to GDP, and the portion of government expenditures going to pay interest on the debt shows a steady rise.”

The government is constrained for the time being by the high unemployment rate. A big fiscal adjustment right now would be politically difficult and could slow the economic recovery. In addition, extra spending for employment creation in the current fiscal year adds to the long-term debt trajectory.

Entitlement programs will also put significant pressure on the government’s fiscal position toward the end of the current decade and thereafter, regardless of the new budget proposals.

“The debt trajectory is clearly continuously upward if further measures are not implemented,” Moody’s Hess says.

He explains that as interest rates rise from their presently very low level and the size of the debt increases, debt affordability will deteriorate in a major way. Under the proposed budget, the ratio of interest repayments to revenue will double from 8.7% in the current fiscal year to a very high 17.8% by 2020—approximately equal to the highest level in recent decades, reached in the 1980s.

However, the ratio of federal government debt to federal government revenue, another measure used by Moody’s to assess the government’s financial strength, will fall somewhat from 429% in the current year to 394% in 2020. This is still a high level and is not a strong improvement.

The government’s projections show that federal debt held by the public will rise continuously, reaching 77% of GDP by 2020 (compared with 53% at the end of FY 2009 and 64% at the end of the current fiscal year). Using the general government measure (including state and local governments as well as the federal government), which is used internationally, this ratio would be well over 100% in 2020.

The administration itself, in the budget release, recognized that further measures were necessary by announcing its intention to establish a Fiscal Commission. The newly released budget projections include a primary deficit of 0.9% of GDP in 2015. The Commission’s mandate would be to move the budget excluding interest expenditures (the primary balance) to a balanced position by 2015. In addition, the Commission’s goal may be politically difficult to achieve in that it would require further budget cuts or tax increases.

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