Credit Rating Agencies and IMF Say More Needs to Be Done

With President Obama's signing of the American Taxpayer Relief Act (ATRA), lawmakers have avoided most of the upfront hit of the fiscal cliff but have made only slight progress on addressing deficits and debt. More will have to be done to control the debt, but it's not just CRFB saying this. Moody's and Standard & Poor's, two of the top credit rating agencies, and the IMF are also saying more needs to be done.

Yesterday, Moody's issued a statement that warned that lawmakers needed to do more in the coming months if the U.S. is going to be able to maintain its Aaa rating. We've talked about the need to put the debt on a downward path as a share of the economy at the end of the decade, and Moody's establishes this goal as critical to retaining the U.S.'s Aaa rating:

Moody's Investors Service said that the fiscal package passed by both houses of Congress yesterday is a further step in clarifying the medium-term deficit and debt trajectory of the federal government. It does not, however, provide a basis for a meaningful improvement in the government's debt ratios over the medium term. The rating agency expects that further fiscal measures are likely to be taken in coming months that would result in lower future budget deficits, which are necessary if the negative outlook on the government's bond rating is to be returned to stable. On the other hand, lack of further deficit reduction measures could affect the rating negatively. Notably, yesterday's package does not address the federal government's statutory debt limit, which was reached on December 31. The need to raise the debt limit may affect the outcome of future budget negotiations.

The Congressional Budget Office (CBO) estimates that the net increase in budget deficits from the fiscal package when compared to its baseline scenario (which assumes taxes on all income levels would increase) is about $4 trillion over the coming decade, excluding higher interest costs on the resultant higher debt. Based on that estimate, a preliminary calculation by Moody's shows that the ratio of government debt to GDP would peak at about 80% in 2014 and then remain in the upper 70 percent range for the remaining years of the coming decade. Stabilization at this level would leave the government less able to deal with future pressures from entitlement spending or from unforeseen shocks. Thus, further measures that bring about a downward debt trajectory over the medium term are likely to be needed to support the Aaa rating.

S&P, which downgraded the U.S. after the 2011 debt ceiling debate, also did not indicate that their outlook would change to stable. Many of the reasons for the downgrade, which we covered in our report "Understanding the S&P Downgrade," still remain. The agency released a statement that cautioned Congress that there was still more work to do to avoid another downgrade:

While Congressional compromise designed to avoid the 'fiscal cliff' may support the still-fragile U.S. economic rebound, the compromise doesn't affect our view of the country's credit outlook, given that we believe yesterday's agreement does little to place the U.S.'s medium-term public finances on a more sustainable footing.

Fitch has yet to comment on the fiscal cliff deal but it is unlikely that their view differs too much from Moody's and S&P. All three major credit agencies have the U.S. on a negative outlook, making it critical that the lawmakers take up more reforms in the next two months leading up to the scheduled activation of the sequester on March 1st.

^{Source: Agency Outlooks}

The IMF has also released a statement about the deal, saying that more needed to be done to put the budget on a sustainable path. From the release:

We welcome the action by the U.S. Congress to avoid sudden tax increases and spending cuts, including through an extension of unemployment benefits during 2013. In the absence of Congressional action the economic recovery would have been derailed.

However, more remains to be done to put U.S. public finances back on a sustainable path without harming the still fragile recovery. Specifically, a comprehensive plan that ensures both higher revenues and containment of entitlement spending over the medium term should be approved as soon as possible. In addition, it is crucial to raise the debt ceiling expeditiously and remove remaining uncertainties about the spending sequester and expiring appropriation bills.”

We hope policymakers heed these warnings and work toward enacting a big and bold package that produces a sustainable debt path. With a clearly communicated and sustainable budget path, the public, businesses, credit agencies, and markets can have the certainty they need to have confidence in the strength of the short-term and long-term economy. We need to take advantage of the upcoming opportunities to go further on deficit reduction.