US debt deal alone won't sustain AAA rating

[August 03, 2011]  NEW YORK (AP) -- The U.S. averted a debt default Tuesday when President Barack Obama signed a bill raising the country's debt ceiling. But the debt deal might not be enough to maintain its coveted AAA debt rating, according to two credit rating agencies.

On Tuesday, Fitch Ratings said the agreement to raise the debt ceiling and make spending cuts was an important first step but "not the end of the process." The rating agency said it wants to see a credible plan to reduce the budget deficit "to a level that would secure the United States' `AAA' status."

And late on Tuesday, Moody's Investors Service assigned a negative outlook to U.S. debt, but confirmed its AAA rating -- for now. A negative outlook means the rating agency could lower the rating in the next 12 to 18 months. Moody's said that continued slow economic growth, higher interest rates could lead to a downgrade. Moody's also said weak fiscal discipline in the coming year could do the same.

U.S. debt has held the AAA rating since 1917. Fewer than 20 countries are currently rated AAA. Among them: the United Kingdom, Australia, Germany and Singapore.

Fitch expects to conclude its review of the U.S.'s debt rating by the end of August. Given the terms of the debt deal signed Tuesday, it is possible the U.S. debt rating could be downgraded at that time, Fitch said.

In an interview with The Associated Press on Tuesday, David Riley, managing director at Fitch, said, "There's more to be done in order to keep the rating in the medium-term."

The three main ratings agencies rate the debt issued by countries, states, corporations and municipalities. Ratings are based on a likelihood of default. The AAA rating is the highest available and signifies an extremely low likelihood of default.

Standard & Poor's, the other major ratings agency, declined to comment Tuesday. In mid-July S&P warned that there was a 50-50 chance it would downgrade U.S. debt. Had the country defaulted, experts have said a downgrade by all three agencies would have been likely.

The U.S. has only faced the threat of a downgrade once in the last 96 years. In 1995, when Bill Clinton was president, a similar default loomed and the credit rating agencies threatened a downgrade. At the time, the country had $4.9 trillion in debt -- nearly $10 trillion less than it has now. Once Congress resolved that debt crisis a year later, the credit agencies removed the threat.

Federated Investors' chief fixed income strategist Joe Balestrino points out that during the Clinton era the U.S. economy was growing at a much faster pace. Now, the economy is emerging from the deepest recession since the Great Depression and growth is sluggish. On Friday, the government said that in the first half of the year, the economy grew at its slowest pace since the recession officially ended in June 2009.

"Growth healed all wounds in 1995," Balestrino said. "However, now the U.S. doesn't have enough vitality to grow its way out."

A Monday report that showed weakness in manufacturing followed Friday's GDP report. And on Tuesday, the Commerce Department said that consumers cut their spending in June for the first time in nearly two years.

Because of that, many analysts believe that U.S. debt will eventually be downgraded to AA. And if that happens, it could be tough to regain the AAA rating.

"If the economy won't grow at 2.5 percent over the long term, it has pretty profound implications from a fiscal point of view," said Riley, the Fitch managing director.

He said "that means the U.S. is poorer than it thought" and that legislators will face even tougher choices "in terms of taxes and spending," he said.

Fitch also said that between federal, state and local government debt U.S. government debt will be as large as the country's economy by the end of 2012 -- or 100 percent of the country's gross domestic product. And Fitch said it expects the country's debt level will continue to rise. The agency warned that would not consistent with a debt level that would allow the U.S. to retain its AAA sovereign rating. Similarly, Moody's said for the U.S. to keep its AAA rating, it expects to see the federal government's debt-to-GDP ratio stay near its projected 2012 level of 73 percent in the next several years, and then decline.

In the short term, Balestrino and others don't expect investors to start selling their Treasury holdings. That's because Treasurys are considered one of the safest investment options.

Fitch said the status of the U.S. dollar and the size of the Treasury market are the biggest reasons investors won't abandon Treasurys soon. The dollar is the global reserve currency, which means a significant amount of global trade is made in dollars -- from toys and computer chips from China, coffee from Kenya or cars from Japan. Central banks in other countries therefore hold large reserves of U.S. currency, mostly through Treasury purchases.

The U.S. Treasury market is the largest government bond market, at $9.3 trillion.

And Moody's said while it expects interest rates to rise some over the next few years "a rise in borrowing costs above and beyond what is now expected would threaten efforts at fiscal consolidation" and could negatively impact the country's AAA rating.

[Associated Press; By PALLAVI GOGOI]

Copyright 2011 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.