Indian markets plunged on Wednesday after rating agency Fitch on Tuesday downgraded the US government's top credit rating, citing expected fiscal deterioration over the next three years and growing general government debt burden.
Fitch downgraded the United States' Long-Term Foreign-Currency Issuer Default Rating (IDR) to AA+ from AAA, in a move that came despite the resolution of the debt ceiling crisis two months ago. In May, Fitch had placed its AAA rating of US sovereign debt on watch for a possible downgrade, citing downside risk.
“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,” the rating agency said in a Wednesday statement.
Alongside Indian markets, Asian peers as well as US futures also felt the ripples of this downgrade. South Korea’s Kospi shed 1.4 percent, Australia’s S&P/ASX 200 fell 0.9 percent and China’s Shanghai Composite Index was down 0.8 percent.
Fitch, in its report, further stated that a steady deterioration has been seen in governance in the last 20 years. However, US Treasury Secretary Janet Yellen said that the downgrade is based on outdated data between 2018 and 2020.
Back home, the BSE Sensex shed as much as 740 points or over 1 percent to its intra-day low of 65,719.47 whereas the broader Nifty lost 223 points or over 1 percent to its day's low of 19,510.15.
Why the downgrade?
Fitch has listed six reasons for this downgrade:
Erosion of Governance: Fitch believes there has been a steady deterioration in standards of governance in the US over the last 20 years, including on fiscal and debt matters, in spite of 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," Fitch pointed out.
Rising General Government Deficits: As per the rating agency, the general government (GG) deficit is to rise to 6.3 percent of GDP in 2023, from 3.7 percent in 2022. It also forecasts a GG deficit of 6.6 percent of GDP in 2024 and a further widening to 6.9 percent of GDP in 2025.
"The larger deficits will be driven by weak 2024 GDP growth, a higher interest burden and wider state and local government deficits of 1.2 percent of GDP in 2024-2025 (in line with the historical 20-year average). The interest-to-revenue ratio is expected to reach 10 percent by 2025 (compared to 2.8 percent for the 'AA' median and 1 percent for the 'AAA' median) due to the higher debt level as well as sustained higher interest rates compared with pre-pandemic levels," said Fitch.
General Government Debt to Rise: The GG debt-to-GDP ratio is projected to rise over the forecast period, reaching 118.4 percent by 2025. The debt ratio is over two-and-a-half times higher than the 'AAA' median of 39.3 percent of GDP and 'AA' median of 44.7 percent of GDP. Fitch's longer-term projections forecast additional debt/GDP rises, increasing the vulnerability of the US fiscal position to future economic shocks, said Fitch.
Unaddressed Medium-term Fiscal Challenges: Fitch pointed out that the medium-term fiscal challenges, including higher interest rates, rising debt stock and rising healthcare costs remain unaddressed. Over the next decade, higher interest rates and the rising debt stock will increase the interest service burden, while an ageing population and rising healthcare costs will raise spending, it stated.
US Economy Likely To Slip into Recession: The rating agency expects the US economy o enter into a mild recession in Q4FY23 and Q1FY24 due to tighter credit conditions, weakening business investment, and a slowdown in consumption. The agency sees US annual real GDP growth slowing to 1.2 percent this year from 2.1 percent in 2022 and overall growth of just 0.5 percent in 2024.
Fed Tightening: Fitch expects one further hike to 5.5 percent to 5.75 percent by September. While headline inflation fell to 3 percent in June, core PCE inflation, the Fed's key price index, remained stubbornly high at 4.1 percent year-on-year. This will likely preclude cuts in the Federal Funds Rate until March 2024, it said.
Following the downgrade, let's see what market experts have to say:
VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services: The major news after the market close yesterday is the rating agency Fitch’s downgrade of the US sovereign rating from AAA to AA+. This has impacted bond and currency markets with the US 10-year yield rising above 4 percent. Paradoxically, during uncertainties, dollar’s safe haven status improves even when the downgrade is that of the US credit rating. This has happened in the past also. The impact on the stock markets is likely to be negative but not large since the US economy is now headed for a soft landing and not a recession, as markets feared earlier. US 10-year yield rising above 4% and the dollar index appreciating to 102 are negative for emerging markets. Also, indicators like PMI from the Euro Zone and China suggest slowdown in these economies. In brief, the economic backdrop is negative. Investors may wait and watch for the dust to settle before jumping to buy on dips.
Mukesh Kochar, National Head-Wealth, AUM Capital: 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. 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.
Santosh Meena, Head of Research, Swastika Investmart: The recent downgrade of the US rating by Fitch may have a minor impact on the Indian market, but it is unlikely to be a major concern since rating changes often come with certain repercussions. Nevertheless, it could provide an opportunity for some investors to take profits, leading to a possible pullback in the market. Signs of exhaustion are evident at higher market levels, following a strong rally from the lows in March. Foreign Institutional Investors (FIIs) have turned net sellers in the past few days, indicating a cautious stance in the market. If the Nifty index begins to trade below its 20-Day Moving Average (20-DMA) around 19,600, it might experience further declines toward 19,300 and 18,888 levels.
Madhavi Arora, Lead Economist, Emkay Global: Moody's still rates the US as AAA, its highest sovereign rating, while S&P and Fitch are now 1 notch lower than AAA. If at all it leads to a reaction from markets, it might be a risk-off reaction leading to buying in USTs and a stronger dollar. US corporate credit will suffer definitely but that means more demand for US treasuries for the same pool of investor money. That has been the immediate reaction after Fitch news release. But mostly in the medium-term, no reaction.