Fitch downgrades US Credit Rating: How it will impact Indian Markets and Global Markets

In a move that was surprise, but not without warning, Fitch Ratings downgraded the credit rating of the US government by a notch from AAA to AA+. The reason for the credit rating downgrade is predicated on concerns over the impasse over the debt ceiling and also on the likelihood of recession. In fact, Fitch in its note has underlined a strong possibility that the slew of hawkish moves by the Fed would lead to a recession in the US economy. However, it must be noted that a downgrade of US debt is not news. Back in August 2011, S&P had downgraded US debt from AAA to AA+. However, at that point of time, Fitch and Moody’s had abstained from downgrading US debt, although they eventually did change their outlook to negative on the US economy. Back then, the S&P CEO had been forced to step down as a matter of compromise with the US government.

Why has Fitch downgraded US debt now?

According to Fitch, the reason assigned for cutting the rating of the US debt from AAA to a notch lower at AA+, is due to fears of a recession as well as steady deterioration in governance. The deterioration in governance largely refers to the delay in agreeing upon a debt ceiling extension. Back in April and May, the Republicans and Democrats could not agree upon a framework to increase the debt ceiling. The Republicans were insisting that any debt ceiling hike must be accompanied by spending cuts, which the ruling Democrats were not willing to commit to. Eventually, a middle path was agreed upon wherein the debt ceiling was put on hold for 2 years subject to certain well-crafted status quo on non-defence spending. Fitch has raised concerns about the way this was handled, almost holding the entire world to ransom for a few months on end.

Janet Yellen is far from happy with the downgrade

Not surprisingly, the US policymakers are far from amused. Treasury Secretary, Janet Yellen, went to the extent of calling the downgrade arbitrary and out of sync with the times. According to Yellen, the downgrade was based on data between 2018 and 2020 and the US economy had qualitatively changed since then. In addition, Yellen also pointed to some practical flaws in the rating downgrade by Fitch. According to Yellen, any credit opinion about debt issued by a company or by a sovereign nation is intended as a benchmark for investors about the risk involved in lending to such an economy. However, Yellen underlined that the US was still considered the safest of safe havens and seen as a highly secure investment because of the size and relative stability of the economy.

Leading economists are also far from impressed by the downgrade

While some of the arguments raised by Fitch may be valid like the political brinkmanship and the recession risks, the justification to downgrade at this juncture still appears to be missing. For instance, the debt ceiling crisis was resolved nearly 2 months back, so downgrading now for that reason sounds a specious reason. The impasse over the debt ceiling is history and that is unlikely to both the policymakers for the next 2 years, at least till the next elections are over. In fact, former US Treasury Secretary Larry Summers went to the extent of terming Fitch's decision as "bizarre and inept.” He underlined that the US economy looked much stronger today than at any point in the last 15 years.

Even other globally renowned economists appear to agree with Summers on the timing and the wisdom of the decision to downgrade US debt. The legendary Mohamed El-Erian went to the extent of calling the move, strange. According to Erian, such a downgrade was more likely to be dismissed as inept than have any lasting disruptive impact on the US economy or the US markets or any of the world markets. Even the Nobel Laureate, Paul Krugman, found the downgrade ironic. He underscored that the biggest economic news of the last one year was about America's remarkable success at getting inflation down without causing a recession. Now downgrading the US economy citing recession fears was absolutely unwarranted at this juncture.

Will the rating downgrade have implications for India?

To be fair, markets across Asia and Europe corrected sharply on Tuesday in response to the rating downgrade of US debt. The US markets are also down in early trades, but the US dollar index (the more relevant measure) actually strengthened. That means, markets are not expecting any pressure on the US dollar. However, other markets including India corrected sharply. The Nifty fell 207 points and the Sensex fell 676 points. In addition, the rupee weakened to 82.71/$. The concern for emerging markets in general and India in particular was that a US downgrade could lead to risk-off selling in most emerging markets. If you go by the wisdom on the street, it is unlikely to have a major impact on the US and gradually sanity should return to emerging markets too. Fitch may have its reasons, but the downgrade was certainly badly timed.