FINANCE
How can Fitch’s downgrade of the US credit rating affect the economy and your day-to-day?
A credit rating downgrade has many knock-on effects as investments are judged to be less safe, potentially pulling money out of the economy.
While an agreement was found between Republicans and Democrats to raise the debt ceiling earlier this year, financiers are unhappy at how long it took to be negotiated. The closer the US got to the financial abyss, the higher the cost of government borrowing was; investors were worried the country could slip into peril and damage the economy.
As a result, rating agency Fitch downgraded the US government’s top credit rating earlier this week, from AAA to AA+.
What is a credit rating?
A credit rating is an assessment of a country’s ability to repay debts. It is determined by credit bureaus based on factors such as financial history, payment patterns, and outstanding obligations. The lower the rating, the riskier a loan from that nation. AAA is the highest score.
The last time the US had its credit rating downgraded was 5 August 2011. It was the first time the rating had fallen below AAA and was the result of another drawn-out debt ceiling negotiation procedure.
“Fitch believes that repeated political standoffs around the debt-limit and last-minute suspensions before the X-date (when the Treasury’s cash position and extraordinary measures are exhausted) lowers confidence in governance on fiscal and debt matters,” the ratings company said in a statement.
There are several implications for a country and its economy if its credit rating is downgraded.
What happens when credit bureaus lower a nations credit rating
In short, nothing good.
A credit rating downgrade leads to higher borrowing costs for the government. When the creditworthiness of a country is questioned, investors may demand higher interest rates on government bonds to compensate for the increased risk. This would make it more expensive for the US to finance its debt.
Rating downgrades would create turbulence in financial markets, with global markets affected by a nation as significant as the US being degraded. This can affect not only the bond market but also stocks, currencies, and other financial instruments.
Inevitably, this erodes investor confidence in the country’s ability to repay its debts. This loss of confidence can lead to a reduction in foreign investment and a decrease in overall economic activity. As investors react to the downgrade by selling off dollar assets, the currency’s value would decline. Exports become more expensive as the dollar weakens.
A credit rating downgrade can have broader economic implications. If a downgrade leads to a weaker US dollar and rising import prices it will contribute to inflation. As everyone will be well-aware of after the last year, inflation leads to increased prices for goods and services, impacting your day-to-day expenses. Another impact is the lowered investment leading to a slower economy and job losses.