ECONOMY
What happens when rating companies downgrade the US’s credit rating?
The debt ceiling drama increased risk of the US defaulting on its debt, surely leading to a decrease in the countries credit rating. What does this mean?
While an agreement was found between Republicans and Democrats to raise the debt ceiling, 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.
“The risk of a downgrade is exacerbated every time Congress flirts with the debt ceiling,” Calvin Norris told Reuters, portfolio manager & US rates strategist at Aegon Asset Management.
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 Ratings, one of the largest ratings companies, has the US on watch for a potential downgrade and will make a decision by the end of September.
“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 the country and its economy if its credit rating is downgraded.
What could happen if credit bureaus lower the US’s 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. It can undermine business and consumer confidence, leading to reduced investment, spending, and economic growth. The uncertainty created by the downgrade may also discourage foreign investors and dampen economic activity.