U.S. Sovereign Debt Aaa Rating at Risk in Next Decade

by: Research Recap

The US government budget presented on February 1 was a small start to the big task of returning to a sustainable debt trajectory, but further measures will be necessary if that task is to be accomplished, Moody’s says in an issuer comment.

Unless further measures are taken to reduce the budget deficit further or the economy rebounds more vigorously than expected, the federal financial picture as presented in the projections for the next decade will at some point put pressure on the Aaa government bond rating.

“Freezing part of discretionary spending for a three-year period beginning in the next fiscal year is a positive step from a rating perspective, says Moody’s Senior Credit Officer Steven Hess. “However, the deficits projected in the budget do not stabilize debt levels in relation to GDP, and the portion of government expenditures going to pay interest on the debt shows a steady rise.”

The debt trajectory is clearly continuously upward if further measures are not implemented.

Hess says that as interest rates rise from their presently very low level and the size of the debt increases, debt affordability will deteriorate in a major way. Under the proposed budget, the ratio of interest repayments to revenue will double from 8.7% in the current fiscal year to a very high 17.8% by 2020—approximately equal to the highest level in recent decades, reached in the 1980s.

However, the ratio of federal government debt to federal government revenue, another measure used by Moody’s to assess the government’s financial strength, will fall somewhat from 429% in the current year to 394% in 2020. This is still a high level and is not a strong improvement.

The government’s projections show that federal debt held by the public will rise continuously, reaching 77% of GDP by 2020 (compared with 53% at the end of FY 2009 and 64% at the end of the current fiscal year). Using the general government measure (including state and local governments as well as the federal government), which is used internationally, this ratio would be well over 100% in 2020.