Scope affirms the USA’s newly published credit rating at AA and changes Outlook to Stable
Scope Ratings AG has today affirmed the United States of America’s long-term local-currency rating at AA following the release of its revised sovereign rating methodology, and has converted its status from subscription to public. The agency has also assigned a long-term foreign-currency issuer rating of AA, along with a short-term issuer rating of S-1+ in both local and foreign currency. The sovereign’s senior unsecured debt in local and foreign currency was also rated at AA. All Outlooks are Stable.
Scope’s affirmation of the AA rating of the United States reflects the country’s wealthy, competitive and diversified economy, its transparent and accountable institutional framework as well as the dollar’s unparalleled global reserve currency status. The rating is constrained by the weakening potential growth outlook due to subdued productivity and labour force growth, the high level of government debt and significant contingent liabilities from pension and health-care related obligations. Given the divisions between the main political parties, and the lack of bipartisan collaboration, solutions to these underlying structural challenges are unlikely to be implemented in the foreseeable future.
The United States recovered quickly from the Great Financial Crisis (GFC) given its flexible and competitive economy, coupled with a comprehensive and coordinated fiscal and monetary policy crisis response. This has resulted in 30 consecutive quarters of real GDP growth, de facto full employment (albeit at low participation rates), inflation near the Federal Reserve’s price stability mandate of 2% as well as one of the highest GDP per capita levels in the world, of around USD 59,000 in 2017 (the seventh highest level, based on IMF figures).
The rating is further underpinned by the US dollar’s unparalleled global reserve currency status which enables the country to run fiscal and current-account deficits with limited debt sustainability concerns. Based on the IMF’s COFER database, about 65% of the world’s total foreign exchange reserves are allocated in US dollars, followed by the euro (20%), yen (5%) and pound sterling (4%), with currently only 1% of allocated reserves being denominated in yuan. Similarly, the share of the US dollar remains the highest for several indicators, including outstanding international debt securities (63%, followed by the euro with 22%), outstanding international loans (59%, followed by the euro with 21%), foreign-currency derivative contracts (44%, followed by the euro with 16%) and international payments (42%, followed by the euro with 31%). This characteristic is unique among the sovereigns rated by Scope, and is captured in the revised methodology by three qualitative adjustments for the sovereign’s ‘excellent market access and funding sources’, ‘excellent external debt sustainability’ and ‘excellent resilience to short-term shocks’.
Despite these inherent credit strengths, the US rating is constrained by several structural features:
Potential GDP growth has slowed significantly as a result of falling total-factor and labour productivity, and is now estimated at around 1.5% for the 2011-2020 decade – an all-time low since the 1950s, according to Congressional Budget Office data. This outlook is, however, in line with highly-rated peers including France and the UK. In addition, OECD data indicates that multi-factor productivity growth has remained subdued in the US, pointing to the fact that the largest contribution to real GDP growth over the past few years has come from increases in total hours worked, which, going forward, is expected to decline as the population ages. Finally, low productivity has been associated with a stagnation in household incomes for a large share of the population, increasing income inequality which, in turn, is curbing consumption, a key driver of economic growth. This has also weighed on labour supply and created disparities in the education system. In Scope’s opinion, these structural weaknesses are hampering human capital formation, reducing future productivity and ultimately US growth prospects.
The accumulation of fiscal deficits in response to the GFC has led to a sharp increase in general government gross debt, rising from 65% of GDP in 2005 to around 107% in 2016. In fact, since 1970, the US federal government has only recorded a fiscal surplus in four years, from 1998-2001. Scope’s public debt sustainability analysis points to some concerns, particularly given the on-going fiscal deficits and expected increase in interest rates, combined with the lower potential growth outlook, which together prevent a downward trajectory in the public debt-to-GDP ratio. In addition, uncertainty due to the lack of clarity on forthcoming fiscal legislation further clouds the public finance outlook. This is particularly the case given the rating-relevant inconsistency resulting from the ‘debt limit’ rule, whereby lawmakers first approve spending but then debate whether to allow the US Treasury to borrow the funds needed to honour its obligations. While Congress has acted 79 times to permanently raise, temporarily extend, or revise the definition of the debt limit, over the past few years this situation has led to several instances in which the US Treasury was weeks or even days away from defaulting on its sovereign obligations. This reflects a unique situation among Scope’s highly rated sovereigns. The next debt limit deadline has been pushed to 8 December 2017.
Scope also believes that contingent liabilities constitute a significant burden to the US federal government. According to the IMF, adding the present value of accrued deficits from pension and health-care related programmes to the debt level results in a debt-to-GDP ratio of around 260% for the United States. This is the second-highest level among advanced economies after Japan (294%) and significantly above the UK (153%), Germany (149%) and France (110%). The figure excludes the rising debt of state and local governments as well as their unfunded pension obligations (together amounting to about 35% of GDP). These liabilities, together with the liabilities from housing-related government-sponsored enterprises (of 45% of GDP), represent moral obligations that, although not legally binding, could, in extremis, also be partially borne by the federal government.
In Scope’s assessment, the polarised political environment in the US is impeding the government’s ability to address these structural weaknesses. The political divide between the parties in Congress across most domestic issues has grown since the 1970s, at the expense of moderates who bridge the parties to broker crucial compromises. Scope believes that this represents a fundamental weakness in the country’s institutional capacity to address its medium-term economic and fiscal challenges. This polarisation results in a less deliberative legislative process, political brinkmanship as well as fiscal policy uncertainty. In Scope’s opinion, given the existing divisions between parties, and the lack of bipartisan collaboration, solutions to the country’s long-term structural challenges are unlikely to be implemented in the foreseeable future.
Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative AA (aa) rating range for the United States of America. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis.
For the United States of America, the following relative credit strengths have been identified: i) market access and funding sources; ii) external debt sustainability; and iii) resilience to short-term shocks. Relative credit weaknesses are: i) fiscal performance; ii) debt sustainability; iii) recent events and policy decisions; iv) geopolitical risk; and v) macro-financial vulnerabilities and fragility. The combined relative credit strengths and weaknesses generate no adjustment and signal a sovereign rating of AA for the United States of America. A rating committee has discussed and confirmed these results.
For further details, please see Appendix II of the rating report.
Outlook and rating-change drivers
The confirmation of the Stable outlook reflects Scope’s view that risks to the ratings remain broadly balanced.
The ratings could be downgraded in the event of: i) evidence of a reduced role of the US dollar as the global reserve currency, leading to lower global demand for US Treasuries; ii) a further deterioration in public finances, for instance, via the materialisation of contingent liabilities; or iii) a relaxation of the fiscal framework, for instance, via the abolition of the debt limit rule without an adequate replacement.
The ratings could be upgraded if effective policymaking leads to: i) meaningful reforms that improve the potential growth outlook; ii) a firm downward path in the public debt trajectory or iii) a reduction in contingent liabilities.
For the detailed research report, please click HERE.
The main points discussed by the rating committee were: i) economic growth potential and outlook; ii) public finance performance and debt sustainability analysis, including contingent liabilities; iii) external debt sustainability; iv) the role of the US dollar; v) financial and banking sector performance; vi) political polarisation and policy uncertainty; and vii) peer consideration.
The methodology applicable for this rating and/or rating outlook ‘Public Finance Sovereign Ratings’ is available on www.scoperatings.com. The historical default rates used by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com. The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months. A rating change is, however, not automatically a certainty.
This credit rating and/or rating outlook is issued by Scope Ratings AG.
Rating prepared by Rudolf Alvise Lennkh, Lead Analyst
Person responsible for approval of the rating Dr Stefan Bund, Chief Analytical Officer
The ratings/outlook were first assigned by Scope as a subscription rating in January 2002. The subscription ratings/outlooks were last updated on 05.05.2017. The senior unsecured debt ratings as well as the short term issuer ratings were assigned by Scope for the first time. As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on the USA are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2017" published on 21.07.2017 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case the deviation was due to the recent revision of Scope’s Sovereign Rating Methodology and the subsequent placement of the ratings under review, in order to conclude the review and disclose these ratings in a timely manner, as required by Article 10(1) of the CRA Regulation.
Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party. The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: US Treasury, Federal Reserve, CBO, BIS, IMF, ECB, OECD, WB, and Haver Analytics.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.
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