Scope affirms the USA’s credit rating of AA with Stable Outlook
Scope Ratings GmbH has today affirmed the United States of America’s AA long-term issuer and senior unsecured local- and foreign-currency ratings, along with a short-term issuer rating of S-1+ in both local and foreign currency. 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 and rising 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 US economy recovered faster from the Great Financial Crisis (GFC) than its peers and, in terms of real GDP, is now a solid 18% above its pre-crisis level. This reflects the country’s flexible and competitive economy, which has led to one of the highest GDP per capita levels in the world, of around USD 60,000 (the seventh highest level, based on IMF figures). At the same time, after growing for 35 consecutive quarters, Scope notes that the economy is beyond full employment with a positive potential GDP output gap, an unemployment rate below 4% since June 2018, and core inflation slightly above the Federal Reserve’s price stability mandate of 2% since April 2018. Going forward, Scope thus expects additional rate increases by the Federal Reserve which is also expected to continue implementing its balance sheet normalisation programme in a gradual and predictable manner.
The AA 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 63% of the world’s total foreign exchange reserves are allocated in US dollars, followed by the euro (20%), yen (5%) and pound sterling (5%), with currently only 1% of allocated reserves being denominated in Chinese renminbi. Similarly, the share of the US dollar remains the highest for several indicators, including outstanding international debt securities (62%, followed by the euro with 23%), outstanding international loans (56%, followed by the euro with 23%), foreign-currency derivative contracts (44%, followed by the euro with 16%) and international payments (40%, followed by the euro with 36%). This characteristic is unique among the sovereigns rated by Scope and is captured 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’, and in addition, an explicit 2-notch adjustment beyond those of the scorecard.
Despite these inherent credit strengths, the US rating is constrained by several structural features: First, potential GDP growth has slowed significantly as a result of falling total-factor and labour productivity and is now estimated at around 1.6% 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, could curb 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.
Second, 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 108% in 2017. Going forward, despite the strong cyclical position of the US economy, the government has cut taxes via the Tax Cuts and Jobs Act and raised both defense and non-defense discretionary spending. According to the IMF, the tax changes are expected to have modestly positive supply-side effects, largely by incentivising an increase in the capital stock and, in doing so, slightly raising the level of potential GDP. However, the fiscal cost is substantial: the IMF estimates that the combined effect of the administration’s tax and spending policies will cause the federal government deficit to exceed 5% this year and stay above that level over the coming years. Scope therefore assesses the US fiscal policy as strongly pro-cyclical, and thus inadequate, raising debt sustainability concerns.
Scope’s public debt sustainability analysis highlights that the high and rising fiscal deficits and expected increase in interest rates, combined with the lower potential growth outlook, together prevent a downward trajectory in the public debt-to-GDP ratio. While the IMF’s baseline scenario estimates the debt-to-GDP ratio to increase to around 117% by 2023, a slight deterioration in any of the debt-relevant variables would quickly bring the ratio above 120%. Notably, even under a more optimistic scenario, the debt-to-GDP ratio of the United States will not fall below 100% by 2023 and will therefore remain significantly above its AA-rated peers whose debt levels are expected to decline gradually over the coming years, in France (89%), the U.K. (83%), and Belgium (89%).
Third, Scope also believes that contingent liabilities constitute a significant burden to the US federal government. According to the IMF, adding the net 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 (277%) and significantly above the UK (160%) 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 46% of GDP), represent moral obligations that, although not legally binding, could, in extremis, also be partially borne by the federal government.
Finally, in Scope’s assessment, the polarised political environment in the US is impeding the government’s ability to address these structural weaknesses. Scope believes that this represents a fundamental weakness in the country’s institutional capacity to address its medium-term economic and fiscal challenges as polarisation results in a less deliberative legislative process, political brinkmanship and policy uncertainty. In addition, recent protectionist trade policy proposals are starting to trigger retaliatory responses and are thus already undermining the open, fair and rules-based multilateral trading system. This administration’s fiscal and trade policies have thus the potential to add to global imbalances, and further, increase the range and size of future risks and uncertainties faced by the United States, as well as the world economy. In Scope’s view, it is unlikely that a new spirit of bipartisanship will emerge post-congressional elections in November to address the country’s underlying structural challenges and reduce the heightened policy uncertainty.
Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, provides an indicative “a” (“a”) 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) economic policy framework, ii) market access and funding sources; iii) current account vulnerability; iv) external debt sustainability; and v) resilience to short-term external shocks.
Relative credit weaknesses include: i) fiscal policy framework; ii) debt sustainability; iii) recent events and policy decisions; iv) geopolitical risk; and v) financial imbalances and financial fragility. In addition, a two-notch positive adjustment is made for the unparalleled status of the US dollar as the world’s global reserve currency. The combined relative credit strengths and weaknesses generate a three-notch adjustment and indicate 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.
Factoring of Environment, Social and Governance (ESG)
Scope considers ESG sustainability issues during the rating process as reflected in the sovereign methodology. Governance-related factors are explicitly captured in Scope’s assessment of ‘Institutional and Political Risk’, in which the United States of America scores high in the World Bank’s Worldwide Governance Indicators, in line with other highly-rated sovereigns. Qualitative governance-related assessments in Scope’s ‘recent events and policy decisions’ and ‘geo-political risk’ categories of its QS are assessed as ‘weak’ compared with the US’ sovereign peers.
Socially-related factors are captured in Scope’s CVS in the US’ very high GDP per capita (USD 59,609 in 2017), low level of unemployment but weak old-age dependency ratio. Qualitative assessments of social factors are reflected in Scope’s ‘macro-economic stability and sustainability’, which Scope assesses the US at ‘neutral’, balancing a very diversified economy with heighted inequality levels. Finally, environmental factors are considered during the rating process but did not have an impact on this rating action.
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; and/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; and/or iii) a reduction in contingent liabilities.
The main points discussed by the rating committee were: i) economic growth potential and outlook; ii) public finance performance, tax and spending policies; iii) debt sustainability analysis, including contingent liabilities; iv) current account balance developments; v) external debt sustainability; vi) the role of the US dollar; vii) financial imbalances with respect to equity and housing markets; viii) political situation and upcoming mid-term elections of Congress and ix) consideration of peers.
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 GmbH.
Rating prepared by Alvise Lennkh, Director
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director
The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The ratings/outlooks were last updated on 29.09.2017.
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, 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.
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.
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