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, and the US dollar’s unparalleled status as the global reserve currency. 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 healthcare related obligations. With the lack of political bipartisanship, these structural issues are unlikely to be adequately addressed in the foreseeable future.
The US economy is in its longest period of expansion in recorded history, with real GDP a solid 20% above the pre-crisis level recorded in 2007. This reflects the country’s flexible and competitive economy, which has led to one of the highest levels of GDP per capita worldwide, of around USD 63,000 (the seventh highest based on IMF figures). After 39 consecutive quarters of growth (annualised), the economy is beyond full employment, with a positive potential GDP output gap and an unemployment rate at or below 4% since March 2018.
At the same time, despite rising real wages, core inflation is remarkably subdued and has been below the Federal Reserve’s price stability mandate of 2% since January 2019. With the prospect of falling inflation and lower inflation expectations, labour market slack curbing inflation-pressures from possible capacity constraints, a growing consensus of a lower neutral interest rate, and continued uncertainties around the global outlook, Scope expects at least one interest rate cut by the Fed this year and at least two more during 2020. This would bring the federal funds rate to or below 1.50%-1.75%. In addition, the Fed announced it will end its balance sheet normalisation programme by the year’s end. In Scope’s opinion, the Fed’s data-driven approach, with its strong easing bias, will cushion – but not prevent – the US economy’s cyclical slowdown, especially as growth effects from the fiscal stimulus fade.
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 little concern being raised over debt sustainability. Based on the IMF’s COFER database, about 62% of the world’s total foreign-exchange reserves are allocated in US dollars, followed by the euro (20%), yen (5%) and pound sterling (5%); only 2% of allocated reserves are denominated in Chinese renminbi. Similarly, the share of the US dollar remains the highest for several indicators, including outstanding international debt securities (over 60%, followed by the euro at around 20%), outstanding international loans (over 55%, followed by the euro at around 20%), foreign-currency derivative contracts (around 45%, followed by the euro at below 20%) and international payments (around 45%, followed by the euro at around 35%). This characteristic is unique among the sovereigns rated by Scope and captured by three qualitative adjustments – for the US’ ‘excellent market access and funding sources’, ‘excellent external debt sustainability’ and ‘excellent resilience to short-term shocks’ – as well as an explicit two-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 1.9% for the 2020-29 decade. While slightly better than the 1.7% estimate for the previous decade, it is still fully 1.5pp below the 1950-2005 average, according to Congressional Budget Office data. This is in line with other highly rated peers including France (AA/Stable) and the UK (AA/Negative). OECD data also indicates that multi-factor productivity growth in the US remains subdued, highlighting that the largest contributor to real GDP growth in recent years has been the increase in total hours worked, which, going forward, is expected to decline as the population ages.
In addition, Scope notes the troubling social outcomes highlighted by the IMF, including a declining life expectancy, a persistently high share of the population depending on federal programmes for nutrition, healthcare, education and housing, the erosion of socio-economic mobility, disappointing tertiary education outcomes, stagnating incomes among many households, and greater income and wealth inequality. In Scope’s opinion, these (often inter-related) structural weaknesses are, individually or collectively, likely to constrain labour-force participation, diminish human capital formation, and suppress aggregate demand and future productivity growth, ultimately reducing US growth prospects.
Second, the accumulation of fiscal deficits in response to the Great Financial Crisis has led to a sharp increase in general government gross debt, from 65% of GDP in 2007 to around 106% in 2018. The rise in deficits and debt has been accelerated by the government’s strongly pro-cyclical fiscal policies, notably the Tax Cuts and Jobs Act, which have raised both defence and non-defence discretionary spending and reduced taxes on households and corporates.
According to the IMF, the tax changes boosted US real GDP growth in 2018, mainly due to increased aggregate demand, which in turn led to higher investment levels. However, positive supply-side effects – largely by incentivising an increase in capital stock and, in doing so, raising potential GDP – are likely to fall short of expectations, as much of the tax windfall has either been retained by businesses or redistributed to shareholders. The IMF estimates that around 20% of the increase in corporate cash was used for capital and R&D spending, with the remainder supporting share buybacks, dividend payouts, and other asset-liability planning and balance sheet adjustments. A possible explanation for the relatively muted response of investment to a lowering in the effective tax rate is the steady rise in US corporate market power.
At the same time, the fiscal cost of the administration’s tax and spending policies is substantial. The IMF estimates that the cost for 2018-27 has risen from USD 1.5trn at the time of approval to USD 1.9trn, or 10% of GDP. The federal government deficit is therefore projected to average 4.3% for 2019-24, while the average primary deficit is projected to stay around 2% for the next decade. Against this background, Scope assesses US fiscal policy as strongly pro-cyclical and thus inadequate, raising debt sustainability concerns. Scope’s public debt sustainability analysis highlights that the combination of the elevated fiscal deficits and the lower potential growth outlook prevents a downward trajectory in the public debt-to-GDP ratio, despite an expected decline in interest rates. While the IMF’s baseline scenario estimates the debt-to-GDP ratio to increase modestly to around 110% by 2024, a slight deterioration in any of the debt-relevant variables would quickly bring the ratio to around 120%. Notably, even under a more optimistic scenario, the debt-to-GDP ratio will not fall below 100% by 2024. This places the US above AA rated peers such as France (99%) and the UK (87%), with debt of the latter two projected to decline gradually over the coming years. The steady increase in the public debt-to-GDP ratio of the US is likely to accelerate as age-related spending on entitlement programmes asserts more pressure in the coming years.
Third, and relatedly, Scope also believes that contingent liabilities constitute a significant burden on the US federal government. According to the IMF, adding the net present value of accrued deficits from pension and healthcare programmes to the 2018 debt level results in a debt-to-GDP ratio of around 259% for the US. This is the second-highest level among advanced economies after Japan (277%), and significantly above that of the UK (160%) and France (127%). The figure excludes the debt of state and local governments (about USD 3.0trn) and their unfunded pension obligations (about USD 1.4trn, depending on discount rate assumptions), which collectively represent about 22% of GDP. These liabilities, together with liabilities from housing-related government-sponsored enterprises at 45% of GDP, represent moral obligations that, although not legally binding, could, in extremis, also be partially borne by the federal government.
Finally, the polarised political environment in the US is impeding the government’s ability to address these structural weaknesses. Scope believes 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. This was demonstrated in early 2019 with another government shutdown – this time, for 35 days – again due to Congress having approved spending without a commensurate increase in the debt ceiling. The US Treasury has warned that the next debt-ceiling deadline could come as soon as September this year. While Scope expects that Congress will agree to another suspension, or, eventually, an increase in the debt ceiling, the recurring misuse of the debt ceiling for political purposes creates non-negligible market uncertainty around a technical US default.
In addition, global uncertainty is also heightened by the US instigating protectionist trade policies, which include imposing direct tariffs on steel, aluminium and USD 200bn of imports from China as well as threatening to link trade policies with both perceived currency undervaluation and the objective to curb illegal immigration. These have triggered retaliatory responses and undermined the open, fair and rules-based multilateral trading system, with negative consequences for the US and global economic activity. In addition, the IMF considers it more likely that the US government will reduce bilateral trade deficits through fiscal adjustment and supply-side reforms that improve productivity and competitiveness.
Overall, this administration’s fiscal and trade policies are adding to global imbalances and increasing the range and size of future risks and uncertainties for not only the US but also the world economy. As the 2020 presidential election nears, neither a new spirit of bipartisanship to address the country’s underlying structural challenges, nor a multilateralist approach to assuage trade policy uncertainties (and the associated risk that a sudden repricing of global financial conditions exposes vulnerabilities in leveraged corporates and the non-bank system), is likely to emerge anytime soon, in Scope’s view.
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.
The following relative credit strengths have been identified for the US: 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 has been made for the unparalleled status of the US dollar as the 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.
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 US 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.
Social factors are captured in Scope’s CVS in the US’ very high GDP per capita (USD 62,606 in 2018) and 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’, for which the US is assessed at ‘neutral’ for balancing a very diversified economy with heightened inequality. Finally, environmental factors were considered during the rating process but had no 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 the run-up to the presidential elections; and ix) peer considerations.
The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on http://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 21.09.2018.
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.
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