Danger of downgrade remains after US deal

The US has a proposed plan to tackle its deficit and raise its $14.3 trillion debt ceiling, but concerns linger over a possible downgrade of its credit ratings.

Economists and investors fear the US may still face a damaging credit downgrade, even though a provisional deal on raising its debt ceiling was reached before today's deadline.

Barack Obama, the US president, and congressional leaders hammered out a compromise late on Sunday that envisaged at least US$2.1 trillion (Dh7.71tn) of new borrowing and $2.5tn of spending cuts.

But the proposed deal, which awaited approval by both chambers of the US Congress, fell short of the amount Standard and Poor's (S&P) said it wanted to avoid a downgrade.

"If the plan is approved by Congress, the US can avoid a debt default but the proposed $2.5tn in spending cuts fall well short of the $4tn that rating agency S&P indicated would be required to avoid a downgrade," said Timothy Fox, the chief economist at Emirates NBD in Dubai. "Consequently, we maintain our view that a downgrade is still very likely, and could happen as soon as this month."

The ratings agency said last month there was a 50-50 chance it would downgrade the US from its highest "AAA" mark, depending on how aggressively legislators tackled its deficit woes.

Initial reaction to the compromise was positive, with global markets and oil prices rising. The deal also marked a turning point for a nation locked in a fractious debate over deficit reduction as a threatened debt default deadline loomed today.

Even if passed by the US Congress, however, the fallout from the months-long debt ceiling debate may not be over, said Peter Fisher, the head of fixed income at BlackRock and a former undersecretary of the US Treasury.

"Will this put off the risk of a downgrade by one of the ratings agencies?" he said on Bloomberg Television yesterday.

"It's right on the cusp. I think it's going to be up to them, but the signals they've sent is that they'd have to see something more like $3tn or $4tn, and this is a little bit under that threshold, so I think that uncertainty stays with us."

Yet as a resolution to months of uncertainty drew nearer, Brent crude prices rose by 2.4 per cent yesterday to $119.54 and the dollar - the international reserve currency to which the dirham is pegged - strengthened against the euro and the Japanese yen in midday trading before retreating.

The compromise was also expected to cheer stagnant US stock markets when they opened yesterday. If approved, it would raise the US's $14.3tn borrowing limit by $900 billion at first, coupled with spending cuts of $917bn over 10 years.

A congressional committee would then identify another $1.5tn in cuts to be enacted by the end of the year. If legislators meet those goals, the debt ceiling would be raised by another $1.5tn. Mr Obama hailed the measures as a "serious down payment" on the country's deficit on Sunday night.

But a ratings downgrade could raise the borrowing costs for the US and heighten worry among investors. It could also force international players to liquidate their holdings of US debt in search of stabler places to invest their money. US Treasury bills and notes have been some of the world's most popular assets during the financial crisis because of the perception of their safety.

Nevertheless, the compromise was met with relief by many legislators. Harry Reid, the Democratic Senate majority leader, called it a "historic bipartisan compromise that ends this dangerous standoff". Mitch McConnell, his Republican counterpart, said there was now a "framework to review that will ensure significant cuts in Washington spending".

The financial fate of the US has hung in the balance since early this year, when negotiations over raising the debt ceiling began. The US Congress has repeatedly raised the debt limit in the past to little debate, but this time the country's sagging economy and rising deficit propelled it into a political issue that threatened to end in a catastrophic default.

Timothy Geithner, the US Treasury secretary, said in May the government's borrowing capacity had been reached and that it would officially run out of money today.



Published: August 2, 2011 04:00 AM


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