ANALYSIS: If growth returns more quickly and the political consensus continues, Ireland's credit rating could be raised
US GOVERNMENT debt has had the top AAA rating for almost 100 years but late last Friday, in a widely expected move, Standard Poor’s downgraded US debt by one notch to AA+. There are now 19 triple-A rated countries, including Germany, France, the Netherlands and Britain.
The US stands with Belgium and New Zealand as the three countries with an AA+ rating. Countries with a lower rating include Japan, China, Saudi Arabia as well as Italy and Spain.
Earlier on Friday, the agency released a statement which reaffirmed their BBB+ rating for Irish Government debt. Ireland was AAA rated up to March 2009 but a number of downgrades since then has seen this drop six notches below the new rating assigned to the US. However this is still an investment grade rating in contrast with rival agency Moody’s which reduced Ireland to “junk” status in early July.
As the US government controls the printing presses for the dollar, the probability of a US default should be close to zero. It can simply print more dollars to meet existing liabilities – at least this would be the case if the US did not have an artificial debt ceiling which limits the size of national debt. Until last week’s agreement to raise the debt ceiling, this limit was $14.3 trillion. With an annual deficit of about $1.5 trillion, the US faced the prospect of a default once an August 2nd deadline for borrowing beyond that ceiling had passed.
The last-minute deal hammered out in Congress calls for $2.4 trillion of cuts in government expenditure growth. Government expenditure will continue to rise, but the rate of increase is expected to slow. The agency felt the deal would not offer the necessary deficit reduction and forecast the net general government debt of the US would be 85 per cent of GDP by 2021 which, it felt, was too high for a country to be given an AAA rating.
However, this was agency’s second estimate. Its original forecast was that the debt would reach 93 per cent of GDP by 2021. The agency was forced to revise this down to 85 per cent because of a $2 trillion error in their figures. They admitted the error but said they did not feel it was sufficient to warrant changing the decision to downgrade. The main problems the agency sees for the US are political rather than purely economic. It cannot see the US political system delivering an effective response to the annual deficit that is causing the debt to balloon. While there is no doubt that the US faces severe problems, it is still clear the probability of a US default is tiny.
One would expect the market to reflect a ratings downgrade through higher yields on US bonds. On Friday, when the markets closed, the yield was 2.6 per cent. By Tuesday the yield was down to 2.3 per cent.
Investors are using US government bonds as a safe haven in the face of the turmoil that has emerged in other investment markets. For the time being, the agency stands very much alone in its opinion on a default on US debt. Its views on the political system are likely correct, but it is not sufficient to justify their decision.
Last Friday, the agency also released some details on Ireland. It sees Irish net general government debt peaking at 110 per cent of GDP in 2013 and falling to 103 per cent by 2015. This is inclusive of the money needed to recapitalise the banks and all of Nama’s debt obligations. These are higher than the levels forecast for the US, but not by a huge amount.
Like the US, we face a substantial annual deficit. Unlike the US, the agency sees Ireland as having the political consensus and fiscal strategy to reduce the deficit. The agency views the targets as ambitious but if growth were to return more quickly it would even consider raising the rating. In the Irish case, the market reaction has tallied with the view of the agency. In the run-up to the EU summit in Brussels the 10-year yield on Irish government bonds was over 14 per cent. These yields have fallen almost every day since and on Monday they fell below 10 per cent for the first time since April. The agency sees this improvement continuing and forecasts yields of 6 per cent or lower by 2013. This would allow Ireland to source market funding just as the official support from the EU-IMF is due to expire. The agency sees Irish Government debt becoming less risky and it has company in its view. Moody’s itself admits that Ireland has met, and in some cases exceeded, the targets laid out in the EU-IMF programme. In the light of recent developments, the Moody’s downgrade to junk status does not seem warranted.
The Irish economy is still facing into a strong headwind and significant risks remain. Over the summer the pressure has eased because of the reduction in EU interest rates and the injection of more than €1 billion of private sector investment into Bank of Ireland. These are relatively small in the context of the huge annual deficit but they are steps in the right direction. It is up to us to maintain this change of momentum.
Séamus Coffey is a lecturer in economics at University College Cork
