Fitch Ratings downgrade: Could a cut in US rating mean higher inflows to India, other EMs?
4 min read 02 Aug 2023, 09:40 AM ISTFitch Ratings downgrades the US credit rating to 'AA+' from 'AAA' due to fiscal deterioration and debt burden. The US saw a downgrade a decade ago in 2011 also when S&P Global Ratings downgraded the US credit rating to AA+, one notch below the top tier, after the debt ceiling impasse.
PremiumRating agency Fitch Ratings downgraded the long-term foreign-currency issuer default rating (IDR) of the US to an 'AA+' from an 'AAA' with a 'stable' outlook on Tuesday (August 1).
The one-notch downgrade in the US debt rating has come after US lawmakers waited until the last moment to agree on a debt ceiling deal this year in May, putting the country at risk of its first-ever default. But the downgrade not only considered the latest debt ceiling crisis in the US but also took into account the fiscal deterioration of the US in the last few years along with the growing government debt burden and erosion of governance.
"The rating downgrade of the United States reflects the expected fiscal deterioration over the next three years, a high and growing general government debt burden, and the erosion of governance relative to 'AA' and 'AAA' rated peers over the last two decades that has manifested in repeated debt limit standoffs and last-minute resolutions," Fitch Ratings said.
The US saw a downgrade a decade ago in 2011 also when S&P Global Ratings downgraded the US credit rating to AA+, one notch below the top tier, after the debt ceiling impasse.
What does this US rating downgrade mean?
In simple terms, credit rating shows the creditworthiness of an individual, company, or government. Different rating agencies follow different practices for assigning ratings. As per experts, for Fitch Ratings, 'AAA' rating is the best and 'AA+' is high-quality.
The US rating has just come down to 'AA+' from 'AAA' and the outlook is 'stable' so the creditworthiness of the US still remains strong.
The US rating downgrade is an extraordinary thing and has the potential for a global impact.
For example, it could result in higher interest rates on US government bonds which could result in higher interest payments on the national debt, putting additional strain on the government budget. This could affect the overall economy and erode investor confidence, leading to negative market sentiment.
This downgrade may also dent the stability of the US dollar which will influence the movement of global currencies with respect to it.
Read more: Fitch downgrades US credit rating; here's what market experts say
Could it mean higher inflows to India, other EMs?
Anything significant happening in the US impacts the world market. However, experts do not see a significant impact of the US rating downgrade on foreign inflow as Fitch had already warned about the possibility of a downgrade in May.
The market might have factored in already. The US ratings downgrade was not followed by a knee-jerk reaction in the US financial market as the dollar and Treasury yields dipped marginally.
"This rating change will not drastically impact the inflows into the emerging markets (EMs), including markets, primarily because the possibility of this downgrade was already flagged by Fitch in May only. There were speculations in the market that this downgrade would come," Manish Chowdhury, Head of Research at StoxBox told Mint.
"I feel that this news is already built up everywhere in the markets so it will not have a major impact on the market. If you see the US yields yesterday, there were no major reactions to the rating downgrade," Chowdhury said.
Shiv Sehgal, President & Head of Nuvama Capital Markets also has similar views.
"Nothing Fitch says is wrong, but nothing it says is new either and there are not any real-world implications of the downgrade (as far as covenants being tripped or people not being able to own Treasuries). In my view, US stocks given the recent ramp up are quite expensive, and this leaves them very exposed to exogenous events, but as we saw with the BOJ (Bank of Japan) last week, if the macro development isn’t actually material, equities will be quick to reverse a knee-jerk sell-off," said Sehgal.
Sehgal pointed out that India has been the best destination amongst emerging markets.
"In the last few months in terms of inflows, we continue to see this trend ongoing given the magnitude of outflows we saw in the prior two years (FIIs also sold nearly $60bn over two years in FY22 and FY23) and a reversal of this extremely bearish FII positioning which has already started playing out in FY24 has driven the sharp rally we’re witnessing in India," Sehgal observed.
"India has had a relatively better inflation trajectory and monetary policy management than most other countries globally. Recently, RBI hit the pause button on its rate hike cycle. Inflation forecast models are indicating further softening of inflation in India. This makes India stand out compared to its peer group," Sehgal said.
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