Jul 16, 2012, 02.01 PM IST | Source: Equitymaster.com

Are `AAA` ratings a joke?

The US lost its AAA rating for the first time in its history in August 2011; post a downgrade by credit rating agency Standard & Poor's (S&P). The agency asserted a negative outlook on long term US debt and cut its rating from AAA to AA+.

The US lost its AAA rating for the first time in its history in August 2011; post a downgrade by credit rating agency Standard & Poor's (S&P). The agency asserted a negative outlook on long term US debt and cut its rating from AAA to AA+. While the agency's calculations for the growth trajectory of the giant nation's debt were proved to be wrong, we still believe that it stuck the right chord, albeit a little too late.

Now, almost a year later, Fitch Ratings has retained the US at its top of the line 'AAA' rating, but has left the outlook negative with room left open for a future downgrade. The agency cited the failure of the Congress and the Obama administration to come up with a solution on reducing the nation's bleeding deficit as its major concern. Fitch states that the uncertainty over federal tax and spending policies worth US$ 500 bn also weighs on the near term outlook for the economy. Plus the country is still not out of the woods as yet, and more strain on its finances can push it into another recession. Thus what perplexed us is what made the rating agency upgrade the US economy despite no material changes to its fundamental outlook! Is the whole business of ratings a joke?

A massive budget showdown may begin after the elections which take place in November and stretch well into next year. The burden of massive government debt on US economy will continue to rise and may hurt growth if an agreement isn't reached quickly on the subject. The deficit is the major contention point for a number of rating agencies and until it is fixed for good, there is still a possibility of the US economy's rating being downgraded further.

Having said that, one must acknowledge that not everything gloomy about the US economy. On the plus side, the US has a highly productive, diversified and wealthy economy. It's flexibility in monetary and exchange rates, and the greenback's status as a reserve currency are all positive points. Plus, the risks to the financial system from the 2008 crisis are diminishing. Irrespective, the negative outlook on the world's biggest economy is here to stay for another few years at least, assuming that there are no further economic shocks. So far the Euro crisis still needs to be resolved and the US debt burden needs to reduce. Plus one needs to wait and watch for the outcome of the elections and see whether the new administration can come up with a new strategy to control the deficit. Or whether the current one can finally figure a way out of the mess.

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