Fitch: Raise debt ceiling and cut deficit, or face downgrade

Olivier Knox

That’s a nice national credit rating you’ve got there. It’d be a shame if you didn’t raise the debt limit, failed to cut the deficit and played games with a default.

That’s the message from the Fitch Ratings agency in London, which warned Tuesday that any failure by Congress to raise the debt ceiling quickly could lead to a downgrade that risks raising interest rates and sending shock waves through the international financial system.

“Failure to raise the debt ceiling in a timely manner will prompt a formal review of the U.S. sovereign ratings,” Fitch said in a statement advising clients that the risk of an actual default is “extremely low.”

“Protracted debate prior to increasing the debt ceiling is not an exceptional event, but against the backdrop of unprecedentedly large peacetime budget deficits and outstanding debt, any delay in raising the limit would pose ever increasing risks to the ability of the federal government to honour its obligations in a timely fashion,” the agency said.

Fitch also warned starkly that the U.S. rating could be downgraded even if Washington gets its act together and raises the debt limit without a self-inflicted crisis first, because America’s economic strength is “being eroded by the large, albeit steadily declining, structural budget deficit and high and rising public debt.”

Fitch added: “In the absence of an agreed and credible medium-term deficit reduction plan that would be consistent with sustaining the economic recovery and restoring confidence in the long-run sustainability of U.S. public finances, the current Negative Outlook on the 'AAA' rating is likely to be resolved with a downgrade later this year even if another debt ceiling crisis is averted."

The agency also dealt a blow to a popular conservative response to warnings about the dire consequences of not raising the debt ceiling. Some Republicans have said that the government will still take in enough cash to make interest payments, meaning that it won’t default on its debt, and will simply have to “prioritize” which programs it will fund.

“It is not assured that the Treasury would or legally could prioritise debt service over its myriad of other obligations, including social security payments, tax rebates and payments to contractors and employees,” Fitch said.

So what would happen? You guessed it. Per Fitch: “Arrears on such obligations would not constitute a default event from a sovereign rating perspective but very likely prompt a downgrade even as debt obligations continued to be met.”

Republicans have warned they will pair spending cuts on a one-to-one ratio with the increase in the debt ceiling. President Barack Obama has rejected that approach and called for one that includes new tax hikes as well as reductions in outlays. The two sides have to resolve their differences in a matter of weeks to avoid a default.

What about the looming fight over funding the government for the rest of the fiscal year after a stopgap measure expires March 27?

“Recent history suggests that short term fixes will be agreed, albeit only just before each deadline is breached, that do little more than postpone key decisions and perpetuate the uncertainty over tax and spending policies and fail to place U.S. public finances on a medium-term sustainable path,” Fitch said.

That’s British English for “Washington will kick the can down the road.”

Fitch also weighed in bluntly against the debt ceiling, calling it “an ineffective and potentially dangerous mechanism for enforcing fiscal discipline.” Not only does it fail to restrict Congress and the White House from agreeing on tax and spending policy that will produce more red ink, “the sanction of not raising the ceiling risks a sovereign default and renders such a threat incredible," Fitch said.