US: Debt Ceiling Deadline Highlights Risks to Sovereign Ratings, Need to Reform Fiscal Framework

The debt limit is a drag on the US ratings without a better-designed alternative instrument enforcing budget discipline.

Scope Ratings says the US debt ceiling is the most relevant near- to medium-term risk to the US sovereign credit ratings (of AA/Stable Outlook) – one that is likely to increase after the 2022 midterm elections if they should lead to a divided or Republican-controlled Congress.

The only technical US government debt default of the post-war era took place in 1979 in a crisis related to the debt ceiling, a reminder that one should not simply assume debt-related political standoffs are inevitably resolved.

The debt ceiling today increases rather than decreases the likelihood of a US credit event.

Risk of another technical default remain a relevant consideration for the US credit ratings

In the period since 1979, while another debt ceiling-related default has been prevented – risks of another technical default remain a rating-relevant consideration when the US government gets so close to severe payment difficulty every year or few years. Risks relating to the debt ceiling have also increased since 1979 due to the intensification of domestic political brinkmanship, including the use of the debt limit in partisan grandstanding.

In today’s political context in Washington, we expect the most likely compromise will be for the Joseph R. Biden administration and Democrat-controlled Congress to again raise the debt ceiling or, alternatively, suspend the ceiling once more later on in the year, sidestepping debt default.

Such a move will become even less straight-forward, however, in the future should Democrats lose control of Congress in 2022 if the experiences of the 2011 and 2013 debt-ceiling crises are anything to go by when President Barack Obama faced a divided Congress.

Scope’s AA credit assessment of the US recognises risks associated with the debt limit and impact on the likelihood of a credit event, even an ‘accidental’ one such as in 1979. No other sovereign credit rated AA by Scope either experiences such frequent crises during which default is a real scenario barring last-minute legislative action or has experienced a post-war credit event.

Higher US budget deficits reduce room for manoeuvre during debt-ceiling crises

We see pressures building seeking resolution of the debt ceiling before Congress’s recess in August.

For one, federal deficits are now much higher – meaning the fiscal largess of past and present US administrations is presenting shorter-run credit risk via curtailing the duration during which Treasury can mobilise extraordinary measures to meet spending obligations after debt ceilings are reinstated.

The Congressional Budget Office projects a federal deficit of USD 2.3trn in 2021, the second largest since 1945 and USD 1.3trn more than the deficit the US recorded when it last suspended the debt limit. Treasury faces growing pressures to slash T-bill supply ahead of the coming debt deadline. Any credit event affecting US treasury bonds impacts the US and global financial systems given treasuries are the global risk-free asset of choice and vital for inter-bank liquidity as collateral.

Treasury warnings are exaggerated, but government has likely only until the autumn prior to acute payment stress

Treasury’s warnings about the US running out of available funds by August are likely exaggerated, partially designed to focus minds in Congress. Nevertheless, the US government likely has until the autumn for the debt limit to be resolved before it encounters acute debt payment problems.

The expected resolution over the coming period of the debt ceiling could come via packaging a debt-limit suspension within the infrastructure spending legislation or the American Families Plan or alongside stopgap funding to avert a partial government shutdown after the fiscal year ends on 30 September – bills with more substantive congressional backing. If this does not work, Democrats, currently controlling technical majorities in both houses of Congress, could hold the option, at this stage, of using budget reconciliation to push back the limit – although there’s a view among experts that the reconciliation process may require raising the ceiling rather than suspending.

Acrimonious negotiations could serve as reminder of a longer-standing crisis of governance

Even assuming the debt ceiling issue is resolved in the end this go around, the likely acrimonious negotiations surrounding any agreement will be a reminder of a crisis of governance in the US’s divided political and social landscape. Governance risk has not disappeared with the new US administration. Republican members of Congress, mindful of primary challengers in 2022, will be under pressure to extract concessions from a Democrat-controlled White House and Congress and push for deep budget cuts.

Frequent debt crises underscore the need to reform the US’s fiscal framework

Frequent debt crises in the United States underscore deficiencies of the fiscal framework in the world’s largest economy, with the debt limit requiring reform in an age of political obstructionism.

Here, the US credit outlook would benefit from the replacement of the debt limit with an alternative credible and better-designed fiscal instrument that more effectively enforces budgetary discipline, particularly given the US government’s otherwise unparalleled capacity to raise funds and refinance debt.

On 2 July 2021, Scope took no rating action on the US but noted the debt ceiling as a credit constraint.

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Dennis Shen is a Director in Sovereign and Public Sector ratings at Scope Ratings GmbH. Thibault Vasse, Senior Analyst at Scope Ratings, contributed to writing this commentary.