Ratings agency Moody's Investors Service on Thursday withdrew its threat to downgrade the U.S. government, citing a much-improved outlook for the budget deficit and moderate economic growth that is helping to keep the federal deficit on a downward path.
Moody's shift means the U.S. will remain in the exclusive but dwindling club of nations that enjoy a AAA rating from at least two of Wall Street's three top ratings agencies. Moody's at the start of the year had threatened to downgrade U.S. government debt a notch unless Congress and the White House achieved agreement on a deal that tamed deficits above $1 trillion that had lingered in the aftermath of the Great Recession.
But the deficit, which topped $1 trillion a year during President Obama's first term, has fallen dramatically in recent months and is now projected to end the fiscal year in the $500 billion range. Economists attribute the decline to the improving economy as well as automatic spending cuts and tax increases imposed at the beginning of the year as part of a year-end tax deal between the administration and Congress.
Moody's cited the steep fall of the deficit from 7 percent of economic output to 4 percent this year in deciding to put aside its review of the U.S. rating for a potential downgrade. The agency attributed the fall in the deficit to the tax deal and across-the-board spending cuts of $85 billion in discretionary spending that started this spring, as well as a slowdown in health care spending that is producing major dividends for the Medicare and Medicaid programs.
A stronger credit outlook and rating typically allows governments to borrow at lower interest rates by signaling that their bonds are less risky. Weaker credit ratings should force them to pay higher rates.
Because of these improvements, Moody's noted that the Congressional Budget Office is projecting the budget deficit will fall to as low as 2.1 percent of economic output by 2015 and remain below 3 percent through 2020, before increasing sharply once again as the bills come due for the retirement of the baby boom generation. The deficit peaked at 10.1 percent of economic output in 2009 in the wake of the Great Recession.
"The U.S. budget deficits have been declining and are expected to continue to decline over the next few years," said Steven A. Hess, Moody's senior vice president, in announcing the move to take the U.S. off Moody's credit watch list for the first time since 2011. "Furthermore, the growth of the U.S. economy, which, while moderate, is currently progressing at a faster rate compared with several [countries with AAA ratings] and has demonstrated a degree of resilience to major reductions in the growth of government spending."
The deficit improvement in the next few years will be powerful enough to reduce the U.S. debt-to-GDP ratio from a peak of 76 percent in 2014 to 71 percent by 2018, Moody's estimates. Mr. Hess said the agency might reconsider its decision to uphold the U.S. AAA rating if economic growth turns out to be weaker than expected or interest rates rise more sharply, driving up the massive interest bill on U.S. debt obligations and bloating the deficit once again.
Standard & Poor's Corp., the largest credit rater, already has downgraded the U.S. to AA-plus, but the Fitch Ratings agency, like Moody's, maintains a AAA rating.
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