Earlier this week, rating agency Fitch provided a new facet for anxiety and excitement in global financial markets. Fitch downgraded the debt rating of the United States, the world’s largest economy, from AAA to AA+, essentially citing fiscal deterioration worsened by erosion of governance and fears of a recession. The tremors sent bonds into a spin and stocks found what Greenspan famously called the proximate cause for correction.
The downgrade of the giant economy didn’t dent the dollar nor did it drive investor traffic to gold. The dollar ticked upward and gold depreciated. It could be argued that the impact of rating action must be measured over a longer duration of time. An objective analysis calls for a thorough interrogation of history.
Almost to the day on August 5, 2011, rating agency Standard & Poor’s downgraded US debt from AAA to AA+, citing debt burden and, yes, political risks. What happened in the 12 years since is instructive. S&P estimated US debt to GDP would rise from 74 per cent in 2011 to 85 per cent by 2021. This year the US debt-to-GDP ratio hovers at around 118 per cent as per the St Louis Federal Reserve. Debt and deficit didn’t dam the flow of FDI. The US continued to be the top destination and attracted nearly three trillion dollars in the decade. And foreign country reserves parked in US dollars rose from $4 trillion in 2011 to over $ 7.6 trillion in 2023.
Of course, not every country enjoys what former French President Valery Giscard d’Estaing, as Finance Minister in 1965, called America’s ‘privilege exorbitant’. The dollar dominates world trade and is the preferred store of value. As the issuer of global reserve currency, the US is able to run expansionary policies to stabilise the economy, leveraging flows and monetisation to finance its deficits.
In contrast, Japan, which is the third largest economy, struggled to recover from downgrades. In 2011, S&P downgraded Japan’s rating from AA to AA- as liabilities ballooned to nearly twice its economic output. In the past decade, Japan’s debt-to- GDP ratio has risen from 185 per cent to over 226 per cent of GDP. Japan was downgraded further in 2015 by S&P and in March 2023 Japan as per S&P has a rating of A+.
How other countries fared post-ratings downgrade is equally illuminating. France lost its AAA rating in January 2012. It was downgraded first by S&P and then by others to AA+ as French President Nicholas Sarkozy mounted a campaign for re-election. In April 2023, S&P downgraded France further to AA-.Between 2011 and 2023, general government debt as a percentage of GDP rose from 90 per cent to over 114 per cent.
France was not the only country to be hit by downgrades that year. Austria was cut to AA+ from AAA; Cyprus to BB+ from BBB; Italy to BBB+ from A; Malta to A- from A; Portugal to BB from BBB-; the Slovak Republic to A from A+; Slovenia to A+ from AA-; and Spain to A from AA-. The rationale invariably is about the management of government finances and despite well-intentioned advisories revisions have been hard to come by.
This begs the question of whether rating actions alter the cause politics – do downgrades deter politics of populism? A good candidate for comprehending the trend and trajectory is the United Kingdom – once an empire where the sun didn’t set and now sixth on the ranking of economies. The UK was downgraded in April 2013 by Fitch from AAA to AA+. The reason: “weaker economic and fiscal outlook and upward revisions of budget deficits and government debt”. That alarm didn’t quite ring in Westminster and downgrade didn’t daunt the politics of Brexit.
In June 2016, S&P downgraded the UK two notches from AAA to AA. It ominously warned that Brexit “will lead to a less predictable, stable and effective policy framework” and a “marked deterioration of external financing conditions”. In 2015, the government debt in the UK was around 81 per cent of GDP. In 2023, it is hovering at 110 per cent of GDP, the highest since 1961. The chaotic parade of four chancellors and three prime ministers in two years has not helped.
The ‘erosion of governance’ underlined by the Fitch rating report is ubiquitous and global. Populist polarisation is manifest in the many mutinies playing out across democracies. The arithmetic of politics is shackling the algebraic arrangement of factors that propel prosperity. It is instructive to note that only two of the top ten economies, Germany and Canada, are rated AAA. The nine entities boasting AAA ratings add up to barely a tenth of global GDP.
The US may stumble, struggle and survive schisms and downgrades but for others, ratings have a material impact on the sustainability of aspirations – and the visible, stark corrosion of social harmony has existential implications for developing economies. The shadow of demographics on employment, displacement of lives by climate change and retrenchment of the human interface by technology will only heighten and aggravate the faultlines.
The former EU President Jean Claude Juncker, once said: “We all know what to do, we just don’t know how to get re-elected after we’ve done it.” The context signals the need for an urgent rethink of the idiom of contemporary politics, a modern draft of the social contract to install trust between society and the State.
Shankkar Aiyar
Author of The Gated Republic, Aadhaar: A Biometric History of India’s 12 Digit Revolution, and Accidental India
(shankkar.aiyar@gmail.com)