The fact that the mighty US dollar has lost some of its lustre was finally recognised by Standard & Poor's regarded as one of the best credit rating agencies in the world. According to its announcement, it was cutting the credit rating of US debt from "stable" to "negative" because of the general perception that medium and long-term fiscal challenges to the US economy would continue to persist even after national elections in 2012 and this posed a considerable risk to the stabilisation efforts.
Some of the analysts thought that this could be a turning point since the dollar was believed to be the pillar of the post-war global financial system and the S&P had always kept America's credit rating at triple A. The chances that the rating agency could follow through with a downgrade were not trivial either. Historically, a negative outlook means that there is a one-third chance of a downgrade in the next two years.
Although the decision by S&P to put the US rating on negative outlook has sent a kind of frisson through markets, the announcement itself was not very much unexpected. The US, it may be noted, was not very much on a promising fiscal path in the 1990s but the boom of the 2000s, which could have improved the fiscal balance, was frittered away in tax cuts, and spending commitments that left the public purse in a parlous state for the crisis. Massive fiscal stimulus during the recent recession made the downturn less deep than it would otherwise have been, but the rapidly mounting debt that it precipitated has made an already bad situation really excruciating. In other words, the changed outlook highlights the damage to US creditworthiness from the continued fiscal mismanagement that was largely possible due to the position of its currency as a reserve asset throughout the world.
According to IMF estimates, the US will have a budget deficit of 10.8 percent of GDP during 2011 and the net government debt will exceed 70 percent of GDP. More worrying is the fact that despite a crisis situation on the fiscal front, US policy-makers are far from an agreement on how to reverse the recent fiscal deterioration or address long-term fiscal pressures. Both the Democrats and Republicans seem to show too much deference to their power bases and there are no signs of a meaningful deal on less spending, more taxes, close loopholes, etc. However, as expected, the US treasury officials were not at all impressed by the downgrading decision of S&P. They argued that it was strange to cut the outlook just after President Barack Obama and Republican congressman Paul Ryan had set out a long-term vision for deficit reduction, raising the prospect of a deal. According to a senior Treasury official, "we are surprised. It doesn't really fit with the timing of what is going on here in Washington."
Although, the downgrading by S&P could slightly weaken the myth that US sovereign debt was entirely "risk-free", the move could be interpreted as symbolic by the financial markets and investors are not expected to seek safe havens elsewhere. In fact, the initial reaction was some selling of the dollar, equities and treasury bonds but the market stabilised soon and there are no signs of jitteriness anymore. This is so because there are still nine notches to go before the US would lose investment grade status and double A rated credits (USA position after the downgrade), historically speaking, default 1.15 percent of the time within 15 years, while triple A credits default 1.09 percent of the time, suggesting only minor difference in the risk perception between the two top notch rankings. Also, only few funds are mandated to hold triple A securities, so hardly any fund would be forced to sell.
The real concern, nonetheless, could be that rather than reneging on its debt, the US could inflate its way out from the persistent fiscal problems and thus could affect the status and credibility of the world's benchmark paper and threaten dollar's use as a global reserve currency, particularly amid the rise of rivals such as China that have better growth prospects and fewer fiscal challenges. However, it would be a plus point if the action of the S&P could galvanise US leaders to make a sensible attempt to reduce the fiscal and trade deficits of the country by forging the right consensus in Washington so that the risk of another credit downgrading and financial crisis is averted. So far as Pakistan is concerned, the impact on its economy is not likely to be substantial until and unless such moves or counter-moves assume serious dimensions and affect the free flow of goods and services among various countries in a significant manner.
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