How Fitch Downgrade Of U.S. Ratings Will Impact India — BQ Explains

Apart from knee-jerk reactions, impact of the ratings downgrade on India remains unlikely, according to experts.

<div class="paragraphs"><p>Fitch Ratings is the second major rating agency after S&amp;P Ratings to have downgraded the U.S. (Source: Freepik)</p></div>
Fitch Ratings is the second major rating agency after S&P Ratings to have downgraded the U.S. (Source: Freepik)

Earlier on Wednesday, Fitch Ratings downgraded the United States' long-term rating to 'AA+' from 'AAA'. The Rating Watch Negative was removed, and a Stable outlook has been assigned.

Key Drivers

  • The U.S. rating downgrade reflects the expected fiscal deterioration over the next three years.

  • A high and growing general government debt burden.

  • The erosion of governance relative to 'AA' and AAA-rated peers over the last two decades has manifested in repeated debt limit standoffs and last-minute resolutions.

Fitch expects the general government deficit to rise to 6.3% of GDP in 2023 from 3.7% in 2022, reflecting cyclically weaker Federal revenue, new spending initiatives, and a higher interest burden.

The government's debt-to-GDP ratio is projected to rise over the forecast period, reaching 118.4% by 2025. That's higher than the median.

There has been limited progress in tackling medium-term challenges related to rising social security and medicare costs due to an ageing population, Fitch said.

Economy To Slip Into Recession 

Tighter credit conditions, weakening business investment, and a slowdown in consumption will push the U.S. economy into a mild recession in Q4 2023 and Q1 2024, according to Fitch projections.

The rating agency sees U.S. annual real GDP growth slowing to 1.2% this year from 2.1% in 2022 and overall growth of just 0.5% in 2024.

It has become the second major rating agency after S&P Ratings to downgrade the U.S. However, the impact of the downgrade is expected to be limited.

India To See Limited Impact

"We do not expect any durable impact of the ratings downgrade beyond some knee-jerk impact on flows through sentiments," Suvodeep Rakshit, senior economist at Kotak Institutional Equities, said. The fundamental reasons for the downgrade are also known and not a surprise for markets on an incremental basis, he said.

Amid knee-jerk reactions to the downgrade, U.S. bond yields and the dollar rose higher.

Wednesday's reactions are expected to be one-off because the reasons behind the downgrade remain well-known, according to Ritesh Bhansali, vice president at Mecklai Financial Services Ltd. Credit rating agencies, on the other hand, have always been on the back foot, he said.

On Wednesday, while the dollar index was rangebound, the dollar appreciated against emerging market currencies amid risk aversion sentiments, elevating the demand for safe-haven currencies, Bhansali said.

The macroeconomic indicators for India, including a growth rate surpassing the long-term average, lower inflation and interest rates, and improved corporate earnings, all paint a favourable picture, said Feroze Azeez, deputy chief executive officer at Anand Rathi Wealth Limited. The impact of the downgrade will not be significant on the Indian economy, he said.

It is anticipated that India will eventually receive an upgrade, Azeez said. However, it is crucial to monitor global economic trends and the evolving situation in the US to gauge the potential ripple effects on India's financial landscape, he said.