By Vicki Needham - 01/15/13 02:40 PM EST
Failure to raise the debt ceiling ahead of the possible mid-February deadline would likely lead to another downgrade of America's credit rating, Fitch Ratings warned Tuesday.
Fitch said failure to raise the debt ceiling in a "timely manner" would prompt a formal review of U.S. sovereign ratings, with a downgrade to the nation's AAA rating likely even if Treasury cuts back federal spending to ensure that the nation's debt payments can be made.
"It is not assured that the Treasury would or legally could prioritize debt service over its myriad of other obligations, including Social Security payments, tax rebates and payments to contractors and employees," Fitch said, if the borrowing limit is reached.
"Arrears on such obligations would not constitute a default event from a sovereign rating perspective but very likely prompt a downgrade even as debt obligations continued to be met."
Standard & Poor's downgraded the nation's AAA credit rating after the last debt-ceiling fight in 2011 and, like Fitch and Moody's, holds a negative view on the U.S. debt outlook.
"In the absence of an agreed and credible medium-term deficit reduction plan that would be consistent with sustaining the economic recovery and restoring confidence in the long-run sustainability of U.S. public finances, the current Negative Outlook on the 'AAA' rating is likely to be resolved with a downgrade later this year even if another debt ceiling crisis is averted," Fitch said.
President Obama said Monday that he doesn't plan to negotiate with Republicans who want an equal amount of spending cuts in exchange for a debt-ceiling increase, though he said he remains open to more deficit reduction.
The United States reached the debt limit of nearly $16.4 trillion at the end of last year, and Treasury Secretary Timothy Geithner told Congress on Monday that a default could happen as early as mid-February.
Geithner said he taking extraordinary measures to clear up another $200 billion for payments but will run out of options next month.
In response, Fitch said the nation's "economic dynamism and potential, diminishing financial sector risks, respect for the rule of law and property rights, as well as the exceptional financing flexibility" are being "eroded by the large, albeit steadily declining, structural budget deficit and high and rising public debt."
"In Fitch's opinion, the debt ceiling is an ineffective and potentially dangerous mechanism for enforcing fiscal discipline," the group said.
"It does not prevent tax and spending decisions that will incur debt issuance in excess of the ceiling while the sanction of not raising the ceiling risks a sovereign default and renders such a threat incredible."
Still, with the warning, Fitch said its expectation is that Congress will raise the debt ceiling and that the risk of a "U.S. sovereign default remains extremely low."
Adding to the negative outlook, Congress will have to find replacement spending cuts, delayed for two months, for the scheduled final 10 months of a sequester, and complete an omnibus spending bill to cover expenses for the rest of the fiscal year before the end of March.
"Recent history suggests that short term fixes will be agreed, albeit only just before each deadline is breached, that do little more than postpone key decisions and perpetuate the uncertainty over tax and spending policies and fail to place U.S. public finances on a medium-term sustainable path," Fitch wrote.