By Peter Schroeder - 03/04/13 09:33 PM EST
Credit rating agencies are shrugging off sequestration, saying the U.S. government will need to do more to reduce the deficit if it wants to prevent a downgrade of the nation’s credit rating.
While the agencies say the $85 billion in automatic spending cuts represent at least a step towards deficit reduction, they argue much more is needed to prevent the United States from losing its “AAA” rating.
The agencies view it as a positive sign that Congress did not simply scrap the unpopular sequester. Erasing the cuts without coming up with an alternative, something pushed by some liberal lawmakers, would have added to the deficit and debt and further pressured agencies to downgrade the nation’s credit rating.
At the same time, the agencies say they are worried that Washington’s inability to replace the sequester with targeted deficit reduction underlines concerns about the U.S. government’s dysfunction, a concern that led Standard & Poor’s to downgrade the U.S. in 2011.
The S&P downgrade came just days after Congress approved a hike in the nation’s debt limit in August 2011. The months-long debate caused stocks to dip and raised serious doubts about the ability of Republicans and Democrats to come together on fiscal issues.
It also led to the sequester, a series of cuts meant to be triggered only if Congress could not come up with a better deficit-reduction plan.
In downgrading the U.S. credit rating, S&P cited “political brinksmanship” and said Washington’s actions in the debate made the nation “less stable, less effective, and less predictable than what we previously believed.”
Watching both parties continue to butt heads on fiscal issues, S&P is confident they made the right call.
"The political discord around this process was a factor in lowering the credit rating," said John Piecuch, a spokesman for the rater. "We believe that the events since then have validated our opinion."
Agencies are raising similar concerns with the sequester.
Just days before Friday’s deadline, Fitch said allowing sequestration to occur would “further erode confidence” in policymakers’ ability to strike the broader deficit deals needed to get the country’s debt under control.
In addition, while the sequester will reduce spending and the deficit in the short term, U.S. deficits are expected to rise toward $1 trillion again by 2023.
The sequester reduces defense and non-defense discretionary spending, but does nothing to curtail Medicare spending, a key driver of the deficit.
The Congressional Budget Office found the deficit will drop to $430 billion by 2015 partly because of the sequester, and will continue to fall if spending caps remain curtailed by the budget cuts. (The "fiscal cliff" deal in January also improved the nation’s outlook by bringing in an additional $600 billion in revenue.)
Yet the CBO finds deficits will rise again in later years as entitlement costs continue to skyrocket and the population ages.
Raters say Congress will need to make even tougher choices to rein in debt and deficits if the country is to keep its top-shelf ratings.
The overarching concern from credit raters is getting the nation’s debt-to-GDP ratio on a sustainable course.
According to Fitch, assuming Congress leaves the sequester fully in place, policymakers would still need to track down another $1.6 trillion in deficit reduction to get the nation’s debt on a sustainable course. Actually driving down that ratio would require another $3 trillion in deficit reduction.
Federal Reserve Chairman Ben Bernanke struck a similar note when he testified before Congress last week.
He warned that while the sequester cuts might improve the nation’s finances in the short term, they do nothing to address the actual drivers of long-term fiscal woes. He called on Congress to replace the sequester with longer-term fiscal reforms that actually address those issues.
“The difficult process of addressing longer-term fiscal imbalances has only begun,” Bernanke added.
Credit raters are not weighing in on whether Congress should raise taxes, reduce spending or lower entitlement benefits to improve the nation’s fiscal trajectory.
Both Fitch and Moody’s Investors Service still give the U.S. their top rating, but both have placed it on a negative outlook, effectively warning that Washington will need to address the nation’s long-term debt issues in 2013 or face a downgrade.
—This story was updated at 5:09 p.m.