–Likelihood Could Cut Rating on US Within 2 Years ‘At Least’ 1-In-3
–Affirms US ‘AA+’ Credit Rating, Outlook Remains Negative
–Stresses U.S. Needs Credible Medium-Term Fiscal Plan

By Brai Odion-Esene

WASHINGTON (MNI) – Rating agency Standard & Poor’s Friday warned
that continued fiscal and political risks in the United States could
build to a point that it could downgrade the nation’s sovereign credit
rating within the next two years.

In a statement released after market hours, the firm affirmed its
‘AA+’ rating on the U.S., citing strengths that include “its resilient
economy, its monetary credibility, and the U.S. dollar’s status as the
world’s key reserve currency.”

“We believe the Federal Reserve System (the U.S. monetary
authority) has an excellent ability and willingness to support
sustainable economic growth and to attenuate major economic or financial
shocks,” S&P said.

S&P said it believes the risk of the United States returning to
recession is about 20%.

The U.S.’s credit weaknesses include its fiscal performance, its
debt burden, “and what we perceive as a recent decline in the
effectiveness, stability, and predictability of its policymaking and
political institutions, particularly regarding the direction of fiscal
policy.”

S&P maintained its negative outlook on the United States, a
reflection of the rating agency’s opinion that “U.S. sovereign credit
risks, primarily political and fiscal, could build to the point of
leading us to lower our ‘AA+’ long-term rating by 2014.”

The outlook, it added, represents “the likelihood that we could
lower our long-term rating on the U.S. within two years is at least
one-in-three.”

S&P warned that pressure on the U.S. ‘AA+’ rating could build if
the White House and Congress remain unable to agree on “a credible,
medium-term fiscal consolidation plan that represents significant (even
if gradual) fiscal tightening” beyond that envisaged in 2011 Budget
Control Act.

“Pressure could also increase if real interest rates rise and
result in a projected general government (net) interest expenditure of
more than 5% of general government revenue,” it added.

On the other hand, S&P said the rating could stabilize at the
current level with a medium-term fiscal consolidation plan, “or if the
U.S. government makes faster progress toward reducing the general
government deficit than our base case currently presumes.”

S&P said the ability of the administration and lawmakers to
implement reforms has weakened in recent years because of “a sometimes
slow and complex decision-making process,” particularly with regard to
broad fiscal policy direction.

“In particular, we think that recent shifts in the ideologies of
the two major political parties in the U.S. could raise uncertainties
about the government’s ability and willingness to sustain public
finances consistently over the long term,” it said, adding that “we
believe that political polarization has increased in recent years.”

And while the November presidential and congressional elections
could resolve the U.S. fiscal debate, “we see this outcome as unlikely,”
S&P said.

In fact, if the gap between President Barack Obama and Republican
challenger Mitt Romney is close. S&P said the race could reduce
bipartisanship from its already low depths as each party “strives to
rally support by more clearly distinguishing itself from the other.”

Another fiscal issue is the looming across-the-board cuts set to
trigger at the start of next year, but S&P said its current (and
previous) base-case fiscal scenario assumes that the 2001 and 2003 Bush
tax cuts, due to expire by the end of 2012, remain in place indefinitely
and that the alternative minimum tax is indexed for inflation after
2011.

On the expenditure side, its base case assumes Medicare’s payment
rates for physicians’ services stay at their current level, although the
firm also assume the Budget Control Act remains in force. It also
assumes annual real GDP growth of 2% to 3.5% and consumer price
inflation near 2% through 2016.

“Under our base-case fiscal scenario, we expect the general
government deficit, as a share of GDP, to decline slowly, from 10% in
2011 to 9% in 2012 and 5% by 2016,” S&P said, noting that even at 5%,
the deficit would still be at the high end of the ranges it uses to
assess sovereigns’ fiscal performance.

“Under the same base-case scenario, we expect net general
government debt, as a share of GDP, to continue to rise, from 77% in
2011 to 83% in 2012 and 87% by 2016,” it added, “keeping the U.S. at the
high end of our indebtedness range and highlighting the deterioration in
our expectations since last summer.”

And in the absence of significant fiscal policy change, S&P
projected U.S. net general government indebtedness, as a share of the
economy, to continue to increase after 2016.

This is why the rating agency believes the U.S. will likely need “a
more substantial” medium-term fiscal consolidation plan than that
included in the Budget Control Act in order to halt the deterioration in
the government’s net indebtedness as a share of the economy.

Such a plan would need broad support from both parties to be
credible, it said.

“We stress the qualifier “medium-term” because we believe the
fiscal challenges of the U.S. are more structural and recognize that
abrupt short-term measures could be self-defeating when domestic demand
is weak,” S&P said.

Aside from issues at home, S&P said U.S. economic and fiscal
performance is subject to a number of significant risks, including —
not surprisingly — the ongoing crisis in the eurozone.

“These could lower U.S. growth either through a decline in U.S.
exports to the euro area or, more importantly, through second-round
effects on the U.S. financial sector,” S&P said.

** MNI Washington Bureau: 202-371-2121 **

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