LONDON--(BUSINESS WIRE)--The tentative agreement, Monday, to suspend the federal government debt limit until March 2017 as part of a "Bipartisan Budget Act of 2015" is consistent with Fitch Ratings' view that an agreement will be reached to deal with the US debt limit before the Treasury exhausts extraordinary measures. Nevertheless, tail risks that the political impasse persists cannot be completely excluded.
In a letter to Congress this month, Treasury secretary Jacob Lew estimated that extraordinary measures that allow the Treasury to fund the government even after the debt limit is reached will be exhausted no later than Tuesday, November 3. This would leave the Treasury with just a USD30bn cash reserve, "an amount far short of net expenditures on certain days." The Bipartisan Policy Centre has estimated that, if the debt limit is not suspended or raised, the Treasury will be unable to meet all its financial obligations at some point between 10 November and 16 November.
The tentative fiscal deal outlined in a discussion draft for a bill in the House of Representatives to provide a bipartisan budget agreement includes proposals to suspend the debt limit until 15 March 2017, raise expenditure caps by USD50bn in FY16 and USD30bn in FY17 relative to the 2011 budget control act, split between defence and non-defence spending, and introduce some minor reforms to mandatory spending. It still needs to be approved by the House of Representatives and the Senate, and the President. Political dynamics suggest that an agreement is now likely.
Nevertheless, it is useful to outline how Fitch may react to a failure to raise or suspend the debt limit, and to the potential consequences, including a default on US Treasury securities, as the agency has done previously ahead of debt limit deadlines.
In a scenario where the federal debt limit isn't raised or suspended in a timely manner before the Treasury exhausts extraordinary measures and cash reserves, we would consider placing the US sovereign IDR and all outstanding sovereign debt securities on Rating Watch Negative (RWN), reflecting the increasing risk of a near-term default event.
In the event that the debt limit is not raised or suspended before its extraordinary measures and cash reserves are exhausted, the Treasury's capacity to meet its expenditure commitments would be subject to volatile revenue flows. This could result in arrears to suppliers, employees, and social security recipients and cuts to current spending. That would not in itself constitute an event of default from Fitch's perspective. It would, however, damage perceptions of US sovereign creditworthiness and, if payment delays were extensive on non-prioritised obligations, signal that the US government was in financial distress, with negative rating implications. It would also have a detrimental effect on the economy.
The Treasury has said that it does not have clear legal authority to prioritize debt over other mandatory expenditure payments and that to "prioritize principal and interest while missing payments on other obligations" is "an unacceptable outcome."
Fitch would only recognise a sovereign default event if the government failed to honour interest and/or principal payments on the due date of US Treasuries. The first such payment date that it faces after 3 November is interest payments of USD30.4bn on 16 November. In this scenario, Fitch would lower the US sovereign IDR to 'Restricted Default (RD)' until the default event was cured.
Once cured, the US sovereign IDR would be raised to a level reflecting our assessment of its creditworthiness. This would reflect the scale and duration of the default, the perceived risk of a similar episode occurring in the future, the likely impact on the US sovereign's cost of funding and cost of capital for the economy as a whole, and the implications for long-term growth.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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