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Context: Global credit ratings agency Fitch has downgraded the credit rating for the United States to AA+ from AAA, its highest possible rating. This is the second time that the US has lost its AAA rating after Standard & Poor's did so in 2011. Fitch cited fiscal deterioration, repeated debt ceiling standoffs and erosion of confidence in fiscal management as the reasons for the downgrade.

Details

What is the background of this downgrade?

• The US government has been facing a debt ceiling crisis since May when it reached its legal borrowing limit of $31.4 trillion. The debt ceiling is a statutory limit on how much the federal government can borrow to finance its spending. If the debt ceiling is not raised or suspended, the government risks defaulting on its obligations, which could trigger a financial crisis and damage the global economy.
• The US Congress and President reached a bipartisan agreement in June to suspend the debt ceiling until January 2025, averting a default. However, Fitch said that this agreement was not enough to restore confidence in the US fiscal management, as it did not address the underlying fiscal challenges and political polarization that have led to repeated debt ceiling crises.

How will this impact India and other markets?

• Higher borrowing costs: A lower credit rating means that investors may demand higher interest rates to lend to the US government, which could increase its borrowing costs and widen its fiscal deficit. This could also affect other countries that borrow in US dollars or have their currencies pegged to the dollar, as they may face higher financing costs and exchange rate pressures.
• Lower confidence: A lower credit rating could also undermine confidence in the US economy and its role as a global leader and reserve currency issuer. This could reduce foreign investment and trade flows to the US and affect its growth prospects. This could also have spillover effects on other countries that depend on the US market or have strong economic ties with it, such as India.
• Higher volatility: A lower credit rating could also increase volatility in global financial markets, as investors may seek safer assets or diversify their portfolios away from US assets. This could create fluctuations in stock prices, bond yields, currency rates and commodity prices, affecting the stability and performance of various markets.

What steps has India can take to mitigate the impact?

• Building foreign exchange reserves, which provide a buffer against external shocks and exchange rate volatility. India's reserves cover more than 18 months of imports and are equivalent to 118% of its external debt.
• India has to strengthen its macroeconomic fundamentals by reducing its fiscal deficit, current account deficit, inflation and public debt ratios.
• India has implemented various measures to enhance its economic recovery from the Covid-19 pandemic, such as providing fiscal stimulus, monetary easing, liquidity support, structural reforms and a vaccination drive.

What are the challenges and way forward for India?

Managing capital flows

• India needs to manage capital flows carefully, as it may face both inflows and outflows depending on global risk appetite and domestic factors. Inflows may increase if investors seek higher returns in emerging markets like India, while outflows may increase if investors seek safer assets or reduce their exposure to US assets. India needs to balance the benefits and costs of capital flows, such as growth, inflation, exchange rate and financial stability.

Diversifying trade and investment partners

• India needs to diversify its trade and investment partners, as it may face lower demand and competition from the US market. India also needs to explore new opportunities in other markets, such as the European Union, the United Kingdom, Japan, Australia and the Association of Southeast Asian Nations (ASEAN).
• India needs to enhance its trade and investment agreements, such as the Regional Comprehensive Economic Partnership (RCEP), the Comprehensive Economic Cooperation Agreement (CECA) and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP).

Pursuing fiscal consolidation

• India needs to pursue fiscal consolidation, as it may face higher borrowing costs and lower confidence due to the US credit rating downgrade. India needs to reduce its fiscal deficit and public debt ratios while maintaining adequate spending on health, education, infrastructure and social protection. India needs to improve its revenue mobilization, expenditure efficiency and fiscal transparency.

Conclusion

• The US credit rating downgrade is a significant event that could have far-reaching consequences for the global economy and financial markets. India has taken several steps to mitigate the impact of the downgrade, but it also faces several challenges and opportunities in the future. India needs to adopt a prudent and proactive approach to deal with the changing global scenario and enhance its resilience and growth potential.

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PRACTICE QUESTION Q. How can India safeguard its economy against potential international economic shocks? What are the potential impacts of such shocks, and what challenges might arise in the economy? Furthermore, what strategies or measures can be implemented to pave the way forward and enhance India's resilience in the face of global economic uncertainties?

https://indianexpress.com/article/explained/explained-economics/fitch-downgrades-us-rating-8872844/