Fitch downgrades US Ratings: How do credit rating agencies upgrade and downgrade the rankings of countries?

Fitch Ratings, one of the world's premier credit rating agencies, has downgraded the United States' credit rating. Fitch’s downgrade of the United States' credit rating, from AAA to AA+, came over a decade after the S&P Global Ratings had downgraded the world’s largest economy in 2011.

Currently, Moody’s remains the only large rating agency maintaining the AAA rating on US Bonds.

Fitch cited fiscal deterioration, rising government debt, and poor governance as key reasons for the downgrade. This is the second time in history that the US has experienced a downgrade in its credit rating.

Understanding credit rating agencies

Credit rating agencies assess a debtor's ability to repay debts and the likelihood of default. They rate a vast range of debt instruments, including sovereign and corporate bonds. Their assessments directly affect the interest rates applied to these debts and play a significant role in facilitating secondary market trading. These ratings symbolise the issuer's capacity to service their debt on time.

The credit ratings essentially provide a snapshot of the risk and reward ratio of buying these financial instruments. While hundreds of credit rating agencies exist across the world, Moody’s, Fitch, and Standard and Poor’s are the three biggest agencies in the world.

What do credit ratings mean for countries?

A downgrade is a negative change in a debt's rating that indicates weakened future prospects. When a credit rating is downgraded, for instance, moving from an "A" rating to a "BBB”, it signifies an increased risk of repayment failure. Ratings range from AAA (Aaa at Moody’s), which is considered prime grade for securities, to C, which indicate bonds to be in default.

The US bond downgrade reduces US Treasury Bills from the prime to high-grade category. Other economies with prime category bonds include Australia, Singapore, Norway, Denmark, Germany, Switzerland, Netherlands and a few others. Conversely the nations with the worse credit rating at the moment include economically stressed countries like Sri Lanka, Pakistan, and Lebanon and unstable countries like Russia, Belarus, and Ukraine.

An upgrade indicates strengthened future prospects. Ratings are usually based on both objective factors and human judgment. They are inherently forward-looking and predictive opinions rather than factual statements.

Factors Influencing Rating Upgrades and Downgrades

The process of upgrading or downgrading credit ratings involves several elements. Financial firms employ analysts to adjust these ratings based on changing factors. These can include major announcements, the release of new financial statements, or significant industry-related news events. However, specific factors can be different for upgrades and downgrades.

For instance, credit ratings can be upgraded based on factors like improved balance sheets, positive changes in business conditions, industry trends, or beneficial regulatory measures. On the other hand, ratings may be downgraded due to the increased risk of default, deteriorating balance sheets, negative changes in business conditions, and pessimistic market outlooks.

While ratings agencies usually publish notes with the rationale behind credit rating changes, the exact formulation for changes is highly secretive. Fitch based its downgrade of US bonds on “rowing general government debt burden” as well as the “erosion of governance”. The agency blamed the regular partisan political standoff on the debt ceiling along with unaddressed fiscal challenges for the downgrade. Another crucial factor was the country's debt-to-GDP ratio, which currently stands at 113 per cent.

What will this mean for the US economy?

Much like the S&P downgrade in 2011, most economists believe that the downgrade will change very little. The size and stability of the US economy and the strength of US Treasury securities make them still a preferred choice for global investors. This is especially true during times of economic turbulence. However, the key difference between the downgrade in 2011 and the current one is the ongoing bid from countries and multinational blocs to bring a change to the global dollar dominance.