The international rating agency Moody’s downgraded the long-term credit rating of the USA from AAA to AA1 due to the continuing government debt and budget deficit. Evgeny Goryunov, Head of the Monetary Policy Department at the Gaidar Institute, in his commentary for RBC discusses the reasons for the growth of the US government debt and how it affects the US and global economy.
According to the expert, in recent years there has been a process of rebalancing portfolios — China continues to reduce investments in the US government debt, while European countries and Canada continue to buy them, but there are no unambiguously negative signals from the market.
“The imposed tariffs are unlikely to help reduce the deficit, and possibly on the contrary indirectly lead to its growth. An escalation of the trade war is a potentially significant stagflationary shock, with recession accompanied by rising inflation. This is an extremely unpleasant situation, including for the budget, as falling output reduces tax revenues and increases the deficit, while high inflation forces monetary authorities to keep interest rates high. If the US administration is seriously betting on the fact that the tariffs will help reorient investment flows to the US industrial sector and thus trigger economic growth (which is, of course, a very frivolous and surrealistic strategy from the economic point of view), such an inflationary recession is quite likely,” the expert says.
The US default scenario still looks “as absolutely fantastic”, says Evgeny Goryunov. The demand for government bonds from foreigners remains quite high. It should be noted that non-residents hold only about a third of government debt, while the rest is held by US investors.
“There are factors to consider and points to watch. Firstly, long-term rates (10-year bond yields) have stuck at a relatively high level. They have been in the 4–5% range for almost 2 years now. This makes it much more costly to service the debt accumulated during the period of zero rates. The last time this level of interest rates was observed 20 years ago, but at that time the growth rate of the American economy was higher, and the outlook was brighter. Today, in my view, there is no reason to expect particularly strong growth in the US, and this is the second worrying factor. High growth rates allow what is called “growing out of debt”, when the debt-to-GDP ratio is reduced at the expense of economic growth. Such a scenario does not seem likely for the coming years. Finally, the third factor is the high (one could even say abnormal) deficit, which is likely to amount to 6–7% of GDP at the end of the year. This is, of course, less than it was during the pandemic and less than it was in the post-crisis period of 2009–2011. But then, after the global financial crisis for several years managed to normalize the deficit, and now the situation is rather the opposite — the deficit is expanding and there are no signs of its reduction in the near future,” concluded the expert.
