Obama can’t expect a "fiscal honeymoon" in second term, Fitch says

Newly re-elected US President Barack Obama and Congress need to quickly come to an agreement on how to avoid the so-called “fiscal cliff” and raise the government’s debt ceiling, if the nation wants to avoid another recession, Fitch Ratings said Wednesday.

“The economic policy challenge facing the president is to put in place a credible deficit-reduction plan necessary to underpin economic recovery and confidence in the full faith and credit of the US,” Fitch said in a news release outlining steps the US government must take to shore up the nation’s AAA standing with the credit rating agency. “… Failure to avoid the fiscal cliff and raise the debt ceiling in a timely manner, as well as securing agreement on credible deficit reduction, would likely result in a rating downgrade in 2013.”

It’s the latest such warning from a leading credit ratings agency. Last year, Standard & Poor’s Ratings Services downgraded its long-term sovereign credit rating of the US to AA+ from AAA. “The downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of on-going fiscal and economic challenges to a degree more than we envisioned,” S&P said in a statement.

In September, Moody’s Investors Service said budget negotiations during the 2013 congressional legislative session will likely determine whether it decides to downgrade US government debt. Moody’s currently assigns an Aaa rating, but with a negative outlook, to US government debt. “If those negotiations lead to specific policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term, the rating will likely be affirmed and the outlook returned to stable,” Moody’s said in a statement. “If those negotiations fail to produce such policies, however, Moody’s would expect to lower the rating.” 

On Wednesday, hours after Obama defeated Republican Mitt Romney, Fitch weighed in, saying that in the coming weeks, Obama and Congress need to address thefiscal cliff – which includes about $600 billion in tax increases and spending cuts that go into effect on January 1st – and an increase in the debt ceiling, “if the US is to avoid a fiscal and economic crisis.”

Fitch estimates that the fiscal cliff would push the US economy into recession and raise the unemployment rate to above 10% in 2013. “Tax increases and spending cuts implied by the fiscal cliff would not fully address the longer-term drivers of higher public spending and the relatively narrow and volatile tax base,” Fitch said in Wednesday’s news release, under the headline “No Fiscal Honeymoon for President Obama”. “Moreover, the fiscal cliff would likely be at least partially reversed by Congress as the economy slowed and unemployment began to rise, perpetuating the uncertainty over government tax and spending policies that has weighed on the economic recovery.”

About 75% of finance professionals believe overall economic conditions will weaken if various tax law provisions expire and mandated government spending cuts go into effect as scheduled, according to a survey of 949 executives conducted at an Association for Financial Professionals conference last month.

Respondents rated implementing changes to avoid the fiscal cliff as the second-most important issue for federal elected representatives in the US to focus on after the election. The most important issue: resolving long-term government fiscal and deficit issues, identified by 63% of finance professionals in the survey.

“We face a large number of growing problems, and Washington is not addressing them,” David Walker, a CPA who served as US comptroller general in Republican and Democratic administrations, said last month during a speech on the federal government’s debt situation. “Our politics have been taken over by special interests, demagogues and career politicians. That’s got to change. We need policy reforms, operational reforms and political reforms. But we don’t have a whole lot of time.”

Tuesday’s elections didn’t change the power structure in Washington. Democrats retained control of the US Senate, and Republicans retained control of the US House of Representatives – a political combination that has made it difficult for the federal government to make decisions on fiscal policy.

But Obama, a Democrat, said Wednesday that he would work with leaders in both parties to reduce the deficit and reform the tax code. “Progress will come in fits and starts,” he said during his victory speech. “… The recognition that we have common hopes and dreams won’t end all the gridlock, or solve all our problems, or substitute for the painstaking work of building consensus, and making the difficult compromises needed to move this country forward. But that common bond is where we must begin.”

Agreeing on a plan to reduce the federal budget deficit and stabilise federal debt would help the US retain its AAA rating. Failure to reach even a temporary arrangement to avoid the fiscal cliff, and a repeat of the August 2011 debt ceiling episode, “would mean that the general election had not resolved the political gridlock in Washington and likely result in a sovereign rating downgrade,” Fitch said.

Fitch added: “The presidential election underscored the broad political and public recognition of the importance of addressing the federal government deficit and stabilising government debt – the challenge facing President Obama and Congress is to address head-on the hard choices on tax and spending.”

—Jack Hagel (jhagel@aicpa.org) is the editorial director of CGMA Magazine.