A deterioration in U.S. governance, dimming the outlook on the country’s sovereign rating, is a concern for state and local credits.
Fitch Ratings analysts discussed this and other issues during a Thursday webinar focusing on state and local budgeting and how those entities are spending federal coronavirus aid funds. While there is no direct link between the U.S. rating and those of political subdivisions, there is potential for an impact, Fitch said.
“The challenges that affect the sovereign affect state and local governments,” said Eric Kim, a senior director and head of the U.S. States Group at Fitch.
Kim said Fitch is fundamentally concerned about a lack of bipartisanship, and that ineffective governance at the federal level is a potential threat to the credit quality of states and localities that rely on the smooth operation of that government to deliver healthcare spending, infrastructure grants, and other money they count on.
Fitch affirmed the U.S. at AAA with a negative outlook in July, noting specific concerns regarding the nation’s governance.
“Governance is a weakness relative to the ‘AAA’ median, and the future direction of the rating is sensitive to the direction it takes,” Fitch said. “The failure of the former president to concede the election and the events surrounding the certification of the results of the presidential election in Congress in January, have no recent parallels in other very highly rated sovereigns. The redrafting of election laws in some states could weaken the political system, increasing divergence between votes cast and party representation. These developments underline an ongoing risk of lack of bipartisanship and difficulty in formulating policy and passing laws in Congress.”
Highlighting these concerns is another round of partisan brinkmanship related to the debt limit, which caps the country’s ability to borrow. Congress suspended the debt limit through July 31 of this year as part of a two-year budget agreement in the Bipartisan Budget Act of 2019, but with the expiration of that agreement, the Treasury began using what it refers to as “extraordinary measures” to prevent breaching the nation’s debt ceiling.
This week, Treasury Secretary Janet Yellen warned House Speaker Nancy Pelosi, D-California, in a letter that Congress must raise the debt ceiling soon or the U.S. would risk defaulting on obligations as soon as next month, with potentially calamitous economic consequences.
But Republicans appear ready to play hardball, with Senate Minority Leader Mitch McConnell, R-Kentucky, saying on several occasions that Republicans won’t support raising the debt limit but that Democrats should do it themselves via budget reconciliation. Democrats did not include a debt limit increase in the budget resolution to enable the reconciliation, and Pelosi said Congress should raise the limit via normal order.
The Fitch event also noted that states are using coronavirus relief funds in a variety of ways, including on public employee bonuses, infrastructure spending, and to pay down liabilities. Kim said he has some concerns about states using this time period to make permanent tax changes, as uncertainty about future revenues remains high despite recovery from last year.
“It could end up with some unexpected and unintended consequences,” he said. “Forecasting revenues is a tough business right now.”