S&P sounds US ratings cut alert

Failure by the White House and Congress to reach a deal over the American debt ceiling next week could force Standard & Poor’s to lower the US sovereign rating to “selective default”, the ratings agency said on Wednesday.

S&P chief economist Paul Sheard warned that US leaders and politicians were playing a very dangerous “game of chicken, though hopefully it will end in the cars swerving at the last minute rather than hitting each other”.

Sheard told Emerging Markets he remained “very confident” an agreement would be reached before the middle of October, when current government financing is projected to run out. “There’s still a very low chance” of the US defaulting on a debt service obligation, he added.

If President Obama and Congress fail to reach a compromise, resulting in a missed debt payment, that could alter the way the ratings giant assesses and rates the US economy. S&P downgraded the US credit rating – the only major ratings firm to do so – in August 2011, arguing that partisan gridlock undermined confidence in American policymaking.

“If a selective default was triggered,” creating more brinkmanship, angst and gridlock, noted Sheard, “our sovereign [ratings] team would have to take that into account.”

That would lead to a bigger question about “how [S&P should] assess [America’s] credit rating in the future. If a selective default happened, everyone in the world would have to adapt to the reality that it had actually taken place. We take into account the state of the economy but also the effectiveness of policymaking, and the state of the US’s institutional apparatus.”

The economies of Europe and the eurozone present a far grimmer picture, despite the emergence of hopeful economic news out of Germany and the UK. “I’d describe the eurozone as ‘stabilizing but still rather depressed’,” Sheard said. “Europe is certainly not out of the woods yet.”

The big question, he added, was how far and fast Europe can go down the path of increased integration. “The first train leaving the station is the banking union. Even that process has lots of risks inherent in its execution.”

The prognosis across emerging markets was also gloomy. India’s economic star has “faded quite a bit” over the past year, Sheard noted. The appointment of a respected new central bank chief, Raghuram Rajan, augured well, but the S&P chief economist warned that recent emerging-market turmoil, which saw India’s currency slump and growth ebb, “should serve as a serious wake-up call”. Brazil and Russia have also seriously “disappointed”, struggling to push through much-needed supply-side and macroeconomic reforms.

The emerging world in particular should also get used to a new era of market turmoil as radical quantitative easing (QE) policies, which have underpinned market activity for nearly five years, is eased out, Sheard added.

“It’s almost inevitable that we are going to see more volatility spilling over into emerging markets as QE is unwound. Everyone is going to see the tapering signal at the same time, and will react to it at the same time, and that will create the volatility. The question is: will the volatility be of a nature and a scale that impacts the global economy negatively.”