Fitch Ratings has maintained the UK’s long-term foreign currency issuer default rating (IDR), long-term local currency IDR and country ceiling all at AAA, while its short-term foreign currency rating is affirmed at F1+ and the outlooks on the long-term IDRs have been maintained at negative.
The credit ratings agency (CRA) said that the UK’s AAA rating is underpinned by a high-income, diversified and flexible economy as well as robust institutions and a high degree of political and social stability. The independent monetary policy framework, as well as sterling’s reserve currency status, affords the UK higher financial and economic policy flexibility and debt tolerance than many of its high-grade peers. The gradual improvement in the UK banking sector’s capital and liquidity position has further reduced the contingent liabilities arising from this sector. The long average maturity of UK debt – the longest of any high-grade sovereign – also adds to the debt tolerance of the UK as a benchmark borrower in its own currency. Fitch judges the risk of a fiscal financing crisis to be negligible.
However, weaker than expected growth and fiscal outturns in 2012 have increased pressure on the UK’s AAA rating, which has been on negative outlook since March 2012. With a structural budget deficit second in size within the AAA category only to the US (AAA/negative), and general government gross debt (GGGD) approaching 100% of gross domestic product (GDP) in 2015-16 under Fitch’s revised baseline estimates – the upper limit of the level consistent with the UK retaining its AAA status – the likelihood of a downgrade has therefore increased.
Global economic headwinds, including those emanating from the ongoing eurozone crisis, have compounded the drag on UK growth from private sector deleveraging and fiscal consolidation as well as from depressed business and consumer confidence, weak investment, and constrained credit growth. Fitch now expects the economy to contract by 0.3% in 2012 compared to an expectation of growth of 0.8% when the UK sovereign rating was last formally reviewed in March 2012. The weaker than anticipated economy is reflected in lower corporate tax returns and higher public sector net borrowing, which in the five months to August was £59bn compared to £48.4bn over the same period in 2011. In light of these developments, Fitch has updated and revised its medium-term fiscal projections for the UK.
Fitch expects only a weak recovery beginning in 2013 and output is not expected to surpass its 2007 pre-crisis peak until 2014. However, the relative resilience of the labour market underscores the continuing uncertainty regarding the medium-term growth potential of the UK economy. Fitch has not revised its previous judgement that the potential annual growth rate of the UK economy is around 2.25% and this assumption is reflected in Fitch’s latest economic and fiscal projections.
Fitch projects that GGGD and the government’s preferred measure – public sector net debt excluding financial interventions (PSND ex) – will peak in 2015-16 at over 97% and 80% of GDP, respectively, before registering a decline in 2016-17. This is one year later than the authorities’ supplementary target of having PSND ex decline as a share of GDP in 2015-16, and compares to a previous Fitch projected GGGD peak of about 94% of GDP in March 2012. Fitch’s projections assume that the commitment by the Chancellor, George Osborne, in last year’s autumn statement of an additional £8bn and £15bn of deficit-reduction measures in 2015-16 and 2016-17 respectively will be implemented, though they fall outside the term of the current government and have yet to be specified. It is also assumed that the government implements its consolidation programme as laid out in the 2012 Budget. Fitch’s projections are consistent with the government continuing to target a cyclically adjusted current balance by the end of the rolling, five-year forecast period.
The revised profile of Fitch’s projections show debt peaking at a higher level and one year later than was the case when Fitch revised the outlook on the UK’s AAA rating to negative from stable. In line with Fitch’s sovereign rating methodology and previous commentary, with general government gross debt to GDP ratio forecast to approach 100%, the likelihood of a rating downgrade has increased. Nonetheless, Fitch recognises the heightened uncertainty surrounding its economic and fiscal projections and re-affirms its previous guidance that in the absence of adverse shocks, Fitch does not expect to resolve the negative outlook until 2014.
The negative outlook on the UK rating reflects the very limited fiscal space, at the AAA level, to absorb further adverse economic shocks in light of the UK’s elevated debt levels and uncertain growth outlook.
A downgrade of the UK’s AAA sovereign rating would likely be triggered by the following:
- General government gross debt failing to stabilise below 100% of GDP and on a firm downward path towards 90% of GDP over the medium term.
- Discretionary fiscal easing that resulted in government debt peaking later and higher than currently forecast.
- A material downward revision of the assessment of the UK’s medium-term growth potential.
Fitch concludes that better than forecast economic and fiscal performance than currently expected would likely result in the stabilisation of the rating outlook and re-affirmation of the UK’s AAA status. However, in the absence of adverse shocks the CRA does not expect to resolve the negative outlook until 2014.
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