Fitch downgrades UK's credit rating to AA+ from AAA, citing weaker economic and fiscal outlook, resolving negative watch placed on country on March 14, 2012; outlook is stable
April 19, 2013
– Fitch Ratings has downgraded the United Kingdom's Long-term foreign and local currency Issuer Default Ratings (IDR) to 'AA+' from 'AAA'. The Outlook is Stable. At the same time, the agency has affirmed the UK's Short-term foreign currency rating at 'F1+' and the Country Ceiling at 'AAA'.
The rating actions follow the conclusion of the review of the UK's sovereign ratings initiated on 22 March and resolve the Rating Watch Negative. The previous Negative Outlook on the UK's sovereign ratings had been in place since 14 March 2012.
KEY RATING DRIVERS
The downgrade of the UK's sovereign ratings primarily reflects a weaker economic and fiscal outlook and hence the upward revision to Fitch's medium-term projections for UK budget deficits and government debt. Despite the loss of its 'AAA' status, the UK's extremely strong credit profile is reflected in its 'AA+' rating and the Stable Outlook.
- Fitch now forecasts that general government gross debt (GGGD) will peak at 101% of GDP in 2015-16 (equivalent to 86% of GDP for public sector net debt, PSND) and will only gradually decline from 2017-18. This compares with Fitch's previous projection for GGGD peaking at 97% and declining from 2016-17 and the 'AAA' median of around 50%.
- Fitch previously commented that failure to stabilise debt below 100% of GDP and place it on a firm downward path towards 90% of GDP over the medium term would likely trigger a rating downgrade. Despite the UK's strong fiscal financing flexibility underpinned by its own currency with reserve currency status and the long average maturity of public debt, the fiscal space to absorb further adverse economic and financial shocks is no longer consistent with a 'AAA' rating.
- Higher than previously projected budget deficits and debt primarily reflects the weak growth performance of the UK economy in recent years, partly due to headwinds of private and public sector deleveraging and the eurozone crisis. Fitch has revised down its forecast economic growth in 2013 and 2014 to 0.8% and 1.8%, respectively, from 1.5% and 2.0% at the time of the last review of the UK's sovereign ratings in September 2012. The UK economy is not expected to reach its 2007 level of real GDP until 2014, underscoring the weakness of the economic recovery.
- Despite significant progress in reducing public sector net borrowing (PSNB from a peak of 11.2% of GDP (GBP159bn) in 2009-10, the budget deficit remains 7.4% of GDP (excluding the effect of the transfer of Royal Mail pensions) and is not expected to fall below 6% of GDP and GBP100bn until the end of the current parliament term. The slower pace of deficit reduction means that the next government will be required to implement substantial spending reductions (and/or tax increases) if public debt is to be stabilised and reduced over the medium term.
The Stable Outlook on the UK's sovereign ratings reflects the following factors.
- Under Fitch's baseline economic and fiscal scenario, which assumes a continued policy commitment to reducing the underlying budget deficit and medium-term annual growth potential of 2%-2.25%, government debt gradually falls as a share of national income in the latter half of the decade.
- The long average maturity of public debt (15 years) - the longest of any high-grade sovereign -exclusively denominated in local currency and low interest service burden implies a higher level of debt tolerance than many high-grade peers.
- The international reserve currency status of sterling and the ability and willingness of the Bank of England to intervene in the UK government debt market largely eliminates the risk of a self-fulfilling fiscal financing crisis.
- The gradual improvement in the UK banking sector's capital and liquidity position has further reduced contingent liabilities arising from this sector.
The UK's 'AA+' rating is underpinned by its high-income, diversified and flexible economy as well as a high degree of political and social stability. The monetary policy framework as well as sterling's international reserve currency status afford the UK a high degree of financial and economic policy flexibility. Strong civil and policy institutions and a high degree of transparency enhance the predictability of the business and economic policy environment that compares favourably with peers in the 'AA' category.
Weak economic performance and growth prospects, relatively high levels of private and foreign as well as public debt, along with sizeable twin fiscal and current account deficits, are weaknesses relative to rating peers.
The Stable Outlook indicates a less than 50% chance of a change in the UK sovereign ratings over the next two years.
The main factors that could lead to a negative rating action, individually or collectively, are:
- Failure to stabilise the government debt to GDP ratio over the medium term.
- Increased threat to macro-financial stability, for example arising from an intensification of the eurozone crisis or an erosion of confidence in the UK's policy commitment to price stability.
The main factors that could lead to a positive rating action, individually or collectively, are:
- Stronger economic recovery and rebalancing of the UK economy than currently forecast.
- Government budget deficits and debt declining at a faster pace than currently projected so that GGGD is on a sustainable path towards 90% of GDP and below.
A key assumption underpinning Fitch's medium-term fiscal projections reflected in the 'AA+' rating and Stable Outlook is that the growth potential of the UK economy is around 2%-2.25% pa. This assumption is based on the UK's labour market and demographic outlook and expectation that labour productivity will revert to its long-run trend of around 2% pa. In the event that productivity and hence economic growth is permanently lower than its long-run historical average prior to the financial crisis, the fiscal outlook would be materially worse than currently assessed with adverse implications for the UK's sovereign credit profile and ratings.
For the purposes of its economic and fiscal forecasts, Fitch assumes a current 'output gap' of 2.7% of potential GDP that gradually declines over the forecast horizon. However, there is considerable uncertainty over the extent and future evolution of productive spare capacity in the UK economy. According to Fitch's simulations, in a 'no output gap' scenario GGGD would remain above 100% of GDP until 2018 in the absence of further structural deficit-reduction measures.
The strong institutional framework for control of public expenditure and effective tax administration alongside the broad-based political and public commitment to deficit reduction underpins Fitch's assumption that fiscal consolidation will be sustained beyond the term of the current parliament through a combination of spending and tax measures. 3.5pp of the 6.9pp total reduction in expenditure as a percentage of GDP for the 2009-10 to-2017-18 period fall outside the term of the current parliament.
Fitch assumes that no contingent liabilities arising from the financial sector and other government interventions to ease constraints on the availability of bank credit to the private sector will have a material impact on the path of UK government debt over the projection horizon.
Fitch's current global economic forecasts (published in the March 2013 edition of the Global Economic Outlook) are incorporated into its near-term economic forecast for the UK including the assumption that severe tail-risks to the global economy, including a break-up of the eurozone, do not materialise and oil prices remain broadly at current levels.
Fitch will publish early next week an update of its medium-term economic and fiscal projections for the UK that will supplant those published by Fitch in September 2012 ('UK Public Finances Update', 28 September 2012).
The ratings of related entities and transactions will be reviewed in light of today's sovereign rating action and any changes announced shortly.
Additional information is available at www.fitchratings.com.
Applicable criteria, 'Sovereign Rating Methodology' dated August 2012, are available at www.fitchratings.com.
Applicable Criteria and Related Research
Sovereign Rating Methodology
Global Economic Outlook - Amended