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Sovereigns www.fitchratings.com 16 August 2011 North America U.S. Public Finances – Overview and Outlook Special Report Budget Control Act Positive: In Fitch’s opinion, the Budget Control Act passed on 2 August 2011 (BCA 2011) was a significant positive development that provided a substantive and necessary increase in the federal debt ceiling. It also signalled that there is the political commitment to place US public finances on a sustainable path consistent with the US sovereign rating remaining ‘AAA’. USD4.1trn of Deficit Reduction: The BCA 2011 implies USD917bn of savings in discretionary spending and at least a further USD1.2trn in spending relative to the CBO March 2011 (adjusted) baseline to give a total target for deficit reduction over the period 2012-2021 of USD2.1trn. Because the BCA 2011 sets absolute caps on discretionary spending relative to the CBO March 2011 baseline, the overall level of savings on discretionary spending relative to the CBO’s ”alternative fiscal scenario” (”current policy”) is USD2.9trn. Combined with the USD1.2trn of automatic spending cuts if the Joint Select Committee does not reach agreement, the BCA 2011 implies at least USD4.1trn of deficit reduction relative to the CBO’s “alternative fiscal scenario”. If implemented, this would be the first major step towards placing US public finances on a sustainable path . Joint Select Committee Challenge: BCA 2011 has tasked a bi-partisan Congressional Joint Select Committee to agree USD1.5trn of deficit-reduction measures by the end of November 2011. If agreement is reached and passed into law, it would demonstrate that a political consensus can be forged on deficit reduction and provide a platform for additional measures required in the medium term. In the event that the Joint Select Committee is unable to reach an agreement that can secure support from Congress and the Administration, Fitch would be less confident that credible and timely deficit- reduction strategy necessary to underpin the US ‘AAA’ sovereign rating and Stable Outlook will be forthcoming despite the USD1.2trn of automatic cuts that would follow. Debt to Stabilise: Fitch’s fiscal projections updated after BCA 2011 and recent economic data suggest that federal debt held by the public will stabilise at around 85% of GDP in the latter half of the 2010s (about USD16.1trn compared to USD9trn at end-2010). This is substantially higher than the debt burden projected for any other currently ‘AAA’ rated sovereign. In Fitch’s opinion, this is at the limit of the level of government indebtedness that would be consistent with the US retaining is ‘AAA’ status despite its underlying strengths. High Debt Tolerance: US sovereign liabilities, both the dollar and Treasury securities, remain the global benchmark, and accordingly the US credit profile benefits from unparalleled financing flexibility and enhanced debt tolerance, even relative to other large ‘AAA’ -rated sovereigns. Debt Ceiling Ineffective: The agreement reached under BCA 2011 to raise the debt ceiling should be sufficient to allow the federal government to fund itself through 2012. However, in Fitch’s opinion the debt ceiling is an ineffective tool for enforcing fiscal discipline as it cannot prevent future budget decisions that will incur debt issuance above the ceiling. Yet last-minute agreements to raise the ceiling undermine confidence in the sovereign’s willingness to pay. Medium-Term Fiscal Framework: The absence of a medium-term fiscal framework and the continuing debate about the pace and nature of any deficit-reduction strategy undermines the credibility of the commitment to fiscal consolidation and is a sovereign credit and rating weakness. Related Research Fitch Affirms United States at ‘AAA’; Outlook Stable (August 2011) Analysts David Riley + 44 20 3530 1175 [email protected] Douglas Renwick + 44 20 3530 1045 [email protected] John Olert + 1 212 908 0663 [email protected]

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