Fitch jumped on the downgrade bandwagon on Friday, cutting the UK’s credit rating one notch to AA+—just like Moody’s did in February. And like Moody’s downgrade, Fitch’s move shouldn’t be much of a game changer for UK debt markets.
In its statement, Fitch cited the “weaker economic and fiscal outlook” and claimed the UK has “no fiscal space to absorb further adverse economic and financial shocks.”
I polled a few of my colleagues, and none of us have any idea what “fiscal space” means—leave it to a ratings agency to use indecipherable lingo instead of plain English. But if Fitch is referring to the UK’s ability to continue servicing debt if the economy worsens, I disagree—some simple data from gilt markets show the Treasury has plenty of breathing room.
The chart below shows the average maturity and yields of all outstanding gilts, excluding those the government owns itself (which effectively cancel). The longer the maturity, the longer the UK has to repay its debt—and the less near-term economic troubles impact repayment risk. The lower the yield, the cheaper that debt is. As you’ll see, the maturity’s lengthened by nearly three years since June 2005, and the average yield has fallen by more than half. That means UK debt is arguably more sustainable today than it was eight years ago—that hardly merits a downgrade.
Exhibit: Average Maturity and Yield of Outstanding Gilts (Net)
Source: UK Debt Management Office, 6/1/2005 – 12/31/2012.
Another piece of Fitch’s rationale seems similarly flawed: The agency doesn’t believe UK debt will get under 90% of GDP in a reasonable amount of time.
What’s so magic about 90%? Well, that’s the level two well-respected US economists claimed is the tipping point for a country’s public debt—in a study they conducted three years ago, they found that once debt hits 90% of GDP, average economic growth falls from 3% to -0.1% (based on historical data since WWII). Those findings have underpinned many nations’ and organizations’ policies and recommendations since 2010. But last week, a few researchers from the University of Massachusetts debunked those findings. After they examined the dataset and methodology used in the initial study, they found the results were skewed by an Excel coding error, omitted data and a strangely high weighting of one datapoint (New Zealand in 1951). After accounting for those errors, they reran the analysis and found that growth averages over 2% once debt hits 90% of GDP. The 90% mark simply isn’t a dividing line between sustainable and unsustainable debt (as history would tell us, considering the UK’s grown tremendously over time despite having debt levels far higher than 90% at times).
So once again, it seems a rater has based its decision on an arbitrary benchmark, not the UK’s creditworthiness.