Moody’s: More action needed to avoid credit rating downgrade

Moody’s Investors Service announced Thursday that a compromise to avoid the “fiscal cliff” is not enough to protect the nation’s AAA rating, calling for further action from policymakers.

It said a deal over raising the debt limit, which could include new spending cuts, tax hikes and entitlement reforms, could determine whether the nation’s credit rating is downgraded. 

{mosads}”The debt trajectory resulting from this process is likely to determine whether the Aaa rating is returned to a stable outlook or downgraded to Aa1,” the agency said.

The Treasury Department said the U.S. reached its $16.4 trillion debt limit on Dec. 31, but that extraordinary measures can be taken for roughly the next two months to keep paying the nation’s bills.

The credit rater said the deal hammered out by Congress and the White House on taxes is merely a first step, and the U.S.’s credit rating could be affected “negatively” if Washington fails to take further steps to rein in the deficit. In fact, it said it was “necessary” for policymakers to adopt further measures to bring down the deficit to keep the U.S. rating intact.

Moody’s called the compromise a “further step” in clarifying the nation’s debt trajectory, but said it was far from sufficient.

“It does not … provide a basis for meaningful improvement in the government’s debt ratios over the medium term,” the rater said.

The bill approved by the House and Senate raises tax rates on annual incomes above $450,000 for families and $400,000 for individuals. 

But the rater noted that the increased revenue is “far outweighed” by the cost of extending tax cuts for income below that level, the permanent patch to the alternative minimum tax and other tax breaks.

The Congressional Budget Office has said the deal would add $3.97 trillion to deficits over the next decade. 

Moody’s noted that while the package’s overall impact on the economy is positive, the expiration of the payroll tax cut is going to put a pinch on economic growth. And the ultimate fate of the sequester could further hinder economic growth depending on how Congress deals with it, Moody’s added.

“The recent package mitigates part of the fiscal drag on the economy associated with the fiscal cliff but does not eliminate it,” the rater said.

Moody’s and fellow rater Fitch Ratings have kept the U.S. credit rating at AAA, but both have placed it on a negative outlook for a downgrade, pending a change in fiscal course. Standard & Poor’s downgraded the U.S. for the first time ever following the last standoff over the debt limit in August 2011.

Fitch has yet to weigh in on the fiscal-cliff agreement, and what it might mean for its evaluation of the nation’s creditworthiness.