Fitch Downgrades the UK Rating, Predicts Rise in Deficit amid COVID-19 Outbreak

 On 27 March 2020, Credit Rating Agency Fitch announced a rating update for United Kingdom’s Long Term Issuer Default Rating (LT IDR), in which it was reported that United Kingdom’s Long Term Issuer Default Rating was being downgraded to AA- (Negative Outlook) from AA (Negative Outlook).

As per the Fitch Rating report, the primary key driver for downgrade was a reflection of a major deterioration of the United Kingdom's public finances due to the effects of COVID-19 outbreak. The rating agency attributed the negative outlook to a fiscal recession that was started before the severity of the crisis became evident. The downgrade also reflects the deep relatively close-term damage caused by the coronavirus pandemic to the British Economy and the persisting problems with regards to the United Kingdom and the European Union’s post-Brexit bilateral trade agreement.

The rating actions also include some other securities that were downgraded from the United Kingdom’s issuer. It was reported that the Local Currency Long Term Issuer Default Rating (LC LT IDR) was also downgraded from AA to AA- with the negative outlook reaffirmed, while the senior unsecure Long Term Rating was also downgraded by the same metric, with no change in the outlook. The rating giant affirmed the country’s Short Term Issuer Default Rating (ST IDR) as well as the Local Currency Short Term Issuer Default Rating (LC ST IDR) to F1 +. The country ceiling was also reaffirmed at AAA.

Reaction from Bond Investors

Investors are expecting a string of sovereign rating cuts as states ramp up spending to resolve the coronavirus crisis. The bond investors reportedly said that sovereign ratings are rarely a catalyst for government bond markets unless a country is in danger of losing its investment-grade status, which might cause some investors to sell if their mandates require them to hold junk-rated debt.

Some analysts also suggested that the markets would not care if the UK sovereign is downgraded, just like they did not bother when a few years ago other developed economies lost their top credit scores. It has also been suggested that the investors are now well aware that credit scores are on a downward trajectory everywhere. They believe it is just the junking that counts in terms of downgrades.

Rating Rationale by Fitch

The outbreak of coronavirus has caused an unparalleled shock on financial markets and economic activity, with policymakers trying to avert a protracted downturn. Along with other developed nations, the UK has shut down parts of its economy to prevent disease transmission, triggering a deep 2Q20-centered contraction. On March 23, Prime Minister Johnson proposed more drastic steps to curb the spread of COVID-19, including the closing of all non-essential shops and a ban on more than two people's public gatherings.

Based on Fitch’s methodology and much-revised baseline forecast reflecting UK-wide shutdown steps, the rating agency is now forecasting that GDP will decline by nearly 4 per cent in 2020. In the baseline, fitch expects that restraint steps can be unwound at 2H20, allowing for recovery in sequential growth and the broader economy, leading to a rapid recovery in growth to around 3 percent in 2021. Yet these economic projections pose significant downside risk, with too much dependency on the magnitude and duration of the coronavirus outbreak. A possible downside scenario, including a second wave of infections and a prolonged duration of lockout, is expected to see an even greater fall in production in 2020 and a slower recovery in 2021. Recovery strength is subject to Brexit ongoing uncertainty as the final shape of any potential EU trade agreement remains unknown and the possibility of the transition period ending without a contract persist.

Prior to the stimulus measures revealed in the budget on 11 March, the UK's public finances were expected to decline, and are now likely to deteriorate more rapidly. The government has proposed major fiscal policy easing to alleviate the economic effects of the lockdown measures. However, there remain some confusion about the fiscal effect, which seems to depend on the extent and duration of the lockdown and the durability of any progress in containment of coronavirus.

Fitch report on sector outlook after Covid-19 Impact

The deteriorating business climate and economic shutdowns would also present major challenges for companies across regions and most industries. The rapid rise in unemployment and unemployment claims in major developed and emerging markets point out to the significant loss of demand which are expected to have compound effects from the initial shutdown of supply. However, certain sectors, including utilities, telecommunications, food and healthcare, remain well positioned. In response to the rapidly deteriorating macroeconomic and operational environment linked to the effects of the coronavirus pandemic, Fitch Ratings has reviewed and updated their sector outlook globally with 83 per cent of the sector and structured financial asset performance outlooks being negative, an increase from 21 per cent at the start of 2020. As per the rating agency, there are no optimistic outlooks for the market.

Fitch Expects Rise in Deficit Due to Fiscal Loosening Presented in the UK Budget

The rating agency commented on the United Kingdom’s budget announced by the Chancellor of the Exchequer Rishi Sunak on 11 March 2020. Fitch highlighted the budget which showed that under the new rules most of the available fiscal space would be used up by higher expenditure primarily funded by increased borrowing. Sunak has announced yet another review of the fiscal system to be completed by fall 2020. According to the independent Office for Budget Responsibility (OBR), the budget will raise the UK fiscal deficit by approximately around £30 billion (1.4 per cent of 2019 GDP) by 2024-2025 and net debt by £125 billion (5.8 per cent of GDP) compared to the pre-budget baseline. It is when the OBR did not consider the additional GBP12 billion of measure.

In the commentary, Fitch stated that the UK budget reflects significant level of fiscal loosening which has led the agency to increase its deficit forecasts as part of its regular sovereign ratings review. Based on its research and estimates, Fitch predicts that the general government deficit will grow from 2.1 per cent of GDP in 2019 to ~9 per cent in 2021. Under this projection, the rating giant estimates that the Coronavirus Job Retention scheme would cost 1.3 percent of GDP, assuming the scheme would benefit 4.7 million workers over its three month term. The rating agency further expects the entire COVID-19 fiscal response package to cost 4.4 per cent of GDP in 2020.