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Moody's: US Budget First Step, Not Solution, to Debt Sustainability

February 03, 2010 | Moody's Investors Service

New York, February 02, 2010 -- The US government budget presented on
February 1 was a small start to the big task of returning to a
sustainable debt trajectory, but further measures will be necessary if
that task is to be accomplished, Moody's Investors Service says in an
issuer comment.

Unless further measures are taken to reduce the budget deficit further or
the economy rebounds more vigorously than expected, the federal financial
picture as presented in the projections for the next decade will at some
point put pressure on the Aaa government bond rating.

"Freezing part of discretionary spending for a three-year period
beginning in the next fiscal year is a positive step from a rating perspective, says Moody's Senior Credit Officer Steven Hess. "However,
the deficits projected in the budget do not stabilize debt levels in
relation to GDP, and the portion of government expenditures going to pay
interest on the debt shows a steady rise."

The government is constrained for the time being by the high unemployment rate. A big fiscal adjustment right now would be politically difficult and could slow the economic recovery. In addition, extra spending for
employment creation in the current fiscal year adds to the long-term debt
trajectory.

Entitlement programs will also put significant pressure on the
government's fiscal position toward the end of the current decade and
thereafter, regardless of the new budget proposals.

"The debt trajectory is clearly continuously upward if further measures are not implemented," Moody's Hess says.

He explains that as interest rates rise from their presently very low level and the size of the debt increases, debt affordability will deteriorate in a major way. Under the proposed budget, the ratio of
interest repayments to revenue will double from 8.7% in the current
fiscal year to a very high 17.8% by 2020—approximately equal to the
highest level in recent decades, reached in the 1980s.

However, the ratio of federal government debt to federal government revenue, another measure used by Moody's to assess the government's financial strength, will fall somewhat from 429% in the current year to
394% in 2020. This is still a high level and is not a strong improvement.
The government's projections show that federal debt held by the public
will rise continuously, reaching 77% of GDP by 2020 (compared with 53% at
the end of FY 2009 and 64% at the end of the current fiscal year). Using
the general government measure (including state and local governments as
well as the federal government), which is used internationally, this
ratio would be well over 100% in 2020.

The administration itself, in the budget release, recognized that further
measures were necessary by announcing its intention to establish a Fiscal
Commission. The newly released budget projections include a primary
deficit of 0.9% of GDP in 2015. The Commission's mandate would be to move
the budget excluding interest expenditures (the primary balance) to a
balanced position by 2015. In addition, the Commission's goal may be
politically difficult to achieve in that it would require further budget
cuts or tax increases.

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