The US rating agency said the US, the UK, Germany, France, and Spain are walking a tightrope as they try to bring public finances under control without nipping recovery in the bud. It warned of “substantial execution risk” in withdrawal of stimulus.
“Growth alone will not resolve an increasingly complicated debt equation. Preserving debt affordability at levels consistent with AAA ratings will invariably require fiscal adjustments of a magnitude that, in some cases, will test social cohesion,” said Pierre Cailleteau, the chief author.
“We are not talking about revolution, but the severity of the crisis will force governments to make painful choices that expose weaknesses in society,” he said.
If countries tighten too soon, they risk stifling recovery and making maters worse by eroding tax revenues: yet waiting too is “no less risky” as it would test market patience. “At the current elevated debt levels, a rise in the government’s cost of funding can very quickly render debt much less affordable.”
Moody’s said Britain has been slower than Spain to “rise to the challenge” and may be at greater risk of smashing through buffers of AAA creditiblity if rates suddenly rise. Spain made errors at the outset of the crisis but has since become a model pupil, pledging to cut the budget deficit from 11.4pc of GDP to 3pc by 2013.
Britain is moving much more slowly, cutting its deficit to around 5.5pc of GDP over four years – though written into law, unlike Spain’s pledge. At best, debt is likely to stabilise at 90pc of GDP. It could reach 100pc by 2013 if growth falters.
The Treasury said the assessment is unduly gloomy given that the maturity of UK debt is over 14 years, double the AAA average. This greatly reduces roll-over risk, giving Britain time to steady the ship.
The concern is what will happen as the Bank of England stops purchasing bonds. An IMF study said quantitative easing had lopped 40 to 100 basis points off debt costs. “The discontinuation of these purchases creates upside risk to yields,” said Moody’s.
Moody’s said the saving grace for both Britain and the UK is a good a track record of belt-tightening when necessary, and a tax and spending structure that makes it easier to whittle away the debt once recovery starts. Concerns about a hung Parliament in Britain appear overblown given the broad political consensus on the need for austerity.