Warnings continue to sound over U.S. Fiscal Cliff

US Fiscal cliff

Moody’s Investors Service said Monday that if U.S. action to address an upcoming “fiscal cliff” is delayed till next year, which looks increasingly likely, it will need to see commitment from U.S. lawmakers to reaching a budget agreement and a clear timetable for reforms in order for the world’s largest economy to maintain its top-notch rating.

Writing in the biweekly Credit Outlook report, Moody’s Senior Vice President Steven Hess and Managing Director for Sovereign Risk Bart Oosterveld said that the U.S. political landscape remained “highly polarized and unpredictable” after the presidential election.

Unless the U.S. Congress acts before the end of the year, a combination of around $500 billion in tax increases and spending cuts could begin to take effect, which economists have warned could drag the U.S. economy back into recession.

“A scenario whereby action on the budget is delayed until sometime in 2013 appears increasingly likely; for example, via a temporary extension of most measures except the increase in payroll tax,” Moody’s officials said.

“Such deferment, if not accompanied by an apparent commitment to achieving agreement and a credible timetable for implementing the necessary reforms to preserve sovereign creditworthiness, would be inconsistent with maintaining a Aaa rating,” they warned.

If the U.S. falls off this fiscal cliff into recession, the outlook for the world economy, already gloomy, will darken further.

The task of keeping the eurozone afloat, amid scared investors and depression-level unemployment in Spain and Greece, will become even harder.

The risk of a renewed global banking crisis triggered by sovereign defaults in Europe would escalate sharply. Nor could the U.S. or Europe deploy the policy arsenal they possessed in 2008 to right the ship — their fiscal and monetary bullets have been spent.

Confronted with this dire alternative, President Obama will have to compromise by accepting a program of long-term cuts in social programs while Republicans accept phased tax increases, both departing from their diametrically opposed electoral platforms.

As a minimum, this compromise will include a claw back of the payroll tax reduction, and of extended unemployment benefits as well as some expenditure cuts, adding up to 1% to 2% of U.S. GDP in 2013.

The likely effect will be that the recovery will remain sluggish, and the world’s growth locomotives will again have to be found, if anywhere, in China and other emerging markets.

The uncertainty surrounding the U.S. fiscal outlook is likely to persist for several months and if, as is possible, the only feasible compromise turns out to be temporary, new fiscal cliffs may loom in the future, extending the uncertainty over years to come.

This outcome is possible because the election outcome has not fundamentally altered the balance of forces.

Moody’s has a negative outlook on its U.S. rating.

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