Moody's downgrade and U.S. fiscal reality

The Hindu

12-06-2025

Amid the chaos set in by churning events and spurring global uncertainty, there is an interesting financial trend that mainstream analysts are perhaps missing. It is well known in economic history how certain shifts don't arrive with the roar of crisis or the panic of a crash, but with the quiet authority of inevitability — which does have a crisis bearing, a fact that often emerges post the aftermath of a shock.
When Moody's Investors Service finally downgraded the credit rating of the Unites States on May 16, there was no dramatic nosedive in the markets, no frantic emergency meetings, no calamitous plunge in investor confidence.
Outwardly, the world barely flinched. Yet beneath that projected calm, a silent but monumental shift occurred — one, we argue, may be remembered not for the noise it made, but for silently indicating the end of a long era of unchallenged U.S. fiscal supremacy.
Foreshadowed for years
What made this moment so striking was not that it happened suddenly, but that it had been forecast in whispers and footnotes of financial discourse for years. For many, this was a long-delayed acknowledgement that the financial world had been indulging in a fiction for far too long.
For most of the post-war period, the U.S. held a rarefied status in the global economy. Its treasury bonds were the closest thing the financial system had to a sacred object, utterly liquid, unfailingly safe, and supported by the full faith and credit of the world's largest and most dynamic economy. This privileged position was not merely a reflection of economic size or military might; it was about trust.
Trust in America's institutions, its political system, its capacity for self-correction, and its willingness, however flawed, to eventually rein in excess.
But the numbers have grown impossible to ignore.
From discipline to dependence
A national debt that once stood at manageable levels has ballooned into a structural liability, breaching 120% of Gross Domestic Product (GDP), and with U.S. President Donald Trump's latest 'Big New Bill', it's showing no signs of retreat. Policymakers now speak about fiscal sustainability in theoretical terms, while pushing actual solutions further down an ever-narrowing road.
This erosion has been gradual but persistent.
The post-2008 era ushered in a new norm of emergency spending, first to rescue banks, then to stimulate recovery, and later to shield households from the pandemic's chaos.
Each intervention may have been justified in its own moment, but together they forged a long-term addiction of monetarists to deficit finance.
Unlike the post-World War II generation that slashed debt aggressively through a combination of growth and fiscal discipline, today's political class appears paralysed by polarisation and unable to even pass budgets without the threat of shutdown.
The confidence that also once underpinned U.S. borrowing, rooted as much in political stability as in economic fundamentals, has taken a series of subtle but significant blows, culminating in Moody's reluctant decision to strip away its final vote of unquestioning faith.
Global recalibration
But this downgrade, though symbolic, carries implications that ripple far beyond Wall Street. It comes at a time when global financial allegiances are shifting, when the dollar's centrality in international reserves is already under quiet attack, and when major economies are exploring alternatives to a U.S.-centric system.
Central banks that once loaded up on treasuries with near-religious regularity are now hedging with gold. The euro and other digital currencies are not a distant idea. And while the markets have taken this moment in stride, history teaches us that great financial unravelings rarely begin with panic — they begin with a shrug. The cost becomes visible only later.
It is in this context that the Moody's downgrade must be understood, not as a trigger of immediate collapse, but as a marker of long-building pressure finally piercing the illusion of permanence.
The world has not yet turned away from the dollar, but it has begun to look around. And that moment of looking, that quiet recalibration of confidence, may ultimately prove more consequential than any single rating change.
As the curtain lifts on a new era of fiscal realism, it is worth asking what this development means not just for the U.S., but for countries that have built their own economic strategies around American reliability. The implications for India and the rest of the world are only just beginning to come into focus.
India's fiscal mirror
For India, this moment is less about what happens in Washington and more about what it reveals back home: about our financial vulnerabilities, habits, and unwillingness to learn until the consequences knock louder and harder in a crisis like emergency-response mode.
The Indian economy is not immune to global fiscal contractions.
With general government gross debt hovering near 80% of GDP (IMF 2025), our buffers are limited, especially in an environment of rising global interest rates. As U.S. Treasury yields climb to accommodate perceived risk, investors begin to reprice emerging market debt, and India, despite its growth story, remains vulnerable. This isn't just speculation.
We saw it vividly during the 2013 taper tantrum, when capital outflows pummelled the rupee and exposed our dependence on external financing. A similar shift today would pressure the Reserve Bank of India, complicate deficit management, and test India's ability to shield growth without stoking inflation.
Deeper fiscal malaise
But beyond macro shocks lies a deeper malaise, which is our domestic fiscal culture.
While India dreams big, it continues to drag a ball and chain of fiscal populism.
Successive governments have treated pre-election seasons as open tabs of irrational fiscal exuberance, which come with serious budgetary and fiscal health warnings.
The recent Lok Sabha and Vidhan Sabha elections also saw parties tripping over themselves with giveaways, and if Bihar's upcoming polls are anything to go by, we should probably brace for another round of headline-grabbing promises. One suspects the only limit left is creativity.
This fiscal approach comes with compounding ripple effects. High deficits crowd out private investment, distort credit flows, and leave little room for developmental capital. Structural inefficiencies, such as low tax compliance and judicial delays in insolvency cases, to underperforming logistics and lagging education outcomes, further create friction that slows down our momentum when we most need agility. The result is a disconnect.
Globally, the downgrade of the U.S. credit ratings serves as a mirror and a point of deeper financial, fiscal strategic introspection.
Emerging markets with heavy debt burdens and borrowing positions accompanied by low-growth cycles, like Brazil and South Africa too are already facing rising borrowing costs. Even developed economies, including Germany (debt-to-GDP at 62.5%) and Canada (at 110.8%), now operate under closer scrutiny. The message is clear: credibility is no longer inherited; it must be earned and maintained.
For India, this is surely not a moment to panic, but a moment to pause, reflect, and enact fiscal caution and financial discipline. Not because we are in the line of fire, but because the conditions that brought the fire elsewhere are not unfamiliar. The discipline we often defer cannot be delayed forever.
If fiscal credibility is being repriced globally, India must ask whether it wants to wait for markets to demand change or lead that change on its own terms.
Caution and prudence for India
Fiscal caution and prudence are no longer virtues for crisis moments, they are the foundation for resilience in this age of the new normal. Caution for India does not mean a widespread adoption of austerity measures; rather, it means there is more clarity needed in strategy, both in the short, medium-and-long term. It means investing not in headlines, but in core economic foundations: job-creating infrastructure, future-ready skills, and systems that outlast election cycles. It means resisting the seduction of easy populism.
Loan waivers and free power may win votes, but they do little to build the trust that both global capital and citizens themselves seek in a modern state. Structural reforms must move beyond committee reports. Trade resilience must be rooted not in slogans but in strategic diversification.
Above all, Indian policymakers need to recognise that in the age of capital mobility, the loss of credibility is rarely noisy, but always consequentially expensive. While the U.S. has reminded the world that prestige is not protection, India should take the hint early.
(Deepanshu Mohan is Professor and Dean, O.P. Jindal Global University. He is currently a Visiting Professor at London School of Economics and Visiting Research Fellow, University of Oxford. Ankur Singh contributed to this column as a research analyst)