Moody’s Downgrades US Sovereign Debt Rating – Implications for Indian Equities

On May 16, 2025, Moody’s downgraded the US sovereign debt rating from AAA to AA1, aligning with earlier downgrades by Fitch (August 2023) and S&P (August 2011). This is the first time since 1917 that Moody’s has rated US sovereign debt below AAA.

Amidst rising uncertainty and curiosity, this note aims to shed light on the drivers of the downgrade and its implications for Indian equities.

Reasons for the Downgrade

Unsustainable Fiscal Trajectory:
The US federal budget deficit is nearly $2 trillion per year, exceeding 6% of GDP. This persistent fiscal imbalance is worsened by the absence of a credible long-term plan to stabilize or reduce debt levels.

Lack of Effective Fiscal Governance:
Ongoing political dysfunction in Congress, including the recent failure of the Republican-led “Big Beautiful Bill” in the House, and the limited effectiveness of the Department of Government Efficiency (DOGE) in addressing fiscal challenges, have heightened concerns.

Risks from Upcoming Tax and Spending Plans:
The Trump administration’s push to extend the 2017 tax cuts could add over $4.2 trillion to the deficit over the next decade. Proposed offsetting measures-such as spending cuts and new taxes-are widely seen as either inadequate or politically unviable.

Rising Interest Costs:
Elevated Treasury yields, driven by inflation and fiscal worries, are increasing the cost of debt servicing, further aggravating deficit concerns.

Despite the downgrade, it is important to note that all three major rating agencies continue to classify US debt as investment grade.

Impact on Indian Equity Markets

This news could lead to a short-term knee-jerk reaction in US and Indian equities. The long-term performance would depend on various factors, including corporate earnings, GDP growth, inflation and interest rates, among others.

We, at Vika Wealth, track all the above factors on a monthly basis and take informed asset allocation decisions.

We foresee the following indirect effects on India:

Capital Outflows from Emerging Markets:
Higher US yields could trigger capital outflows from emerging markets, creating headwinds for equities in these regions, including India. This dynamic may strengthen the US dollar and exert pressure on the Indian rupee.

APAC Rotation to India’s Advantage:
On the positive side, India-being a front-runner in the Asia-Pacific (APAC) region, backed by strong fundamentals and robust growth potential-is well positioned to benefit from global rotation towards APAC markets.

We remain confident in our outlook for India and its long-term growth potential over the next decade. As such, do not stay out of the Indian markets in attempts to time the market. It is important to have a strategic asset allocation, with periodic reviews.