Credit scores are of critical importance to state governments. A low rating can suggest to investors that a government is more likely to default on the debt it issues. This makes it more expensive for a state to borrow money and adds constraints to its budget. However, a strong rainy day fund can have a significant positive impact on a state’s credit rating.
A net savings account will make rating agencies – and investors – more confident that the state will be able to pay its bills, but state officials sometimes fear that the use of their same day deposited online as intended. Rainy Day funds hurt their ratings, even in an economic downturn, because as severe as the one they face now.
However, interviews with senior officials at the three largest credit rating agencies – Fitch, Moody’s and S&P Global – and additional research from Pew clearly show that withdrawals from reserves at appropriate times may not be negative credit. In fact, tapping the fund for rainy days can reduce the risk of credit downgrade.
Rating agencies typically favor states that design their funds for rainy days to align with turning points in the business cycle by depositing income during good times and spending those reserves when things go bad. Funds can be a tool to cover budget deficits.
Rainy day funds are most effective if used as part of a multi-year strategic plan. Accessing reserves early can save time in the budget cycle to explore other options. Still, Emily Raimes, vice president and senior credit officer for Moody’s Investors Service, said her agency looks more favorable when states don’t fully deplete the fund at the start of a downturn.
Such an approach, she said, “means states are ready to seek out all the tools instead of using the simplest thing first.”
Raimes continued, “If a state has used all of its reserves to close the ’20 fiscal budget, it may indicate that subsequent decisions will be more difficult for it than for other states.”
Experts from rating agencies have all stressed the importance of considering the full range of options available to close budget deficits during a recession.
Doug Offerman, senior director of Fitch, said that “Fiscal reserves are a big part of the conversation, but there is a larger conversation about financial resilience.” Agencies are also supportive of exploring other budget management tools, such as cash transfers and spending cuts.
Eric Kim, senior director and head of U.S. state ratings at Fitch, added that given the speed and severity of this recession, state officials found themselves considering options they would not have. may not have been explored in a typical recession.
Raimes and Geoffrey Buswick, managing director of S&P Global, both stressed the importance for states to have a plan to rebuild their fund balances for rainy days. Raimes explained that Moody’s analysts “positively believe that there are guidelines for investing in the rainy day fund and its replenishment. We consider this to be quite positive when there are rules and guidelines, which shows self-imposed discipline. ”
According to Pew’s research on reserve funds, deposits should be proportional to economic growth or income; the periods of strongest growth should therefore be linked to the largest deposits. This allows reserves to grow as a state’s fiscal outlook begins to recover.
Smart design and management of rainy day funds is at the heart of how credit rating agencies perceive the fiscal health of state government. To earn and keep good grades, heads of state should establish back-up policies that take advantage of income volatility in business cycles. If they have taken such steps, states that withdraw from reserves during recessions – or when a global event such as the COVID-19 pandemic decreases their income – are unlikely to see their creditworthiness drop as a result. .
Jeff Chapman is a director and Airlie Loiaconi and Sheanna Gomes are senior partners in The Pew Charitable Trusts’ State Fiscal Health Project.