The state of California received some good news this week when credit rating agency Standard & Poor’s upgraded the state’s long-term rating to “A” on its $73 billion in general obligation (GO) bonds (a single A rating is four notches below AAA). It’s certainly a feel-good moment for Governor Jerry Brown and other public officials. The municipal bond market has been anticipating the state’s improving credit position for the last year, as you can see in the chart above. It shows that the extra interest cost (over the AAA gold standard) on the state’s bonds has declined in the last year. The Golden State is getting some sunshine in muniland.
A single “A” rating is not great for a state, especially one as large as California, which has substantial debt to service and relatively volatile tax receipts. Among the positive praise that Standard & Poor’s gave the state, there were also reminders of the risks that the state faces in achieving real fiscal stability. These risks include lawmakers loosening their fiscal restraints and restoring the social spending that had been cut during the fiscal crisis. Translation: Politicians will revert to promising more than they can afford. S&P explains (requires free registration):
But another part of the answer likely rests with state lawmakers. Given that fiscal restraint has been a crucial ingredient to the state’s strengthening financial position, we think the budget process itself contains some risk.
After implementing significant program cuts in consecutive years, we anticipate there could be political pressure to restore services that would entail higher costs and could undermine the state’s nascent fiscal balance. We also believe there is potential for windfall-like PIT [personal income tax] collections through the early months of 2013, reflecting robust capital gains from 2012. Initial January tax receipt data suggest a surge of PIT collections may already be underway. A temporary flood of revenue could embolden lawmakers that may already prefer to add back to state programs.
The California budget is now balanced on a knife’s edge and the general economy must keep growing for it to remain in balance. U.S. Fourth quarter 2012 GDP growth of negative 0.1 percent is not supportive of keeping the California budget stable. S&P again: