Record reserve funds built by US states in the past two years are likely to be needed as tax receipts slow, federal pandemic aid dwindles and the economy heads toward a recession.
(Bloomberg) — Record reserve funds built by US states in the past two years are likely to be needed as tax receipts slow, federal pandemic aid dwindles and the economy heads toward a recession.
California already is projecting a massive deficit for next year and Illinois posted a “stunning” $1.84 billion drop in April receipts from a year ago. The National Association of State Budget Officers says most states are planning for softer revenue growth or slight declines for fiscal 2023 and 2024, after double-digit percentage increases for two consecutive years.
Overall states’ tax revenue growth is poised to decrease to between 0% and 5% from as high as 20% in each of the last two years, Nicholas Samuels, a senior vice president for Moody’s Investors Service, said in an emailed statement Wednesday.
“Reserves are at record highs and provide an important buffer to a potential downturn, but spending pressures are high too, especially for state employee wages that haven’t kept pace with inflation,” Samuels said.
Most states have built reserves amid increased odds of an imminent recession. Illinois, for example, is fortifying its rainy day fund to $1.9 billion in the fiscal year that ends June 30 from about $60,000 in 2019.
S&P Global Ratings said in an April 27 report that reserves are expected to remain “very strong,” with an average decline of 1.5% in 2024. Slower revenue growth, prior tax cuts and inflation “will likely necessitate some reserve drawdowns” even in the current fiscal year, BlackRock Inc. municipal analysts said in a report in April.
Even so, Hilltop Securities Inc. expects states to maintain their current credit quality, the highest overall in years, said Tom Kozlik, head of public policy and municipal strategy.
“State government credit quality is very strong,” Kozlik said. “If a economic downturn does materialize, they are much more prepared now,” he said.
Several rounds of federal stimulus and infrastructure legislation have helped state and local governments, even those with more strained budgets, improve to the best financial shape in years, Dan Close, head of municipals at Nuveen, said last week. He cited recent credit rating upgrades for Illinois, New Jersey, Connecticut and Chicago as examples of the strength of municipal issuers.
“Responsible fiscal decisions have led to surpluses allowing us to pay off debt, save for our future, and let us prepare for the possibility of a revenue slowdown,” Jordan Abudayyeh, a spokeswoman for Illinois Governor J.B. Pritzker, said in an emailed statement on Wednesday regarding the state’s budget. Illinois, the lowest-rated state, has earned multiple upgrades in the last two years.
Still, slowing retail sales, rising unemployment and inflation will chip away at revenue and raise costs for states, said Eve Lando, a portfolio manager for Thornburg Investment Management. But because the states haven’t gone on a spending spree with the federal stimulus money, she expects stability for the sector.
“This year is not going to be as robust as last year,” Lando said in an interview on Wednesday. “On the revenue side, it doesn’t feel like it’s going to be a cliff. Things don’t feel as drastic.”
Whether investors reward states with greater demand for their bonds remains a question. Lando expects municipal debt to cheapen as the slowdown takes hold.
“Parts of the curve still feel quite expensive,” she said. “As negative news comes out, the muni market will react.”
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