by Andrew L Dcunha
Aug 8: The world's largest creditor, the United States of America, has lost its top credit rating from Standard and Poor’s (S&P’s). S&P’s downgraded the US’s long term AAA credit rating by a notch to AA+ while keeping the outlook as negative.
“The downgrade reflects its opinion that the fiscal consolidation plan which Congress and the administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.`` the agency said in a statement after market closed on Friday.
US President Barack Obama Tuesday signed a bill that raises the nation's debt limit through 2013 and cuts the deficit by more than $2 trillion, but the deficit-cutting package fell far short of the $4 trillion cited by S&P to avoid a downgrade
The credit ratings agency asserted a negative outlook on long term US debt. It even warned of a further downgrade in the rating within the next 2 years if the US government's debt burden grows higher than that assumed by S&P’s.
China, the largest foreign holder of US government debt, commented that Washington only had itself to blame and called for a new stable global reserve currency.
What is Credit Rating and what does downgrade mean?
Credit rating gives the investor an idea about the creditworthiness of the debtor and the risk of default. If a bond has a low credit rating, it means there is more risk.
Many investors only want bonds with an AAA rating. When there is less demand, the US may have to pay higher interest rates to tempt buyers in the future. That could raise borrowing costs not just for the government, but across the economy. Naturally this will hit and dent the stock market.
Who is Standard & Poor's?
It is one of the three big ratings agencies. Other two are (Moody's Investor Service, and Fitch Ratings) Their job is to look at investments and company debt and decide precisely how safe this is for investors to buy into.
What is India’s exposure to US Debt?
India’s Exposure to US debt is estimated at about $ 41 billion ( Rs 1.83 lakh crores rupees). India is 14th largest foreign debt creditor to US. Others are China ($ 1.15 trillion) followed by Japan ($ 912 billion), the UK ($ 346 billion), Brazil ($ 211 billion), Taiwan ($ 153 billion), Hong Kong (122 billion), Russia ($ 115 billion), Switzerland ($ 108 billion), Canada ($ 91 billion), Luxembourg ($ 68 billion), Germany ($ 61 billion), Thailand ($ 60 billion), Singapore ($ 57 billion)
US downgrade – what is the impact on India?
There will be a short term sentimental impact on India. Stock market will see knee-jerk reaction due to negative sentiments. Sell-off in commodity market may benefit Indian in medium term. Indian currency market and trade flows will be impacted. Indian exports are likely to be affected due to possibility of rupee appreciating against dollar. IT sector is likely to be more hurt. Garments, handicrafts, leather, gems and jewellery exports will get affected due to rupee appreciation and also additional taxes in US.Llikely fall in commodity and oil prices would ease pressure on inflation in medium term. The dollar weakening will benefit imports, thereby putting pressure on domestic manufacturing. Fforeign Institutional Investors may pull out their money from Indian market for shorter term. Current situation might turn out to be good for Indian market in the long-term as India has strong fundamentals among its peers and attracts more international inward financial flows.
Finance Minister Pranab Mukherjee on Saturday said that India has taken several measures to make its markets attractive, robust and vibrant and would continue to do making it an attractive investment destination for foreign capital. Commenting on US downgrade, Finance Minister asserted that India's growth story is intact and the country would achieve appreciable economic expansion despite negative sentiments across the world. "Our growth story is intact and fundamentals are strong. Our markets have the capacity to withstand the negative sentiments affecting the external world," Pranab said while addressing the industry captains at a function organised by the Confederation of Indian Industry (CII).
Andrew L D Cunha, Managing Director, WinWin Fin Advisory Pvt Ltd. Mangalore. Contact: finadvisoryltd@yahoo.com