Who will pay if the US loses its 'AAA'?

Apr 19, 2011

In this issue:
» Consumer prices in India to halve in 2011
» Debt crisis in Europe is far from over
» Panicked investors flock to gold
» World steel demand is set to rise
» ...and more!

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Credit rating agencies so far had been unwilling to downgrade the US. This is even after the global financial crisis deepened in the US in 2008 and wreaked havoc on its economy and the markets. Since then, the US government has been doling out stimulus packages by the dozen all of which has put considerable strain on the government's finances. Fiscal deficit has ballooned tremendously. Unemployment has remained persistently high.

What is more, none of the stimulus measures have done anything significant other than prop up economy recovery for the short term and the government seems quite clueless as to what to do next. So, while it comes as no surprise that the S&P has decided to downgrade America's credit rating, one wonders why it was not done earlier.

Whatever be the case, the possibility of the US losing its AAA rating could result in a wholesale abandonment of dollar assets and would potentially destabilize the entire global economy. For the US specifically, it will put an added pressure in the form of rewards to be meted out for more risks taken by investors from a less credit worthy country. It means that interest rates in the US are bound to go up. This does not bode well for an economy which is still to post a significant recovery. As it is, the US dollar has increasingly come under pressure with many countries questioning its status as the world's reserve currency.

The crisis that US is facing right now is quite similar to what Japan faced in 1998. Then Moody's had revised its outlook on Japan's AAA-rated sovereign debt to negative from stable. Thus, the yen sank to its lowest level in six years and government bond prices fell sharply. Indeed, the US is hard pressed for choice and will have to now focus on bringing its deficit down if it does not want to lose its standing in the global arena. It is very obvious that its stimulus measures have not yielded the desired results and the sooner the government realizes that the better off it may be.

Do you think that a downgrade in the US' credit rating will have an adverse impact on the global economy? Share with us or post your comments on our facebook page.

 Chart of the day
India's inflation was considerably high in 2010, so much so that there was a huge gap between consumer prices in the country and those elsewhere. 2011 is expected to be a different story. As today's chart of the day shows, growth in consumer prices in India are expected to almost half in 2011 as the RBI has resorted to a slew of rate hikes. Not just that, while prices in India are expected to come down, those in the developed world are expected to rise.

Data Source: The Economist

As Standard & Poor downgraded the government debt of United States, panicked investors shifted their focus back to the safe haven. Gold. The importance of having gold in one's portfolio has been highlighted again and again. It is the hard currency that has withstood the test of time. And when times are as testing as those currently, then it is not surprising that gold is in limelight once again. The yellow metal saw its prices surge to US$ 1,500 yesterday when the downgrade of US debt was made. As fresh worries haunt global sentiments, investors have flocked to precious metals gold and silver. However, the run up in silver prices has been much sharper as compared to gold. One could argue that this is mainly on account of the fact that silver was comparatively undervalued and therefore saw a faster rise in prices. However, the steep run may not be in line with its fundamentals. Nevertheless, gold and silver are currently the heroes for investors.

A leading daily reports on how many companies are letting go of permission from SEBI to come out with an IPO. The reason? Well, they believe that if they come out with an IPO now, there may not be enough takers. And even if they do then the valuation discount will have to be high and this would mean greater dilution of promoter holding. Time is fast running out for these companies. As per regulations, IPOs with a certain offer document have to come out within one year of getting approval for it. However, if the deadline is missed then a revised offer document has to be submitted, resulting into more paperwork for the company. Surprisingly, companies are willing to take this latter route rather than come out with an IPO now. They seem to be too scared of the current market environment. Uncertainty is ruling high and investors are not in the best of moods. This logic though is a little baffling to us. And it certainly creates doubts in our minds. If the company under consideration has strong fundamentals and is attractively pricing its IPOs, it should always find takers no matter what the environment. The very fact that there is hesitation on the part of companies means that their quality seems to be suspect. An important lesson to remember the next time you think of investing in IPOs we believe.

The crisis in Japan and Middle East may have clouded the memories of debt contagion in Europe for some time. But rest assured that the crisis in Euro zone is far from over. So much so that the worst affected amongst the PIGS, Greece, may soon have to exit from the European Union. It may be recalled that Greece, sealed a Euro 110 bn (US$ 158 bn) bailout from the EU and IMF a year ago. However, the economy's debt burden has once again rung the alarm bells for EU policymakers. Greece, saddled with a debt burden that is expected to swell to 160% of GDP by 2013, has repeatedly denied its plans to restructure debt. The Bank of Greece is even open to privatizing or selling government assets. However, given the economy's allegiance to the EU, the debt restructuring seems inevitable. Thus, the signs of the Euro emerging any stronger than the US dollar are clearly missing. The need for a more stable currency may keep investor interest in gold at higher levels.

1.4 bn tonnes! That's the estimated 2012 global steel demand by the World Steel Association. While this will be the highest steel demand ever, there is clear ongoing shift in the steel consumption areas. Emerging and developing economies combined are expected to account for 72% of the total steel demand. This will be a significant increase from 61% in 2007.

China, which leads the global steel production, is expected to witness a slowdown in its steel demand from 10% to 5-6%. This is mainly due to austerity measures undertaken by the government to curb the rising inflation. Emerging economies as a whole will see their steel demand going above the pre-crisis levels. India's steel demand is expected to grow by 13.3% this year and 14.3% in 2012. A robust domestic economy, massive infrastructure needs and expansion of industrial capacities will be the main drivers. On the other hand, steel demand in developed economies will lag behind the record levels of 2007-08.

It is important to note that these estimates have not factored the losses caused by natural calamities in Japan, the world's second largest steel producer. There are rough estimates that 7-10 m tonnes of steel capacity have been impacted this year.

Get ready for a double whammy soon. Crude oil prices are currently at a two and a half year high. This rise in prices has the ability to derail global economic growth and spur an increase in inflation, which is already at warning levels. Increased speculation in commodity markets and trading in 'paper barrels' have also led to this huge spike.

In India specifically, high oil prices are an even bigger cause of concern. The Indian population has not yet seen the effect of high oil prices. This is because a large portion of fuel costs are subsidised by the government. At the current levels of US$ 108 per barrel, state oil firms are projected to lose a tremendous Rs 1.8 trillion on selling fuel below market prices. If prices do not slow down, the government will either have to shell out more rupees or we will soon have to get used to paying a lot more for fuel. It looks like we are stuck between the devil and the deep sea.

Indian stock market indices had a rather volatile outing today as they oscillated to either side of yesterday's close. At the time of writing, the BSE Sensex was trading higher by 55 points. Most Asian markets, however, were trading in the red today with China and Japan trading lower by 2% and 1% respectively.

 Today's investing mantra
"The really big money tends to be made by investors who are right on qualitative decisions but, at least in my opinion, the more sure money tends to be made on the obvious quantitative decisions." - Warren Buffett

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13 Responses to "Who will pay if the US loses its 'AAA'?"


Apr 19, 2011

I am not sure if S&P downgraded US Credit Rating. They merely assigned a negative outlook to the credit rating. There is difference between both I guess.



Apr 19, 2011

I have never understood why the US should lose it AAA status for USD debt. AAA signifies that the probability of default is below a certain level!!
US being the issuer of USD can print more notes to retire its debt and hence there is no question of default. let me know if there is any other perspective about credit rating!!



Apr 19, 2011

This downgrade is long overdue.But the price rise in gold & silver is not based on fundamentals of supply & demand - it is only derived from irrational fear due to unstable dollar.

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