downgrading of sovereign debt ratings

8/10/2019 Downgrading of Sovereign Debt Ratings

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SHAHEED SUKHDEV COLLEGE OF BUSINESS STUDIES

Downgrading of the

Sovereign Debt Ratings

Resham Dang BFIA III (15951)

8/28/2011

Sovereign credit rating, Criteria, Rating of US, Japan and India and Impact of downgrades


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Sovereign Credit Rating

What Does Sovereign Credit Rating Mean?

The credit rating of a country or sovereign entity. Sovereign credit ratings give investors insight into the

level of risk associated with investing in a particular country and also include political risks. At the request

of the country, a credit rating agency will evaluate the country's economic and political environment todetermine a representative credit rating. Obtaining a good sovereign credit rating is usually essential

for developing countries in order to access funding in international bond markets.

Another common reason for obtaining sovereign credit ratings, other than issuing bonds in external debt

markets, is to attract foreign direct investment. To give investors confidence in investing in their

country, many countries seek ratings from credit rating agencies like Standard and Poors, Moody's, and

Fitch to provide financial transparency and demonstrate their credit standing.

Source of definition: http://www.investopedia.com/terms/s/sovereign-credit-rating.asp#ixzz1WItiqQOD

CRITERIA FOR SOVEREIGN CREDIT RATING

STANDARD POORS

(Source:http://www.standardandpoors.com/prot/ratings/articles/en/ap/?assetID=1245315323295)

The five key factors that form the foundation of S&Ps sovereign credit analysis are:

Institutional effectiveness and political risks, reflected in the POLITICAL SCORE

Economic structure and growth prospects, reflected in the ECONOMIC SCORE

External liquidity and international investment position, reflected in the EXTERNAL SCORE

Fiscal performance and flexibility, as well as debt burden, reflected in the FISCAL SCORE

Monetary flexibility, reflected in the MONETARY SCORE

Assessing the FIVE main sovereign rating factors:

The analysis of each of the key five factors embodies a combination of quantitative and qualitative

elements. Some factors, such as the robustness of political institutions, are primarily qualitative, while

others, such as the economy, debt, and external liquidity use mostly quantitative indicators.

1. Political Score

The political score assesses how a government's institutions and policymaking affect a sovereign's credit

fundamentals by delivering sustainable public finances, promoting balanced economic growth, and

responding to economic or political shocks.

The political score captures the factors listed below, which are uncorrelated with any particular political

system:

The effectiveness, stability, and predictability of the sovereign's policymaking and political

institutions (primary factor).

The transparency and accountability of institutions, data, and processes, as well as the coverage and

reliability of statistical information (secondary factor).

The government's payment culture (potential adjustment factor).

External security risks (potential adjustment factor).

The potential effect of external organizations on policy setting (potential adjustment factor).


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2. Economic structure and growth prospects, reflected in the economic score

A wealthy, diversified, resilient, market-oriented, and adaptable economic structure, coupled with a track

record of sustained economic growth, provides a sovereign government with a strong revenue base,

enhances its fiscal and monetary policy flexibility, and ultimately boosts its debt-bearing capacity.

The following three factors are the key drivers of a sovereign's economic score:

Income levels- GDP per capita is the most important and prominent indicator of a countrys

income level. With higher GDP per capita, a country has a broader potential tax and funding baseupon which to draw, a factor that generally supports creditworthiness. The determination of the

economic score uses the latest GDP per capita from national statistics, converted to U.S. dollars.

Economic Growth Prospects- A countrys real per capita GDP trend growth is the key indicator for

the Economic Growth Prospects. The term "trend growth" refers to estimates of the rate at which

GDP grows sustainably over an extended period, in other words without creating inflationary

pressure, asset bubbles, or other economic dislocations. Such estimates are generally derived from

empirical observations based on the recent past and longer-term historical trends, and they attempt

to look through the fluctuations of an economic cycle, smoothing for peaks and troughs in output

during the period being analyzed.

Economic diversity and volatility- A comparative analysis of a country with respect to its peers in

terms of economic concentration and volatility helps to decide this score. For example a country

would have a worse score as compared to its peers if the economy was constantly exposed to

natural disasters or adverse weather conditions. Economic concentration and volatility are

important because a narrowly based economic structure tends to be correlated with greater

variation in growth than is typical of a more diversified economy. Pronounced economic cycles

tend to test economic policy flexibility more harshly and impair the government's balance sheet

more significantly than shallow economic cycles.

3. External liquidity and international investment position, reflected in the external score

The external score reflects a country's ability to generate receipts from abroad necessary to meet its public-

and private-sector obligations to non-residents. It refers to the transactions and positions of all residents

(public and private-sector entities) versus those of non-residents because it is the totality of these

transactions that affects the exchange rates of a country's currency.

Three factors drive a country's external score:

The status of a sovereign s currency in international transactions- first step in the assessment of the

external score relates to the degree to which a sovereign's currency is used in international

transactions. The criteria assign a better external liquidity score to sovereigns that control a

"reserve currency" or an "actively traded" currency

The country s external liquidity, which provides an indication of the economy s ability to generate

the foreign exchange necessary to meet its public- and private-sector obligations to non-residents.-

The key measure of a country's external liquidity is the ratio of "gross external financing needs" to

the sum of current account receipts plus usable official foreign exchange reserves.

The country s external indebtedness, which shows residents assets and liabilities (in both foreign

and local currency) relative to the rest of the world.- Standard & Poor's key measure of a country's

external indebtedness is the ratio of "narrow net external debt" to current account receipts. The

term "narrow" in the description of net external debt refers to a more restricted measure than some

widely used international definitions of net external debt. The calculation of "narrow net external

debt" subtracts from gross external indebtedness only the most liquid external assets from the

public sector and the financial sector. The criteria use this special definition for two reasons. First,

financial sector assets are generally more liquid than those of the non-financial private sector.

Second, most financial institutions manage external assets and liabilities, which is not the case for


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many non-financial private sector entities, some of which may be primarily holders of assets, and

others primarily holders of liabilities. In a downside scenario, private sector entities may transfer

their assets in the domestic financial system to foreign accounts.

4. Fiscal performance and flexibility, as well as debt burden, reflected in the fiscal score

The fiscal score reflects the sustainability of a sovereign's deficits and debt burden. This measure considers

fiscal flexibility, long-term fiscal trends and vulnerabilities, debt structure and funding access, and potential

risks arising from contingent liabilities.

This aspect can further be sub-divided into two aspects.

I. Fiscal performance and flexibility

To determine a sovereign's fiscal performance and flexibility score, these criteria first derive an initial score

based on the prospective change in nominal general government debt calculated as a percentage of GDP.

a. Fiscal Performance-The key measure of a government's fiscal performance is the change in

general government debt stock during the year expressed as a percentage of GDP in that

year. We believe that the former is a better indicator of fiscal performance rather than the

reported deficit. The deficit is sometimes affected by political and other considerations,

possibly creating strong incentives to move expenditures off budget.

b. Fiscal flexibility-Fiscal flexibility provides governments with the "room to manoeuvre" to

mitigate the effect of economic downturns or other shocks and to restore its fiscal balance.

Conversely, government finances can also be subject to vulnerabilities or long-term fiscalchallenges and trends that are likely to hurt their fiscal performance. The assessment of a

sovereign's revenue and expenditure flexibility, vulnerabilities and long-term trends is

primarily .qualitative

II.Debt Burden

The debt burden score reflects the sustainability of a sovereign's prospective debt level. Factors

underpinning a sovereign's debt burden score are: its debt level; the cost of debt relative to revenue growth;

and debt structure and funding access. This score also reflects risks arising from contingent liabilities with

the potential to become government debt if they were to materialize.

5. Monetary flexibility, reflected in the monetary score.

A sovereign's monetary score reflects the extent to which its monetary authority can support sustainable

economic growth and attenuate major economic or financial shocks, thereby supporting sovereign

creditworthiness. Monetary policy is a particularly important stabilization tool for sovereigns facing

economic and financial shocks.

A sovereign's monetary score results from the analysis of the following elements:

The sovereign's ability to use monetary policy to address domestic economic stresses particularly

through its control of money supply and domestic liquidity conditions.

The credibility of monetary policy, as measured by inflation trends.

The effectiveness of mechanisms for transmitting the effect of monetary policy decisions to the real

economy, largely a function of the depth and diversification of the domestic financial system and

capital markets.

Methodology

All factors are rated on a score of 1-6, 1 being the strongest and 6 being the weakest. These criteria then go

on to form the sovereigns political and economic profile and the sovereigns flexibility and performance

profile.

The political and economic profile. The political and economic profile reflects our view of the

resilience of a country's economy, the strength and stability of the government's institutions, and

the effectiveness of its policy-making. It is the average of the political score and the economic score


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The flexibility and performance profile. The flexibility and performance profile reflects our view of

the sustainability of a government's fiscal balance and debt burden, in light of the country's

external position, as well as the government's fiscal and monetary flexibility. It is the average of the

external score.

FITCH

(Source: www.fitchratings.com)

Fitchs rating model is based on instances from all those countries which have neared default. These

instances have helped Fitch derive certain criterion on the basis of which a country is scored and further

aggregated to form a risk percentage score for the country which helps in deciding the rating.

The following criterion is used-

1. Demographic, educational and structural factors

2. Labour market analysis (size, sectoral composition, unemployment etc)

3. Structure of output and trade

4. Dynamism of the private sector (rate of business creation & failure, Self-employment etc)

5. Balance of supply and demand

6. Balance of payments


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7. Analysis of medium-term growth constraints

8. Macroeconomic policy

9. Banking and finance

10. External assets

11. External liabilities

12. Politics and the state

13. International position

MOODYS

(Source: www.moodys.com)

Moodys uses two approaches to sovereign rating-

1. Foreign currency vs Local Currency

2. Credit worthiness of government vs Risk of foreign interference

The following table broadly explains the first criterion:

Moodys rating methodology does not differ much from that of Fitch and Standard and Poors though there

might be some difference in approaches.


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SOVEREIGN RATING OF THE UNITED STATES OF AMERICA

Overview of the US economy

The economy of the US is the largest national economy of the world. It has a nominal GDP of

14.7 trillion dollars almost a quarter of the worlds nominal GDP. Its purchasing power parity is

also the largest in the world accounting for almost one fifth of the global purchasing power parity.

It also has the highest level of per capita output. The GDP per capita is $4638, the sixth largest in

the world. Its three largest trading partners are China, Mexico and Canada.

The US economy has been characterised by a stable GDP growth rate, low unemployment rate

and high levels of research and development and thus giving the economy strong fundamentals. It

has been the worlds largest economy accounting for almost 18 % of the world output of goods

and services. The US has 139 of the 500 biggest companies in the world in addition to having the

largest stock exchange New York Stock Exchange.

The United States is also one of the most heavily invested countries of the world with almost 2.4

trillion dollar worth of foreign investments made into the economy. It is also the largest investor

in the world with investments totalling 3.3 trillion dollars. The US economy is also one of the

most heavily leveraged economies in the world with debts of 50.2 trillion dollars about 3.3 times

its GDP.

The US has also the largest number of immigrant workers working in its economic structure.

The following statistics and charts will give us a quick and efficient overview of the US economy-

GDP- 14.527 Trillion USD

GDP growth- 3.0%

Inflation 2.1 % (Feb 2011)

Labour force- 154.5 million

Unemployment- 9.0%

Major industries-petroleum, steel, motor vehicles, aerospace, telecommunications, chemicals,creative industries, electronics, food processing, consumer goods, lumber, mining, defence,

biomedical research and health care services, computers and robotics

Exports 1.280 trillion dollars

Major Export items-agricultural products (soybeans, fruit, corn) 9.2%, industrial supplies (organic

chemicals) 26.8%, capital goods (transistors, aircraft, motor vehicle parts, computers,

telecommunications equipment) 49.0%, consumer goods (automobiles, medicines) 15.0% (2009

Major Export Countries China, Canada, Mexico, Japan, Germany

Imports- 1.948 trillion USD

Major Import items- agricultural products 4.9%, industrial supplies 32.9% (crude oil 8.2%), capitalgoods 30.4% (computers, telecommunications equipment, motor vehicle parts, office machines,

electric power machinery), consumer goods 31.8% (automobiles, clothing, medicines, furniture,

toys) (2009)

Major Import Countries- China, Canada, Mexico, Japan, Germany


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Credit Rating S&P AA+

Moodys-AAA

Fitch AA

(source of charts: www.wikipedia.com)

Reasons for revision of US ratings from AAA to AA+

The downgrade reflects the opinion that the fiscal consolidation plan that Congress and

the Administration recently agreed to falls short of what would be necessary to stabilize

the government's medium-term debt dynamics. More broadly, the downgrade reflects that the effectiveness, stability, and predictability of

American policymaking and political institutions have weakened at a time of ongoing

fiscal and economic challenges to a degree more than envisioned when S&P assigned a

negative outlook to the rating on April 18, 2011.

Since then, S&P changed their view of the difficulties in bridging the gulf between the

political parties over fiscal policy, which makes them pessimistic about the capacity of

Congress and the Administration to be able to leverage their agreement this week into a

broader fiscal consolidation plan that stabilizes the government's debt dynamics any time

soon.

The long-term rating on the U.S. was lowered because S&P believed that the prolonged

controversy over raising the statutory debt ceiling and the related fiscal policy debate indicatethat further near-term progress containing the growth in public spending, especially on

entitlements, or on reaching an agreement on raising revenues is less likely than previously

assumed and will remain a contentious and fitful process.

S&P also believed that the fiscal consolidation plan that Congress and the Administration agreed

to this week fell short of the amount that was believed to be necessary to stabilize the general

government debt burden by the middle of the decade.


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The lowering of the rating was prompted by S&Ps view on the rising public debt burden and

their perception of greater policymaking uncertainty.

The rationale given by S&P for the downgrade was-

1. Governance and Policy making instability-

The effectiveness, stability and predictability of the American policies and political institutions at

a time of the ongoing fiscal and economic crisis were far worse than what was earlier envisioned.

These policies had heavy implementation challenges. There was a lot of difficulty in bridging the

gap between the diverging views that the two political parties possessed over the fiscal policy to

be implemented thus reducing the political score of the country.

The political arena had become unstable and ineffective on the whole. The debate over the level

of statutory debt ceiling and the fiscal policy was nearly impossible to bridge which is why fiscal

consolidation became a farfetched dream and this leading to the downgrade.

2. Revenue

There were diverging views of the Democrats and the Republicans over the raisingtax revenues

and government spending cuts. This made revenue projections for the future unstable leading to a

downgrade.

3. Rising Debt Burden

The US has a public debt burden of almost 14.77 trillion dollars about 100% of its GDP. Such a

high Debt to GDP ratio is absolutely unsustainable considering the diverging political views in the

nation over revision of debt ceilings, government spending cuts and policies for fiscal

consolidation

4. Instability in macro-economic factors

Various macroeconomic indicators as declared by the BEA like the GDP etc were much below the

expectations and also the recent recession was much deeper than was previously envisioned.

5. Comparison with peers

When compared to other nations like Canada, France, Germany and UK, with AAA ratings , thetrajectory of public debt in the United States is diverging on the downside with a negative outlook

, hence it was not possible to give US the same rating as its peer nations

6. Debt Burden Projections

It is projected that the Debt to GDP ratio of countries such as Canada will be about 30% , in

France about 83% and in the US about 79% in 2015 however unlike other countries the position

of the United States will continue to deteriorate further.

7. Ineffective spending cuts.

The US is looking at 2.4 trillion dollars of spending cuts to be implemented in 2 phases. Despite

this S&P projects the debt in USA to rise to unsustainable levels.

Implications of the Debt to GDP ratio

The United States public debt is the money borrowed by the federal government of the United

States at any one time through the issue of securities by the Treasury and other federal

government agencies. The US national public debt consists of two components:


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Debt held by the public comprises securities held by investors outside the federal

government, including that held by the Federal Reserve System and foreign, state and

local governments.

Intra government debt comprises Treasury securities held in accounts administered by the

federal government, such as the Social Security Trust Fund.

The public debt increases or decreases as a result of the annual unified budget deficit or surplus.

The federal government budget deficit or surplus is the cash difference between government

receipts and spending, ignoring intra-governmental transfers. However, there is certain spending(supplemental appropriations) that add to the gross debt but are excluded from the deficit.

The Public Debt in the US currently stands about 14.77 trillion dollars of which 9.78 trillion USD

is held by the public and the rest in intergovernmental holdings.

The Debt to GDP ratio of the United States is about 100%. Generally a Debt to GDP ratio of about

60 % is considered sustainable.

The Debt to GDP level that USA possesses is one which will have adverse impacts on inflation,

employment and interest rates in the country.

A critical evaluation of the implications of such a high and unsustainable debt ratio suggests the

following-

1. Almost all the savings will go into financing of this debt and hardy any of it will be spent

on generating productive capital assets which are quintessential in driving the growth of

any economy

2. Rising debt would mean rising interest costs. If such interest is financed through increased

taxation the level of savings in the economy will reduce

3. Rising interest repayment obligations will divert funds away from important

developmental programmes of the government.

4. Such high repayment obligations make it difficult for the government to use fiscal policy

in the country

5. Higher interest rates will be demanded in the economy. As the quantum of leveraging

will increases, the risk of default of repayment of such leverages will increase too,

resulting in the holders of such debt demanding greater returns in the form of increased

rates. Such increased interest rates will make the debt further unsustainable

6. The amount of interest repayments in 2007-2008 was about 240 billion dollars which is

about 9.5 percent of their GDP which is difficult to sustain in the long run.

7. More than 50% of the obligations were due to foreigners. This meant that an equivalent

amount was flowing out of the country which is potentially damaging to the economy as

money which flows out of the economy cannot be used for productive use within it.

8. Current statistics indicate that by 2030-2040 the quantum of medical expenditure and

social security payout that the US incurs will exceed the GDP hence leading ti further

borrowing which will have adverse impacts on the economy.

9. United States has far from crossed the red line of borrowings. According to economist

Paul Krugman generally a debt level of 90% of GDP indicates a red line and the United

States already has one of 100%.Fed chairman Ben Bernanke has himself stated that the

quantum of debt and rising associated costs both in terms of interest and principal


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repayment have crossed the danger level for the economy. It is hence essential for the US

economy to pay heed to such warnings well in time.

10. Not only is this but the total quantum of debt which includes both public and private debt

in the US economy about 50.2 trillion dollars which is about 3.3 times that of the GDP.

This is also an alarming figure.

11. The credit rating downgrade by S&P from AAA to AA+ suggests that considering the

political environment and tense fiscal and economic position of the United States

repayment may become difficult.

SOVEREIGN DEBT RATING DOWNGRADE OF JAPAN

Overview of the Japanese economy

Japan proudly boasts of having the third largest economy in the world in addition to being a

highly industrialised and technologically advanced country. With an annual GDP of close to 5.5Trillion dollars its economic power with respect to the rest of the world is of great consequence. It

is also the 5th largest importer and exporter in the world. With a striking growth rate of close to

10% in the 1960s , the growth declined to about 4% in 1980s and about 1.7% in 2007-2008

before reaching sub zero levels In 2008-2009.

The following facts will give us a quick run through of the Japanese economy-

GDP (2010) - $5.459 trillion

GDP growth (2011) -.7 %

GDP - composition by sector:

Agriculture: 1.4% Industry: 24.9%

Services: 73.8% (2010 est.)

Foreign exchange reserves including Gold - $1.063 trillion (Dec. 2010)

Unemployment rate 5%

Exports - $765.2 billion (2010 est.)

Imports - $639.1 billion (2010 est.)

Major import partners are China, US, South Korea and Australia.

Inflation (-)0.7% (2010 est.)Central Bank Discount Rate 0.30%

Pubic Debt 225.08% of GDP

Credit Rating

Fitch - AA- (Negative Outlook)

S&P-AA- (Negative Outlook)


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Moodys - Aa3 (Stable Outlook), Revised as on 25th August 11

Downgrade of Ratings

The rating downgrade is prompted by large budget deficits and the build-up in Japanese

government debt since the 2009 global recession. Several factors make it difficult for Japan to slow

the growth of debt-to-GDP and thus drive this rating action:

1. Recovery from the 2009 global recession is delayed by the March earthquake and nucleardisasterthe severity of which has increased government debt by a sizable amount and is

aggravating deflationary conditions.

2. Japans very low potential GDP growth rate places a heavy burden on fiscal austerity measures

and reform policies.

3. The fiscal adjustment plan is partial and tentative, and vulnerable to domestic political shifts

and to global shocks because of its long time horizon.

4. Lack of policy continuityfrequent changes in administrations over the past five years have

prevented implementation of a long-term economic and fiscal strategy.

Moodys downgraded Japans rating from AA3 to AA2 notch lower and about three notches lower

than S&Ps AAA. The major reasons cited for the same are-

1) Japan has extremely high budget deficits and the debt quantum in Japan has been building

up to highly unsustainable levels since the 2008 recession. Japans public debt is about

225% of its GDP. Generally a Debt to GDP ratio is considered highly dangerous when it

crosses the 90% mark and here it has touched almost 225%.

2) Further the economic position of Japan has been worsened by the recent earthquakes

slowing down economic growth quantifiably and thus making Japanese riskier.

3) Japan has fiscal deficit of 9% coupled with the sub zero levels of growth and extremely

high GDP to debt ratio makes the Japanese economy very prone to default and recession.

Critical evaluation of Japanese Debt to GDP ratio

1) Facts and figures collected from Japan are alarming. A debt to GDP ratio of 225% , a fiscal

deficit of 9% and sub zero growth rates are indicators of high default probabilities.

Further worsened by the latest tsunami which has trampled any signs of early recovery

for Japan.

2) A major positive point about Japanese debt is that most of it is domestic unlike that of

USA. This means that most of the interest and principal repayments are made within the

economy hence not much of it is lost to external sources. Only about 2.6 trillion dollars is

borrowed from external sources.

3) Japanese workforce is contracting and so is productivity. Japanese demographics showthat most of the economy is aging which arent exactly positive signs for the economy.

4) The persistent deflation isnt a positive sign either

5) Consumer spending has also declined in the past which is not a good sign for any

economy.


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The chart above shows a comparison of Japans Debt to GDP ratio with some other sample nations

SOVEREIGN DEBT RATING OF INDIA

Overview of the Indian economy

The economy of India is the tenth largest in the world in terms of GDP and fourth largest in

terms of PPP. The per capita GDP of India is about 3868 USD. After having a socialist economy

for more than 40 post independence years India moved into economic reforms post 1991 by

following a strong policy of economic reforms.

The following points provide a fleeting glance over the Indian economy

1) GDP- 1.53 trillion dollars

2) GDP growth 8.5 %

3) Inflation 9.44%

4) Population below poverty 37 %

5) Unemployment- 9.4 %

6) Main Industries-telecommunications, textiles, chemicals, food processing, steel,

transportation equipment, cement, mining, petroleum, machinery, information

technology, pharmaceuticals

7) Public Debt 758 bn dollars -56% of the GDP

8) Rating- BBB- by S&P

9) Major Exports-petroleum products, precious stones, machinery, iron and steel, chemicals,

vehicles, apparel

10) Major Imports-crude oil, precious stones, machinery, fertilizer, iron and steel, chemicals


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Sovereign rating of India

India has a robust economic system coupled with a strong external economic system which

underlies its BBB rating considering it is still in its developing stage. With A Debt to GDP ratio of

55% and a constantly reducing fiscal deficit growth is sustainable. Unlike USA and Japan , India

has still not reached its 60% Debt to GDP ratio and can thus further leverage its economy.

The new fiscal consolidation strategy is vital if India's authorities want to ensure that the

sovereign's public debt dynamics stay on a more sustainable path and are brought into line with

other 'BBB'-range rated sovereigns. India's general government debt-to-GDP ratio, which Fitchestimates stood at 66% of GDP in FY2010/11, is well above the median for the 'BBB' category of

35.6%. However, it is important to note that India's sovereign ratings continue to benefit from the

largely local-currency profile of its debt (92% of the stock) and from its stable access to domestic

sources of financing, mainly from the banking system.

India's 'BBB-' rating is also supported by solid external finances, as highlighted by a modest

external debt service ratio and a robust external liquidity ratio. Further, the country's foreign

exchange reserves are large, standing at USD 313 billion, May 2011. Fitch also considers that the

widening in India's current account deficit, to an estimated 2.6% of GDP in FY2010/11, is not a

significant risk in light of India's current stage of economic development. India's sovereign ratings

would benefit from structural fiscal reform leading to a faster improvement in the fiscal deficit

and general government debt ratios. In addition, an improvement in India's investment climatesupporting greater infrastructure investment, and a sharp, sustained decline in inflation would

also be supportive developments for India's ratings.

IMPACT OF DOWNGRADES

Bryan Wynter, Governor of Bank of Jamaica, has said that the downgrade of the United States' credit rating,

and the debt crisis in the Euro area, have increased uncertainty in global financial markets. The markets

response was exacerbated by the worse-than-expected U.S. GDP outturn for the quarter, and downward

revisions to GDP estimates for the past two years. The negative economic publicity also resulted in a flight

to safe-haven of assets such as US Treasuries. As a result, the yields on 5-year, 10-year and 30-year U.S.

Treasuries have fallen to all-time lows. At the same time, U.S. consumer confidence has fallen to the lowest

in three decades. Also, commodities market prices have been fluctuating, particularly crude oil prices whichplunged initially, but have since shown some marginal recovery, while the price of gold has hit all-time

highs.

IMPACT OF DOWNGRADES ON INDIA

1) Indian exposure to US debt stands at about 41 billion dollars. India stands in 14th position

in terms of open debt exposure to the United States. A down grade of ratings increases the

risk of receiving these obligations by India which is dangerous. China ranks first with an

exposure of close to 1.15 trillion USD

2) Further coupled with debt crisis in Europe, there was instability in the world markets

which has had an impact on Indian markets too.

3) Growth in India will hover around 8% in 2011-2012 despite the tremors felt due to

downgrades.

4) Analysts however feel that the impacts of these downgrades on stock markets are

temporary. At worst we can look at a 5-7% downfall


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5) Exports of IT, gem handicrafts and leather will be affected. Major chunk of Indias 50bn

USD worth of exports go to the United States. A downgrade has been a mojor hit to these

exports

6) About 100 million dollar worth of Invisible exports are made to the US. Downgrade

affecting the debt repayment capability of USA has had an impact of thrse in terms of

Indian firms reducing their business to safeguard their interest.

7) Credit downgrade for USA has meant INR strengthing against USD which is a positive

sign for the economy. Even though now imports for USA have become more expensivehowever there isnt too much of a hit on that front.

8) To conclude, in the long term, India should be ready to take advantage of such global

shocks by concentrating on economic reforms so that its rating improves.

India will remain big beneficiary in terms of fund flows both in the portfolio and direct

investment segments in the long term.

The US downgrade was not only valid but overdue because of highly-

leveraged customers, over borrowed government and a political system that

is not working.


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Related websites used:

www.investopedia.com

www.standardandpoors.com

www.wikipedia.com

www.moodys.com

www.fitchratings.com

www.google.co.in

downgrading of sovereign debt ratings

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