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US Debt Downgrade and Its Impact-VRK100-15Aug2011

US Debt Downgrade and Its Impact-VRK100-15Aug2011

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Rama Krishna Vadlamudi, Hyderabad, has analysed the impact of Standard & Poor's downgrade of US credit rating from AAA to AA+. This is highly readable in question and answer format.
Rama Krishna Vadlamudi, Hyderabad, has analysed the impact of Standard & Poor's downgrade of US credit rating from AAA to AA+. This is highly readable in question and answer format.

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Published by: RamaKrishna Vadlamudi on Aug 15, 2011
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Rama Krishna Vadlamudi, HYDERABAD 15 August 2011 
Since the beginning of August 2011, financial markets around the world have been veryvolatile due to surfeit of fears and uncertainties. The biggest event that has impacted themarkets is the Standard & Poor’s downgrade of the United States’ Government debt from AAA to AA+ on August 5
th
. However, the other two rating agencies, Fitch and Moody’shave retained the AAA rating for the US on August 2
nd 
. In reaction to the S&P’sdowngrade, equity markets and commodity markets have fallen heavily with increased volatility. However, gold price has surged by around five per cent as it is considered as asafe haven asset amidst debasement of paper currencies by several countries. After the demise of the Soviet Union in 1991, the US had become the most powerfulnation in the world. It has lost the superpower status politically after some seriousblunders in Iran, Iraq, the Middle East and Afghanistan. Now, with mounting debt  problems and credit rating downgrade, the US has been losing its predominance in theworld economy also. One thing is sure: the US economy is on a decline and therepercussions will be felt across the world. Here is an analysis of the issues behind the downgrade and its impact on markets:
Why has S&P downgraded the US credit rating?
After closing of market hours on 5 August 2011, S&P had downgraded the US long termsovereign rating from AAA to AA+. The reason cited by the credit rating agency for thedowngrade is that the debt deal brokered by US lawmakers is not sufficient and expressedits doubts about the ability of US lawmakers to bring down the US debt level. S&P isconcerned that US political parties are not working in tandem when it comes to fixing theUS economy and bringing about fiscal consolidation. It’s first time in 70 years that anyrating agency has downgraded US’ AAA-rating. The downgrade has not come as a totalsurprise. In April this year, Standard & Poor’s had first cautioned that there was apossibility of US downgrade if the US lawmakers did not agree for a deal over raising thestatutory US debt level and bringing down the debt over long term.
 
Rama Krishna Vadlamudi, HYDERABAD 15 August 2011
www.scribd.com/vrk100
MY BLOG: www.ramakrishnavadlamudi.blogspot.com 
What is the difference between AAA and AA+ rating?
According to the standard definition of S&P:
AAA : Extremely strong capacity to meet financial commitments. (Highest Rating)AA+ : Very strong capacity to meet financial commitments (just below AAA)
As can be seen from above, AAA is the highest rating and AA+ is just below AAA. Andstill AA+ rating is considered as one of the best credit ratings in the financial world.Other countries that are having AA+ rating are Belgium and New Zealand, as per S&P.
What is the US debt deal?
The US Congress had on August 2
nd
approved a plan to raise the US debt level from thecurrent USD 14.3 trillion in the short turn while bringing down the overall deficit byUSD 2.4 trillion over the next 10 years. S&P is of the opinion that this USD 2.4-trilliondebt reduction is not sufficient and it prefers a USD 4-trillion deficit reduction instead.
What are reasons for the high level of US Government debt?
The United States of America has been living beyond its means – meaning the countryhas been spending more than its earnings – for more than a decade. At the end of president Bill Clinton’s term, the US has enjoyed huge budget surpluses. But afterGeorge Bush took over as president in 2001, the US economy has been hurtling towardone disaster after another. Economists and market pundits have been warning the USabout its debt burden for almost a decade. Due to the excessive spending, the USGovernment debt has mounted to a record USD 14.3 billion in May this year.
How is the US Government funding its fiscal deficit?
As the budget expenditure exceeds its revenues, the US Government every year raiseshuge money by selling its Treasury Securities and funds the fiscal deficit. The bonds arebought by various foreign governments that are having huge export surpluses. Some of the biggest holders of the US debt are: (in USD billion) China - 1,160; Japan – 910; theUK – 350; Brazil – 210; and Taiwan – 150. India holds USD 41 billion in US treasuries.Other investors in the US government debt are banks, pension funds, sovereign wealthfunds and individual investors.
Will investors sell US treasuries now?
A substantial portion of the US debt is held by central banks around the world. They maynot sell their holding of US treasuries as they do not have any worthwhile alternativeinvestments to buy at this point of time. Large holders of US debt, like, China, Japan andthe UK may hold US treasuries grudgingly for the time being unless a credible alternative
 
Rama Krishna Vadlamudi, HYDERABAD 15 August 2011
www.scribd.com/vrk100
MY BLOG: www.ramakrishnavadlamudi.blogspot.com 
to US dollar emerges, which is a remote possibility as of now. Of course, investors havebeen moving to the Swiss Franc and the Japanese Yen for some time now. The euro ishaving its own problems. The dollar is relatively stable against major currencies till now.
What is the importance of US treasuries?
--- Till the S&P downgrade, the US treasuries are considered as benchmark securities forvarious classes of assets across the world.--- It is a practice in the financial world to benchmark several securities against the UStreasuries.--- Every country will have its own risk-free interest rate. However, the US treasuries aretreated as risk-free across the world.--- With the downgrade, the US treasuries have lost some of their sheen and this willcreate problems for asset valuation models.
Why are the US economy and dollar so important to the world economy?
--- Till the S&P downgrade, the US dollar was considered as safe to hold it for long term--- For several decades, the US debt has attracted investors due to the US’ stable growth--- Much of the world trade in merchandise exports and services is done in dollar--- The US dollar has become a reserve currency for the world--- The reserve currency status has become questionable now--- The US has 43 per cent weight in the MSCI Index, an index of global stocks--- About one-fourth of the world’s GDP comes from the US--- About 20 per cent of the oil is consumed by the US--- Much of the world’s wealth is concentrated in the US
What steps should the US Government take to bring down its huge debt burden?
The following steps will help the US to cut down its debt levels:--- The US Government should raise taxes without hurting the poor--- The US Government should cut its wasteful expenditure, like, defence and others.--- The Government should stimulate the economy through various measures
How does the downgrade impact US economy?
Theoretically speaking, if a country’s debt rating is downgraded the country’s interestburden will increase as the cost of raising money goes up. As such, US Government bondprices should come down and yields should go up. The US companies will have to payhigher interest rates when they raise money abroad for their needs. But it reality, this hasnot happened. After the downgrade, the benchmark 10-year US Government Treasuryyield decreased by 20 basis points – meaning bond prices went up. This aberration is dueto the fact that investors selling equities and commodities have moved the money to US

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RamaKrishna Vadlamudi added this note
Who is America's banker? The US Federal Reserve. Wrong answer. The correct answer is China!
RamaKrishna Vadlamudi added this note
Which is the greatest Ponzi scheme ever in history? America's Government debt programme!
RamaKrishna Vadlamudi added this note
Which is the greatest Ponzi scheme ever in history? America's Government debt programme!
RamaKrishna Vadlamudi added this note
Who is America's banker? The US Federal Reserve. Wrong answer. The correct answer is China!
RamaKrishna Vadlamudi added this note
Which is the greatest Ponzi scheme ever in history? America's Government debt programme!
RamaKrishna Vadlamudi added this note
Who is America's banker? The US Federal Reserve. Wrong answer. The correct answer is China!

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