RUSSIA | ECONOMICS JULY 29, 2011
Chief Economist’s View If the US Gets Downgraded… So What?
Amid continuous speculation about the debt problems in Europe and the US, rating agencies have kept downgrading European peripheral countries, but have done nothing to US ratings, apart from occasionally sending warnings of a possible downgrade. Meanwhile, European governments eventually were able to agree on a temporary solution for Greece based on a combination of a bailout with public funds and the “voluntary” restructuring of Greek debt by private bondholders, which many considered a model solution for other indebted European countries. So far, the US has not come up with any solution, but its rating remains at the highest level. Early in the year, S&P downgraded Japan’s rating to AA– on the grounds of the absence of a “coherent strategy” to curb debt levels. The US administration lacks this strategy as well, but still retains its top rating. Clearly, Japan’s debt/GDP ratio is twice as high as that in the US, but the bulk of Japanese debt is held by locals, which makes the country less vulnerable. In contrast, around a third of US Sovereign debt is held by foreign investors (over $4.4 trln), such as other countries’ Sovereign funds and central banks. Given that Japan is a country where inflation is not an issue and deflation used to be quite regular, domestic investors holding low yielding public debt was not the worst option. At least they did not lose money. Rating agencies normally cut ratings when they see a threat of investors losing money, which in some sense occurred in the case of US debt held by foreigners, as the dollar has weakened 12 15% against many currencies. In the past twelve months, for instance, the US currency depreciated around 12% against the Japanese yen – thus, Japanese investors, who hold around $0.9 trln in US debt, lost about $0.1 trln. The Korean won, Singapore dollar and the euro also appreciated 11 12% against the dollar over the past year, while the Brazilian real gained over 13% in the same period. That said, in the case of the US, there is a combination of at least three factors that have in the past encouraged rating agencies to downgrade other countries. These include the lack of a “coherent strategy” of debt reduction, US politicians’ inability to come up with a mutually acceptable solution regarding the debt ceiling, and the threat of continued loss of external money invested in US government paper, which could eventually undermine the myth of US exclusiveness.
Chief Economist, Managing Director Evgeny_Gavrilenkov@troika.ru
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which is why markets have once again proven to be ahead of rating agencies as the dollar has depreciated. but whether the debt ceiling will be raised to a level sufficient to finance expenditures throughout 2012 or if it will be a series of hikes (say. Higher costs of borrowing will most likely accelerate inflation.4% interest on a 2y note. sustainable budget deficit of around 9 10% of GDP and debt/GDP ratio of around 100% pays only 0. Overall. have priced this in already. one of the three rating agencies should bring the US down at least one notch relatively soon. This is very similar to Russia’s continuous uncertainty regarding whether the next presidential candidate will be Vladimir Putin or Dmitri Medvedev. further weakening of the dollar will be the most likely outcome. The problem is that the entire rating system is tied to a single benchmark. due to remaining double deficits (current account and the budget balance). the current debate on the debt ceiling centers not around debt reduction strategy (which ideally should be “coherent”. and at minimum. as. This may help increase tax collection and slightly soften the debt problem. but some currently “unacceptable” steps might need to be taken if appetite for US paper goes down amid potential rating downgrades (we do not consider US default a serious option. Both politicians are trying to keep it a secret so neither becomes a lame duck too early. Given that the magnitude of economic imbalances in the US is of far larger scale than that in the Eurozone. as a result) that a country with a weakening currency. while the economy and investors’ interests are considered less important. as it will eventually require quite unpleasant and seemingly “unacceptable” austerity measures aimed at eliminating internal imbalances. Economic and financial issues have become hostages of a political struggle between the two parties. to some extent. The fact that the greenback has weakened over the past year illustrates that markets. Politicians do not care that the uncertainty surrounding the debt ceiling dispute is a less than ideal environment for investors. should the answer be yes. which might encourage the Fed to resort to a new series of quantitative easing). In the latter case. it will be much more difficult for Democrats and President Barack Obama personally to compete with a Republican presidential candidate. we trust that the country’s politicians will eventually discover their long lost common sense). but not provide a solution. investors rushed for safety and moved money to US Treasuries. though it is highly unpopular and seemingly “unacceptable” – at least for now. which caused the dollar to
. decelerating growth and a rising debt/GDP ratio. it is already of secondary importance (albeit. From this standpoint. Raising domestic fuel taxes is. Higher borrowing costs will look normal. while the country produces around 23% of global GDP). economic issues are in fact of secondary importance. We are not in the position to discuss in detail how the US administration should try to deal with the budget deficit and debt problems. Indeed. another measure to reduce the budget deficit. as the current US administration will be held on a short leash by Republicans. for instance). it looks as though the dollar will remain crippled and could weaken even more. despite the bombastic populist rhetoric from both sides. such as overeager defense spending (the US’ share of global defense expenditures is around 50%. as required by S&P. and if the benchmark is moved it is not completely clear what to do with the rest. 2011
CHIEF ECONOMIST’S VIEW – IF THE US GETS DOWNGRADED… SO WHAT?
Decision making in the US has proven to not always be as efficient as it was traditionally considered. in theory. Partial forced selling of US government paper (inevitable in the case of a rating downgrade) will inevitably increase borrowing costs nationwide (at least a bit. which is what makes the difference between the current situation and the 2008 crisis – at that time. despite the fact that the prospects of eliminating those imbalances are quite unclear on both sides of the Atlantic. That said. quarterly). quantitative easing alone was enough reason to downgrade US paper. It seems much more abnormal (and unsustainable. Taking the above observations into account. namely the US paper. In our view. it looks as though the US deserves rating cuts. still an essential issue for the markets) whether or not rating agencies downgrade the US and when.JULY 29. being optimists. which is still a rather modest punishment for long term macroeconomic mismanagement.
while the foreign debt/GDP ratio remains below 30%. as the economy is not as overheated as it was three to four years ago. It looks likely that in the event that the US finds itself in undesirable trouble (such as hypothetical technical default).5% (or even lower) by year end (from 9. while official statistics. 2011
appreciate and commodity prices to fall. Inflation has declined to 0. Russia once again became a twin surplus economy. That said. Russia looks to be in quite good shape versus many other economies. Russia’s economy currently looks less vulnerable than it did before the Lehman Brothers crash. Moreover. money will still keep moving – at least away from the US dollar. which could bring y o y inflation to around 6. The greenback’s fundamental weakness will maintain commodity prices at a relatively high level – a rather comfortable environment for Russia.4% m o m since February.
. we expect the Russian market to rally once the dust settles. In 1H11. point to the former.2 0. while these days. such move would not seem logical.CHIEF ECONOMIST’S VIEW – IF THE US GETS DOWNGRADED… SO WHAT?
JULY 29. demonstrating growth of around 4 5% – we think that growth is actually closer to the higher number.6% in January). which are quite inconsistent. Money stopped moving at end 2008 as a result.
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