The USA debt rating has been downgraded from AAA (triple A) to AA+ (double A plus). This downgrade has happened after 1917, an event which has taken 94 years. I believe to understand the complexity of ratings, economy, stock markets, currencies and commodities one needs to be of a minimum age of 16 years, which means that unless somebody who is 110 years old and active would have been witness to such an event in 1917 and would have experienced the same. Very clearly many such people would certainly not be there in the world as of now.
The effect of this downgrade would have a different effect on stocks, currencies, commodities, bond yields and so on. It would also matter on which side of the table you are and what your economic balance with the USA exists. A country like China which is the world’s largest investor in US treasury bills of 1.1 trillion US $ will be affected in a different manner than other economies.
Trading would begin in Australia and Japan in the morning followed by Hong Kong, China, Singapore and other Asian economies followed by India and then onto Europe. Trading in the US would begin a good 12-14 hours after the whole world has reacted to an event which has happened in the US. There will be uncertain markets, and it appears that the US dollar could depreciate against many other currencies. The knee-jerk reaction would be panic, mayhem and blood on the streets.
Coming to the Indian markets, a selling on the dollar is good news for importers and a fall in commodity prices excellent news for consumption economies like China and India. If commodity prices fall and this would include crude oil, our government would heave a sigh of relief as the current unabated rise in inflation would shoe a declining trend and also the fall in commodity prices would be beneficial to the manufacturing sector. Similarly the loss to exporters particularly the IT sector could be made up to some extent by higher outsourcing as US cuts costs.
There is a saying in the English language that one man’s food is another man’s poison and the world markets is one great place to use and experience it. The US would have to cut costs to rein in the deficit and it is widely expected that the government is likely to raise the retirement age by 2 years so that pension liabilities get deferred by two years straight away. There is also an expectation that in the cost cuts needed there could be changes in the healthcare bill and this could be negative news for the sector.
The effect of this downgrade means that the country would have a negative effect on the economy and would increase the interest payments on account of higher rate of interest and also an increase in borrowings by roughly 100 billion $. The other risk is that after a downgrade, the ratings are put on a watch and the US cannot afford the ignominy of a second downgrade. The US Senate would have to set aside its differences and work towards resolution of this crisis which is large enough to eat them up if not resolved speedily.
What should we do in India when the markets open tomorrow? Buy the markets if they fall, sell the markets if they rally. I believe neither of the above two are a solution. There are plenty of combinations and permutations possible and the markets are going to remain choppy, extremely volatile and more important dangerous. The whole day people who have no experience of such an event in their lifetime will be advising what to do. Why not observe the market carefully and see developments and let the American market trade before forming a view. The markets which have been extremely nervous and weak over the last 10 trading sessions are not going to suddenly shoot up and nothing would be lost if we are cautious and staying away from the market for a couple of days. We need clarity, stability and the markets are far away from it.
The markets need to consolidate, trade freely, understand various implications, combinations and permutations before they stabilise. The world will not come to an end if you do not trade tomorrow. Trade cautiously once you have some clarity on the events.
