Impact of US downgrade on global markets

 | August 17,2011 10:37 am IST

What we have witnessed in the past few days is the bloodbath in markets across the world. The S&P downgrade of US from AAA to AA+, in my opinion will have a short to medium term impact on the world economy.


Reason is that most economies deal with US for business and if US is hurt, tremors will be across the world (butterfly effect). An example is IT industry. With downgrade, US will get less fund flow, and so the organizations will find it difficult to raise money and so this will impact their capacity to implement IT solutions. This way, they will cut down on IT spending, thus hurting IT vendors across the world.


But when we look at emerging economies like India and China, they have too much domestic consumption, so even if these countries are hit on exports, they will make it out on domestic consumption. So, In my view emerging economies will have only short to medium term impact due to this downgrade.


Investors across the world will now move to safe haven like gold and other metals and so the prices of these commodities will definitely rise as more investment flows in these asset classes.


There is definitely a cause of concern for economies which are heavily dependent on US for exports. For example- Japan, which exports around 16% of its total exports to US; and Taiwan, which exports around 10% of its total exports to US. Such export driven economies which have high dependency on US will have to look at measures to reduce their exposure to US by diversifying their exports and by making domestic consumption better.


China, followed by Japan, is the highest holder of US treasury securities, which means that these countries will have a huge concern over the downgrade of treasury.


So overall, China will be hit by its huge accumulation of US treasury securities; but will be protected by it's huge domestic consumption.


In the long run, I feel that the BRIC nations will be less affected compared to other economies. There is definitely impact on shares of Indian corporate, but this also offers an opportunity to buy blue chip stocks at throw-away prices. One should look for investment in those companies which have strong fundamentals and whose stocks are available at low prices and go for long term investment in such companies.

 

Concluded.

 

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Comments


Nikit Gangwani on 08/18/11 at 12:01 am

Short and crisp read! The positive conclusion helps calm some nerves (of the double-dip). :-)
What are your thoughts on:
1. China holds $1bn+ US treasury securities; with the downgrade in effect, I think its in China's best interests to continue to hold on to these securities else the returns on these investments would be much much lower!
2. S & P has downgraded the US credit ratings. Do you think Moody and Fitch are also considering such a move and by when? If they do, the effect will be catastrophic.
3. IMHO, the downgrade will also have long term effects. With further cost reductions, the outsourcing from US will move from India to other relatively cheaper economies (it has already begun).


Ankit Arora on 08/19/11 at 03:28 pm

Nikit,

Thanks for your comments. Reg your points:

#1 : China has no other option except to keep holding these securities. Since they are the largest holder, if they even try to sell these- it would hurt them only. In case there is large selloff of US securities by China, it wuold further bring down their value [ kind of similar to how stock markets react when a single security is being sold- it nosedives ! ]
So, China will not take such a move.

#2 : All these rating agencies are independent in their assessment. So I don't think that by taking cue from S&P, Moody's and Fitch would follow the same steps. If this does happens, then definitely it will further bleed the already bleeding markets.

#3 : Yes, low cost destinations will always be at an advantage. US will look for cheaper destinations, but India will not be impacted. Reason being, we have huge population and thousands of IT firms. So we can cater to all segments of US customers. I am sure that within India itself, US will find a gamut of offerigns at low cost, due to the sheer size and potential of India.

Thanks
Ankit


Nikit Gangwani on 08/21/11 at 12:39 pm

Thanks Ankit for sharing your insights! Specifically, the third argument. It gives a different perspective about the intense competition in India ensuring services being available at a competitive price.
Thanks buddy! :)