From ‘AAA’ to ‘AA+’: What the world can expect

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Standard & Poor?s announcement on Friday of its decision to downgrade the once invincible credit-rating of the world?s largest economy has, as expected, produced widespread ripples in the global economy, already weakened by a European debt crisis that is considered to be on par with the financial crisis of 2008.

With plummeting global stocks strongly indicating more financial and economic upheaval to come, analysts and skeptics alike remain uncertain about the magnitude of a potential financial disaster of a kind the world has allegedly never faced before.

Consequences of Downgrade uncertain
However, even as investors worldwide dive into an erratic frenzy and world leaders scramble to salvage their economies with the G-20 holding an emergency conference call on Sunday to ?discuss? the ?twin debt crisis? in Europe and the United States, corporate analysts have adopted a less pessimistic stance, hinting that the consequences of the downgrade may not be as deadly as worldwide panic might cause it to seem.

In a study conducted last month, Goldman Sachs, a significant dealer of US treasuries itself, iterated that the impact of a US-credit rating downgrade cannot easily be forecasted.

The investment bank stated in its analysis, “The size of the United States economy and Treasury market and the dollar?s status as a reserve currency make it impossible to find a clear historical parallel for the current situation,”.

Goldman Sachs further hinted that the impact could be mild, suggesting there would be a ?modest selloff? in financial markets, a claim that seemed to somewhat materialize when the Dow Jones Industrial Average dipped 400 points on Friday soon after news of a possible S&P downgrade leaked into the corporate circuits, regaining 300 of those points before closing even as danger remained imminent.

This trend was also reflected in the Gulf Markets, with stocks seeming to recover considerably from the drastic plunge they experienced on their opening this week, a few analysts even predicting a full market recovery in light of the allegedly more resilient Saudi and Qatar bourses.

Banks: We were ready
While a few may allege a little too much has happened a little too soon, banks around the world, particularly heavyweights that have much at stake in the wake of the downgrade, claim they weren?t caught by surprise by S&P?s announcement late last Friday.

Gearing up since July for a potential US debt default in the event of the debt ceiling crisis, the possibility of a credit-rating downgrade wasn?t ruled out by banks even as the US government finalized a $2.1 trillion budget cuts plan to trim its exorbitant $14.3 trillion debt.

Nevertheless, while the announcement may not have generated chaos and confusion in the banking world, bankers assert they aren?t immune to the potential consequences, particularly those unseen, that may result even as S&P is expected to declare further related downgrades for financial institutions.

However, one banker said: ?Even if there are follow-on downgrades, everyone will stay in place relative to each other.? The general consensus also remains that a single-notch downgrade by one among three credit-rating agencies is unlikely to produce significant impact in bonds and securities markets, among several others.

Short term and long term implications, downgrade alone not to blame
While the US government and most of the corporate world might understandably harbor hostile sentiments towards S&P?s decision, even as the two other credit rating agencies Moody?s and Fitch chose to avert a downgrade, some analysts point out that it may not be the downgrade alone that is to be held responsible for the turmoil likely to unfold in the event?s aftermath, citing external influences in a shaky global economy that come into play as well.

One such analyst, Barclays Capital?s Ajay Rajadhyaksha, pointed out a number of these factors while citing possible long-term and short-term implications of S&P?s decision, one of the most significant ones being his observation that the ultimate fate of the global economy rests not on a credit-rating agency?s downgrade, but on the overall world market downgrading the sovereign rate as global investors react to the radically fragile situation.

In the short term, bond markets aren?t expected to pay much heed to the downgrade, a prediction that seems likely to hold true as the yield-to-price rate on government bonds remains stable on a percentage of 3.3817% for bonds maturing in ten years, a figure that indicates a stable credit outlook for an economy.

Furthermore, since several US banks are already several rankings below the stellar ?AAA? rating, the credit-ratings of banks do not seem endangered by a single notch downgrade, or at least not threatened to the extent that additional collateral requirements become insurmountable.

Those anticipating a vicious selloff of US treasuries by investors may also abandon their fears as the reputation of US treasury as the deepest and most liquid bond market is likely to remain intact in the face of a credit-rating downgrade.
It is the longer term risks, however, that seem more worrying. Predictions of a rise in interest rates remain rife with investors losing confidence in the creditability of US debt and are hence expected to demand a higher rate of return, an example of consequence of a market downgrade.

Moreover, increasing diversification of investments away from the USD poses another threat as foreign investors, particularly countries that hold significant amounts of US debt in their reserves, look for alternate and possibly more creditable investments. This could not only deepen the US financial crisis and aggravate the tribulations of the global economy further as several currencies remain pegged to the dollar.

Nevertheless, with S&P signaling a further downgrade if the US doesn?t abandon its alleged ?political brinkmanship? and make more serious attempts to prevent its economy sinking further under a gargantuan pile of government debt, the biggest question of them all that hangs in the air is whether the world?s largest economy will be able to retain its stature as the world?s financial superpower.

Sources: Reuters, Yahoo! News, Business Insider, Financial Times

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