On Aug. 5, customary & Poor's (S&P) cut the US's top-rank triple-A rating down a notch, to AA+, the primary time ever, technically signaling that the country's reliability for paying its debts has decreased. additionally to the downgrade, it issued a negative outlook, suggesting that there was an opportunity it'll cut back the rating any inside 2 years. S&P discarded recent US political system efforts to demonstrate that it's acted prudently to cut back the country's deficit and restrain the expansion of future public debt. The debt burden has already reached $14.6 trillion, like one hundred pc to GDP, virtually identical ratio of Italy, whose debt has been abandoned in monetary markets over rising default fears, the Jeddah-based National business Bank (NCB) said in its report "The S&P's downgrade people and its implications on the Saudi economy" released on Wednesday.
Meanwhile, the US government continues to borrow around forty cents for each dollar it spends, whereas the economy is hardly growing and unable to come up with the required revenues to sustain its fiscal path.
S&P cited 2 reasons for the downgrade: 1) the fiscal consolidation set up agreed to be around $2 trillion in deficit reduction over consequent ten years falls short from containing the debt growth over the medium-term. 2) the extended political dialogue relating to raising the debt ceiling underscored the gap between the political parties. These indicate that measures required to restrain the expansion of public debt, like raising taxes and entitlement reforms were less doubtless to be adopted than S&P had initially envisioned.
The S&P's call wasn't a complete surprise, however the surprise within the accelerated timing since the July 14th announcement when S&P place the US on CreditWatch negative, hinting that a downgrade was imminent over consequent few months. Apparently, the announcement shortened the time amount within which S&P needed the political parties to agree on deficit reduction, with an bold $4 trillion debt reduction target. because the deficit reduction set up, that was passed last week, was considerably less at $2.4 trillion, a downgrade appeared unavoidable.
The Saudi economy
The impact of the S&P's downgrade of US's credit on Saudi Arabia economy can come back through 3 channels. the primary is thru its impact on crude oil demand and costs. Triggered by worries of a replacement economic decline or a double-dip recession within the US, the world's largest oil shopper, this may greatly undermine world energy demand. additionally, recent considerations that Europe's debt crisis may unfold to Italy, the euro zone's third-largest economy, accentuated fears of a vicious new world economic downturn. Oil costs sank over $10 a barrel last week, highlighting simply how quickly commodity markets will swing within the peak of a crisis, and continued to sag below $80 a barrel.
Apparently, the NCB report said drop in costs reflects the market's revision to expected demand growth. On Monday, light-weight sweet crude for September delivery, fell $2.08, or 2.56 percent, to the amount of $79.23 a barrel. Meanwhile, Brent North ocean crude for September delivery dropped $1.21 or 1.17 % to $102.53. additional volatility in oil costs is expected within the near-term as monetary investors cut back their long positions on the rear of risk aversion and also the unsure world economic outlook. However, the NCB believes, that the autumn in oil costs could also be nearing an finish. this may be very true if the Fed steps up its purchases people government bonds. However, though oil costs fall below the $80 a barrel level, Saudi Arabia won't have an excellent impact because the Kingdom enjoys an oversized reserve to satisfy its planned spending.
The second channel of impact on the Saudi economy is thru the US dollar. The US dollar response against most currencies can doubtless follow broader market developments. As equity and commodity markets keep falling globally, investors are doubtless to chop long positions in equities, and commodities.
These are mainly funded by short US dollar, thus whether or not or not the safe-haven standing of the US dollar is impaired over the long-term, a downward shock to markets is probably going to be US dollar positive within the close to term. There are contradictory forces at work with the pull down from the credit rating and also the push up from an equity market disturbance, for as stocks are sold and greenbacks are bought. though this is often positive for the US dollar within the short-term, once things calm down, as noted earlier, the downgrade would have a negative impact on the US dollar. Meanwhile, there could also be different considerations in FX markets that the euro AAAs aren't sturdy, given the economic problems facing the euro zone. whereas investors instinctively might want to sell US dollar and get euro, the euro sovereign problems don't look higher as a result of the US' appearance worse. With the impact of S&P's downgrade being positive on the US dollar within the short-term, it's unlikely to boost the amount of imported inflation within the kingdom, particularly that commodity costs are falling. However, weaker US dollar within the future, owing to the S&P's downgrade, could eventually contribute to higher imported inflation, the report said.
The third channel of impact is thru the official holdings people treasuries, that is believed to represent the bulk of the Kingdom's web foreign assets, currently amounting to $492 billion. The downgrade is truly additional of a referendum on the dollar instead of US treasuries, owing to the actual fact that US's ability to pay its debt obligations remains a elementary certainty as a result of the dollar remains the world's reserve currency and also the US government will still print cash to fund its obligations. Therefore, holders people treasuries like Saudi Arabia shouldn't be troubled that they will not receive interest payments on US bonds. However, the worth of these payments can basically decline, given the actual fact that with additional greenbacks in circulation owing to the printing presses, the worth of every dollar by definition declines. as long as the dominion is keeping rather more than enough to keep up the peg of the Saudi riyal to the US dollar, it's advisable that the dominion ought to prefer diversifying future excess revenues removed from US Treasuries into different real assets across completely different currencies and regions, the NCB report said.
US Treasury market
Despite the S&P downgrade, treasuries trading strengthened, with the costs of long-term treasuries soaring to high levels and accordingly yields falling any. In fact, the yield on the 10-year Treasury benchmark fell to a record low of two.034 % on Aug. 9. Demand for treasuries goes sturdy until date, with investors submitting $2.99 in bids for each dollar of the $1.26 trillion sold this year, exceeding the $2.26 in bids for each dollar of debt sold throughout the budget surplus years between 1998 and 2001. this is often additionally partly owing to speculation that the Fed may get longer period treasuries. One cannot rule out that that the US Treasuries are driven by the changing perceptions concerning financial policy, and additionally fears of a replacement euro zone sovereign debt crisis. Nonetheless, the flattening yield curve is that the opposite of what one would expect if the markets concurred with S&P's downgrade.
The US Treasuries stay the flight to quality asset category of selection, and that we don't believe that recent S&P's call can amendment that within the as regards to medium term, the report added.
It has been for a few time believed that based mostly on fiscal stance alone, the US was now not a triple A rated sovereign. however the credit rating of a rustic isn't a operate of its fiscal stance solely, in addition to for a rustic just like the US. within the case people, 2 factors are of exceptional importance, that embody the political weight and also the reserve currency standing. it's true that political system in recent months has demonstrated gridlock, diminishing its political can, however the standing of the US dollar because the world reserve currency can still give the US with a big advantage no different economy enjoys.
In addition, the shortage of immediate credible alternatives can keep the remainder of the planet highly de- pendent on the US treasury market. the 2 biggest bond markets when the US are the japanese and Italian bond markets. Japanese yields are low and are currently so much below the US's and additionally Japan's fiscal position is considerably worse than that of the US. In Italy, the fiscal stance has been worsening, with its debt/GDP ratio so much exceeding that of the US debt/GDP ratio. Notably, despite its fiscal challenges, the US economy is additional positioned to recover than either of those 2 economies.
Emerging markets, on the opposite hand, don't supply trustworthy alternatives as their bond markets beside being little, their currencies are generally not absolutely convertible, and their political and legal establishments are non predictable.
The monetary business
The near-term impacts of S&P's downgrade expected, as noted higher than, to be minimal for the US bond markets. "We don't anticipate forced selling people treasuries from any major investor base. Foreign central banks maintain an oversized share of their FX reserves in US treasuries as a result of it's the deepest and most liquid bond market. But, international funds that limit their investments to "AAA" rated bonds could dump the US holdings, inflicting the US dollar to depreciate. Yet, mutual fund investment tips do retain some flexibility relating to the handling of such matters," the NCB said in its report,
In the US banking system, where US treasuries are benchmarks for lending and collaterals, the impact may be additional disruptive. that's very true within the interbank "repo" market, where banks swap bonds for money to balance their books within the short-term. To mitigate the impact on banks, the US Treasury quickly issued a ruling on Friday stating that the danger weight people debt in their reserves wouldn't amendment despite the downgrade, therefore banks shouldn't be forced to sell. Moreover, as long as major US banks are many notches below AAA, a single- notch downgrade shouldn't cause downgrades within the credit ratings of banks. Assuming that this occurred, further collateral needs believed to be manageable, the NCB report said.
Similarly, insurance firms also are unlikely to be forced to sell because the National Association of Insurance Commissioners (NAIC) has already de-emphasized credit ratings for regulatory capital needs. Meanwhile, the impact could also be seen on establishments, that suppose the US government guarantee for his or her bonds, like heavily indebted home lenders Freddie Mac and Fannie Mae. Their borrowing prices could rise, which would spill over into higher mortgage prices and presumably bank lending rates for the customers.
The US dollar
The size of the US economy and its treasury market and also the dollar's standing as a reserve currency create it not possible to search out a historical parallel for the present state of affairs. However, being the world's reserve currency, the US dollar currently seems inconsistent with an AA+ rating. The longer-term effects are driven primarily by whether or not international markets can eventually additionally downgrade the US. Consequently, the most important impact ought to be through the impact on the US dollar as a reserve currency. Theoretically, the downgrade ought to raise the borrowing price of the govt, to rates beyond different AAA countries like Germany. This, in turn, ought to push down the dollar's price relative to different currencies of sturdy economies.
With China alone holding over $1.2 trillion value people debt and Japan, $900 billion any questioning of US's ability to pay its debts ought to unnerve the world financial set-up. Foreign investors have provided nearly forty % of non-financial credit creation within the US over the past few years. Ultimately, the downgrade may increase diversification removed from the US assets. Therefore, a rise within the pace of diversification ought to have a negative impact on the dollar and additionally would be an economic drag on the US, as domestic savings would ought to rise to select up the slack, the NCB report said.
