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Cut in US government rating sends world markets in frenzy in H1-August 2011

Cut in US government rating sends world markets in frenzy in H1-August 2011

The month of August, particularly the first half, has been a volatile month for financial markets, on increasing fears of yet another global recession amid downgrade of the US government�s credit rating and acceleration of debt problems in the Eurozone. Though chances of a new recession have risen, the more plausible upshot seems a period of low economic growth. Stock markets all across the globe have been shaken, as per a report by Jadwa Investment Research Department.
In the first week of August, credit ratings agency Standard and Poor�s (S&P) cut the rating of the US government. Prior to the cut, USA�s credit rating had always been at the highest level available (AAA). A credit rating is a measure of the creditworthiness of a borrower; the lower the rating, the more likely that a borrower will default. S&P�s move was triggered by disappointment about the recent deal to extend the ceiling on the amount of debt the US government could issue. Although the deal was concluded before the debt ceiling was hit, which meant that the US government was able to make all scheduled payments, S&P considered that the deal did not go far enough to tackle the debt problems the country faces. It also highlighted that the political climate in the US, which was the main barrier to extending the debt ceiling, complicated the prospects for a long-term debt deal.
Another factor contributing to the volatility is mounting concern about the extent of spread of the debt problems in the Eurozone. Specifically, Italy and Spain were forced to pay much higher rates to borrow through financial markets owing to weak economic growth, continuing budgetary stresses and political uncertainty. The new framework established by EU institutions to deal with the debt problems in Greece, Ireland and Portugal in late-July would be overwhelmed if it were extended to cover Italy and Spain given the far greater size of these countries� debts (total financing needs for Italy and Spain over the final 5 months of 2011 are around �245 bln (US$350 bln), greater than the value of Greek debt maturing over the next 6 years before it was restructured). Fears that EU institutions were not being bold enough to confront this problem were heightened in first week August, when the European Central Bank (ECB) chose to purchase (and thereby lower borrowing costs) only Greek, Irish and Portuguese bonds. European policy makers held emergency meetings over the weekend, after which the ECB signaled that it would start buying Italian and Spanish bonds in an attempt to blunt the spreading crisis. In addition, Italy announced plans to reduce its budget deficit late last week. Nonetheless, serious Eurozone debt problems remain. Concerns abound among investors on stream of economic data showing that the global economy is struggling- recent data released in USA on economic growth, housing and manufacturing all point to a slowing economy, amid other parts of the world.
Recent measures by leading economies to tackle debt problems by a cut in spending and raising taxes will also contribute to restraining the economy. Emerging economies have increased interest rates and taken other policy measures to tackle inflation resulting in a slowdown in growth. Overall economic uncertainty and falling stock markets have negatively impacted consumer and business confidence throughout the world. This has been accompanied by a surge in gold prices and a rise in the price of US government debt despite the downgrade. The Japanese yen and Swiss franc have also been pushed up, despite intervention from both countries� central banks aimed at holding down the value of their currencies. Remarkably, price of US government bonds has risen, reflecting the fact that the US is still considered a safe haven for investment,mainly due to the breadth, depth and liquidity of the US financial markets. No other financial market is of a comparable size or has the same variety of financial instruments as the US. Also, although one rating agency downgraded the US, it is still top-rated by the other two leading agencies, Moody�s and Fitch, and neither has indicated that a downgrade in imminent. Markets are likely to remain volatile in the near term. New economic data will be scrutinized closely, as will the actions of economic policy makers. This risk that the global economy slips back into recession has increased, but even if the economy does return to recession, it will be nothing like that of 2008/2009 because the global banking sector is in far better health.
The deepening global economic crisis has had limited impact on markets in India and the current volatility in global markets seems to be a temporary turbulence. The Indian government has decided to provide stimulus measures to absorb the impact of moderation in exports following a rating downgrade of the United States by Standard & Poor's. Indian exports should grow more than 25% in the current financial year 2011-12. India's merchandise exports rose by 38% to US$246 bln in FY 2010-11, and are estimated to nearly double to US$500 bln by 2014. India generated foreign direct investments totalling US$14 bln in Q1 of 2011-12. The United States is India's biggest trade partner in goods and services combined. But India remains a potentially good growth story with a strong domestic market driven by 1.2 bln people. The GDP will continue to grow at a rate of 8% as it rests on robust fundamentals. It is unlikely that ongoing events will have a great an impact on the Saudi economy, as the growth momentum stems from high government spending that can be afforded comfortably. However, oil prices remain the main link between the global economy and that of the Kingdom. Falling oil prices remain above US$84 per barrel (Saudi export crude) estimated necessary to avoid a budget deficit this year. Average for 2011 to date for Saudi export crude is comfortably in excess of $100 per barrel. Further signs of a worsening global economic environment could pull oil prices lower. However, this time the recession, if any, is anticipated to be a more normal recession than in 2008, hence the movement in oil prices would be much less volatile. A spectacular drop in prices seen in H2-2008: from almost US$150 per barrel to just over US$30 per barrel, is unlikely to be repeated. The downgrade is negative for the dollar and therefore the Saudi riyal, but it should not trigger a significant short-term fall. After the downgrade, the dollar was fairly stable in the first few days of trading, due to - First, other leading economies also face serious problems; second, countries with stronger economic fundamentals or those that are considered safer than the US are intervening to stem the rise in their currencies; and third, the US continues to be viewed as a safe haven.
Major exporters, particularly from Asia, are nervous after the downgrade of the United States credit rating, stoking fears that the world�s biggest consumer market is falling back into recession. This along with the continued debt-crisis in Europe has been forcing global exporters to immediately apply contingency plans to secure their bottom lines. Consumer sentiment for goods such as cars, electronic devices as well as business-to-business (B2B) products could slow. Revenue for most of Asian exporters usually peaks in the latter half of a year because of increased buying activity for consumer goods or upgrade thanks to good price offers from manufacturers to lower inventories and prepare for a new year. A weakening dollar vs other currencies will mean exporters lose price competiveness
Growth in the petrochemical industry is strongly correlated with macroeconomic growth, as polymers are the basic inputs for most industrial sectors, feeding automotive, construction, industrial, and consumer product chains. Hence the profitability of the industry is notoriously volatile.
 
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