impact of us and chinese downgrade

7/29/2019 Impact of Us and Chinese Downgrade

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IMPACT OF US ANDJAPANESE DOWNGRADE ON

INDIA Made by:Sanya Sharma

Bfia3

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RECENT STATUS OF USECONOMY

Statistics GDP:$14.527 trillion (2010) ( nominal and PPP)

GDP growth:3.0% (2010)

GDP per capita:$46,844 (2010)(17th, nominal; 6th, PPP)

GDP by sector: agriculture: (1.2%), industry: (21.9%), services: (76.9%) (2009 est.)

Inflation (CPI)2.1% (February 2011)

Population below poverty line:14.3% (2009)

Labour force:154.5 million (includes unemployed) (2009 est.)

Unemployment:9.2% (June 2011)

Ease of Doing Business Rank:5

External Exports:$1.280 trillion f.o.b (2010)

Main export partners: Canada, 13.2%; Mexico, 8.3%; China, 4.3%;Japan, 3.3%. (2009)

Imports$1.948 trillion c.i.f. (2010)

Main import partners: China, 15.4%; Canada, 11.6%; Mexico, 9.1%;Japan, 4.9%; Germany, 3.7%. (2009)

FDI stock$2.398 trillion (31 December 2009 est.)

Gross external debt$14.39 trillion (30 Sept 2010)

Public finances Public debt $14.77 trillion (Jun 2011)100% of GDP

Revenues $2.162 trillion (2010)

Expenses $3.456 trillion (2010)

Economic aid ODA $19 billion, 0.2% of GDP (2004)

Credit rating

Standard & Poor's:AA+ (Domestic)AA+ (Foreign)AAA (T&C Assessment)Outlook: Negative

Moody's:[

AAAOutlook: Negative

Fitch: AAA

Outlook: Stable

Foreign reservesUS$140.607 billion (May 2011)


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RECENT STATUS OF USECONOMY U.S. Budget Spending: For Fiscal year (FY) 2012, US budget- $3.7 trillion.

Of which-57% was for mandatory programs ,such as Social Security, Medicare and Military Retirementprograms. Rest forms the dicretionary budge. Nearly half of the Discretionary budget wenttoward military spending. The remaining 4.6% of spending ($240 billion) went toward interest paymentson the $14 trillion national debt.

Economic Growth Cannot Keep Up With Government Spending:

Before the recession, budget spending was at 20% of GDP each year. This meant the budget onlygrew as fast as the economy, which was about 3% per year. However, spending to lift the economy outof recession increased this ratio to 25% of GDP. The budget will drop to 23% of GDP in FY 2012, and22% in FY 2013 onwards. Increased spending was needed to stimulate consumer spending, whichsupports 70% of economic growth. However, its expected that once the economy recovers, fiscalspending would be reduced to avoid inflation and reduce the debt.

Interest Payments on the National Debt:

Just under 5% of the budget, $240 billion, was for interest payments for the national debt. However, by

2021, interest payments on the debt is projected to increase to $928 billion, or 15% of spending. It willbe the fourth largest budget item, after Social Security ($1.3 trillion), security spending ($1.03 trillion)and Medicare ($792 billion).


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Criteria of sovereign ratings Like other credit ratings, sovereign ratings are assessments of the relative likelihood that a borrower

will default on its obligations.2 Governments generally seek credit ratings to ease their own access(and the access of other issuers domiciled within their borders) to international capital markets, wheremany investors, particularly U.S. investors, prefer rated securities over unrated securities of apparentlysimilar credit risk. In the past, governments tended to seek ratings on their foreign currency obligationsexclusively, because foreign currency bonds were more likely than domestic currency offerings to beplaced with international investors. In recent years, however, international investors have increasedtheir demand for bonds issued in currencies other than traditional global currencies, leading moresovereigns to obtain domestic currency bond ratings as well. To date, however, foreign currency

ratingsthe focus of this articleremain the more prevalent and influential in the international bondmarkets.

Sovereign ratings are important not only because some of the largest issuers in the international capitalmarkets are national governments, but also because theseassessments affect the ratings assigned toborrowers of the same nationality. For example, agencies seldom, if ever, assign a credit rating to alocal municipality, provincial government, or private company that is higher than that of the issuershome country.

DETERMINANTS OF SOVEREIGN RATINGS In their statements on rating criteria, Moodys and Standard and Poors list numerous economic, social,

and political factors that underlie their sovereign credit ratings .Identifying the relationship between theircriteria and analysis to measure the relative significance of eight variables that are repeatedly cited inrating agency reports as determinants of sovereign .the relationship between each variable and acountrys ability and willingness to service its debt is explained below:


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Per capita income.:The greater the potential tax base ofthe borrowing country, the greater theability of a government to repay debt. This variable can also serve as a proxy for the level ofpolitical stability and other important factors.

GDP growth. :A relatively high rate of economicgrowth suggests that a countrys existingdebt burden will become easier to service over time.

Inflation. :A high rate of inflation points to structuralproblems in the governments finances.When a government appears unable or unwilling to pay for current budgetary expensesthrough taxes or debt issuance, it must resort to inflationary money finance. Publicdissatisfaction with inflation may in turn lead to political instability.

Fiscal balance.: A large federal deficit absorbs private domestic savings and suggests that agovernment lacks the ability or will to tax its citizenry to cover current expenses or to service itsdebt.

External balance. A large current account deficit indicates that the public and private sectorstogether rely heavily on funds from abroad. Current account deficits that persist result ingrowth in foreign indebtedness, which may become unsustainable over time.

External debt. :A higher debt burden should correspondto a higher risk of default. The weightof the burden increases as a countrys foreign currency debt rises relative to its foreigncurrency earnings (exports)

Economic development. :Although level of development is already measured by per capitaincome variable, the rating agencies appear to factor a threshold effect into the relationshipbetween economic development and risk. That is, once countries reach a certain income orlevel of development, they may be less likely to default.

Default history. :Other things being equal, a country that has defaulted on debt in the recentpast is widely perceived as a high credit risk. Both theoretical considerations of the role ofreputation in sovereign debt (Eaton 1996) and related empirical evidence indicate thatdefaulting sovereigns suffer a severe decline in their standing with creditors .


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Characteristics of countries in the differentrating bands are summarised as follows:

BandCharacteristics

AAA Capacity and commitment to honour obligations not in question under anyforeseeable circumstances.

AA Capacity and commitment to honour obligations not in question.

A Capacity and commitment to honour obligations strong.

BBB Capacity and commitment to honour obligations currently but somewhat

susceptible to changes in economic climate. BB Capacity and commitment to honour obligations currently but susceptible to

changes in economic climate.

B Capacity and commitment to honour obligations currently but very susceptibleto changes in economic climate.

CCC Questionable capacity and commitment to honour obligations. Patchypayment record.

CC Somewhat weak capacity and commitment to honour obligations. Patchypayment record. Likely to be in default on some obligations.

C Weak capacity and commitment to honour obligations. Patchy payment record.Likely to be in default on significant amount of obligations.

D Very weak capacity and commitment to honour obligations. Poor paymentrecord. Currently in default on significant amount of obligations.


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CAUSES OF REVISIONOF US SOVEREIGNRATING


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Causes of revision of rating Standard & Poor's sovereign credit rating on the U.S. federal government is still 'AAA/A-1+'. S&P

define an entity with a 'AAA' long-term rating as one that has an extremely strong capacity to meet itsfinancial commitments. 'AAA' is the highest issuer credit rating they assign. The ratings on the U.S.primarily reflect opinion of the U.S.'s high-income, highly diversified, and exceptionally flexibleeconomy. The ratings also reflect view of the U.S.'s strong track record in terms of growth-enhancingpolicies as well as the unique advantages coming from the U.S. dollar's role as the world's keyinternational currency.

Reasons for revision of rating: These include the view that there is a material risk that efforts toreduce future U.S. government budget deficits will fall well below the $4 trillion and $4.4 trillion medium-term targets that Congressional leaders and the Administration separately set out earlier this month.

Factors stated to support the revision: The focus will be on two issues: first, whether agreementcan be reached on a program that would reduce projected budget deficits by the target of $4 trillionover the coming decade, and, second, if so, the nature and likely effectiveness of the legislativedecisions and assumptions underlying the program


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Ownership of debt

Because a large variety of people own the notes, bills, and bonds in the "public" portion of the debt, the U.S. Treasury alsopublishes information that groups the types of holders by general categories to portray who owns United States debt. In thisdata set, some of the public portion is moved and combined with the total government portion, because this amount isowned by the Federal Reserve as part of United States monetary policy.

As is apparent from the chart, a little less than half of the total national debt is owed to the "Federal Reserve andintergovernmental holdings". The foreign and international holders of the debt are also put together from the notes, bills, andbonds sections. To the right is a chart for the data as of June 2008:

Foreign ownership

Composition of U.S. Long-Term Treasury Debt held by foreign states, Nov. 2005Nov. 2010. June figures are results ofcomprehensive Treasury Department surveys.

As of January 2011, foreigners owned $4.45 trillion of U.S. debt, or approximately 47% of the debt held by the public of$9.49 trillion and 32% of the total debt of $14.1 trillion. The largest holders were the central banks of China, Japan, theUnited Kingdom and Brazil.[5 The share held by foreign governments has grown over time, rising from 13% of the public debtin 1988to 25% in 2007.

As of May 2011 the largest single holder of U.S. government debt was China, with 36 percent of all foreign-held U.S.Treasury securities (16% of total US public debt).China's holdings of government debt, as a percentage of all foreign-heldgovernment debt, have decreased a bit over the last year, but are up significantly since 2000 (when China held just 6percent of all foreign-held U.S. Treasury securities).

Major Foreign Holders of U.S. Treasury Securities, 20002010(next slide)

Major Foreign Holders of U.S. Treasury Securities, June 2010-May 2011 (next slide)

This exposure to potential financial or political risk should foreign banks stop buying Treasury securities or start selling themheavily was addressed in a June 2008 report issued by the Bank of International Settlements, which stated, "Foreigninvestors in U.S. dollar assets have seen big losses measured in dollars, and still bigger ones measured in their owncurrency. While unlikely, indeed highly improbable for public sector investors, a sudden rush for the exits cannot be ruled outcompletely."

On May 20, 2007, Kuwait discontinued pegging its currency exclusively to the dollar, preferring to use the dollar in a basketof currencies. Syria made a similar announcement on June 4, 2007.In September 2009 China, India and Russia said theywere interested in buying IMF gold to diversify their dollar-denominated securities. However, in July 2010 China's StateAdministration of Foreign Exchange "ruled out the option of dumping its vast holdings of US Treasury securities" and saidgold "cannot become a main channel for investing our foreign exchange reserves" because the market for gold is too smalland prices are too volatile.


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Us debt and its effect on theeconomy

What the U.S. National Debt Is: The U.S. debt is over $14.5 trillion, nearly two-thirds is the public debt, which is owed to the people, businesses and foreign

governments who bought Treasury bills, notes and bonds.

The rest is owed by the government to itself, and is held as Government Account securities. Most of this is owed to SocialSecurity and other trust funds, which were running surpluses. These securities are a promise to repay these funds whenBaby Boomers retire over the next 20 years.

The Size of the U.S. Debt:

The U.S. debt is the largest in the world. Why? Purchasers of Treasury bills still reasonably expect the U.S. economy torecover enough to pay them back. For foreign investors like China and Japan, the U.S. is such a large customer it is allowed

to run a huge tab so it will keep buying exports.

Even before the economic crisis, the U.S. debt grew 50% between 2000-2007, ballooning from $6-$9 trillion. The $700billion bailout helped the debt grow to $10.5 trillion by December 2008.

The U.S. Debt Level:

The debt level is the debt as a percent of the total country's production, or GDP, which was $14.7 trillion in 2010. The debtnearly 100% of GDP, up from 51% in 1988.

Interest on the debt was $414 billion in Fiscal Year 2010, higher than the $383 billion in FY 2009, but lower than its peak of$451 billion in FY 2008. That's because of lower interest rates. The interest on the debt is the fifth largest Federal budget

item, after Defense and Security spending ($890 billion), Social Security ($730 billion) and Medicare ($490 billion). (Source:U.S. Treasury)

How Did the Debt Get So Large?:

Government debt is an accumulation of budget deficits. Year after year, the government cut taxes and increased spending.In the short run, the economy and voters benefited from deficit spending. Usually, however, holders of the debt want largerinterest payments to compensate for what they perceive as an increasing risk that they won't be repaid. This added interestpayment expense usually forces a government to keep debt within reasonable limits.

The U.S. also has a debt ceiling, which attempts to limit the debt. However, Congress usually raises the ceiling to preventthe negative consequences of a debt default.

The most recent budget forecast from the Office of Management and Budget (OMB) showed the FY 2011 budget deficit at$1.3 trillion, more than the $1.17 trillion deficit for FY 2010, but down from the $1.7 trillion deficit for FY 2009. This was aresult of the 2008 government bailout measures and the roughly $800 billion a year defence/security spending.(Source:


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Contd..

The U.S., however, has been the beneficiary of two unusual factors. First, the Social Security Trust Fund took inmore revenue through payroll taxes leveraged on Baby Boomers than it needed. Ideally, this money should havebeen invested to be available when the Boomers retire. In reality, the Fund was "loaned" to the government tofinance increased deficit spending. This interest-free loan helped keep Treasury Bond interest rates low,allowing more debt financing. However, it's not really a loan, since it can only be repaid by increased taxes whenthe Boomers do retire.

Second, foreign countries increased their holdings of Treasury Bonds as a safe haven, also keeping interestrates low. These holdings went from 13% in 1988 to 31% in 2011. During the recession, countries like China andJapan increased their holdings of Treasuries to keep their currencies low relative to the dollar. Even thoughChina warns the U.S. to lower its debt, it keeps buying more Treasuries.

Of the total foreign holdings ($4.49 trillion), China owns $1.1 trillion and Japan owns $900 billion. The U.K. owns$300 billion, while Brazil, the oil exporting countries, Hong Kong, Russia and Canada own between $100-$280billion each. The Bureau of International Settlements suspects that much of the holdings by Belgium, CaribbeanBanking Centers and Luxembourg are fronts for more oil-exporting countries, or hedge funds, that do not wish tobe identified. (Source: Foreign Holding of U.S. Treasury Securities)

How The U.S. Debt Affects its Economy:

Over the next 20 years, the Social Security funds must be paid back as the Baby Boomers retire. Since thismoney has been spent, resources need to be identified to repay this loan. That would mean higher taxes, since

the high U.S. debt rules out further loans from other countries. Unfortunately, it's most likely that these benefitswill be curtailed, either to retirees younger than 70, or to those who are high income and therefore theoreticallydon't need Social Security.

Second, many of the foreign holders of U.S. debt are investing more in their own economies. Over time,diminished demand for U.S. Treasuries could increase interest rates, thus slowing the economy. Furthermore,anticipation of this lower demand puts downward pressure on the dollar. That's because dollars, and dollar-denominated Treasury Securities, may become less desirable, so their value declines. As the dollar declines,foreign holders get paid back in currency that is worth less, which further decreases demand.

The bottom line is that the large Federal debt is like driving with the emergency brake on, further slowing theU.S. economy


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US debt movement


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Comparison of us fiscal profileswith other AAA rated countries


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Comparison U.S. government's

external profile with that of other

'AAA' sovereigns

C i f th t


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Comparison of growth prospectsof US with other AAA rated

countries


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Brief of Indian economy Statistics GDP: $1.53 trillion (nominal: 2010),$4.06 trillion (PPP: 2010)

GDP growth: 8.5% (2010-11)

GDP per capita: $1,265 (nominal; 2010),$3,339 (PPP; 2010)

GDP by sector: services (55.3%), industry (28.6%), agriculture (16.1%) (2010)

Inflation: (CPI) 9.44% (June 2011)

Population below poverty line: 37% (2010)

Labour force 478 million (2nd; 2010)

Unemployment 9.4% (200910)

Main industries telecommunications, textiles, chemicals, food processing, steel, transportation equipment, cement, mining, petroleum, machinery,

information technology, pharmaceuticals.

Ease of Doing Business Rank: 134th(2011)

Exports $247.4 billion (2010)

Main export partners UAE 12.87%, US 12.59%, China 5.59% (2009)

Imports $359.3 billion (2010)

Main import partners China 10.94%, US 7.16%, Saudi Arabia 5.36%, UAE 5.18%, Australia 5.02%, Germany 4.86%, Singapore 4.02% (2009)

FDI stock $35.6 billion (2009-10)

Gross external debt $237.1 billion (31 December 2010 est.)

Public finances

Public debt $758 billion (2010)[6]55.9% of GDP

Revenues $170.7 billion (2010 est.)

Expenses $268 billion (2010 est.)

Economic aid $2.107 billion (2008)[7]

Credit rating BBB- (Domestic)BBB- (Foreign)BBB+ (T&C Assessment)Outlook: Stable(Standard & Poor's)

Foreign reserves $319 billion (July 2011
http://en.wikipedia.org/wiki/Economy_of_Indiahttp://en.wikipedia.org/wiki/Economy_of_Indiahttp://en.wikipedia.org/wiki/Economy_of_Indiahttp://en.wikipedia.org/wiki/Economy_of_Indiahttp://en.wikipedia.org/wiki/Economy_of_India


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Effect of downgrade of US

sovereign rating on India


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Effect on India

Indias central bank through the media, said that the central bank for any possiblecrisis have made adequate preparations. India has enough liquidity to overcomethe problems caused by the crisis, Indias economic system and the 2008 financialcrisis as likely to survive the coming impact.

US crisis to benefit India:

India will be impacted in the short term because of the US sovereign debt crisis,but it will also benefit from the economic turmoil as softening crude prices will

bring down inflation, prompting the Reserve Bank of India (RBI) not to hike rates One positive fallout of the rating downgrade, could be the Indian market

perception that a possible decline in crude prices may signal a pause in RBI ratehikes, buoying investor sentiments. (source:FICCI)

Additionally, the spreads between a US sovereign and Indian sovereign paper ofcomparable duration may decline, thus acting as an enabler to foreign institutionalinvestors inflows into the country. This may have a sobering impact on the currentaccount deficit.

As far as the impact of the crisis on the Indian economy, FICCI said some short-term impact would be seen in terms of market uncertainties."An uncertain globalenvironment could, however, depress India's exposure to global markets (exportsof goods and services, more than a quarter of India's GDP) and knock offpercentage points from India's GDP growth," the industry lobby said whileoutlining some of the risks.


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Sno. Share of topf ive invest ing

coun tr ies in

FDI inf low s.

(20002010)

Inflows(in USD)

Inflows(%)

1 Mauritius 50164 42

2 Singapore 11275 9

3 USA 8914 7

4 UK 6158 5

5 Netherlands 4968 4


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Conclusion How to address the problem

First, the nonperforming assets from the latest crisis have been chopped up and embedded in various forms of differenttypes of securities that have been spread among investors and financial institutions across the world. The disposition ofnonperforming assets involves identifying the holders of these securities, determining the amount of losses the creditorshave incurred on such securities, and then persuading them to take their share of the losses. Altogether, this process wouldrequire an enormous amount of time and effort. Negotiations on burden-sharing are, by definition, a troublesome task that noone wants to deal with. That task is even more challenging this time around because the disposition of nonperforming assetswill have to proceed multilaterally with affected parties scattered around the world.

However, due to strong public opposition and/or the intertwining of interests, most countries are far from being ready tocoordinate and work together to clean up nonperforming assets. At the present time the US is most likely in a state ofparalysis in terms of addressing the problem of nonperforming assets.

Wishful thinking on fiscal stimulus This might be the state in which the Americans find themselves today. A counter-reaction to this state of paralysis might be

manifesting itself in the form of excessively wishful thinking about the effects of fiscal policies. Many decision makers want toforce themselves to believe that fiscal measures will cure the problem because there is nothing else they can do at themoment. However, people in the US will soon realize that f iscal measures alone cannot provide an ultimate cure.

One probable future scenario would have the US temporarily regaining strength over the next two to three years with thesupport of fiscal measures, but the problem of nonperforming assets, the root cause of the ongoing economic turmoil, wouldremain unsolved because of various political difficulties such as strong public opposition to bailing out banks. Consequently,once the painkilling effect of fiscal measures wears off, the US would once again plunge into another serious crisis.

Only after going through this ordeal and realizing that fiscal measures alone cannot solve the problem would peoplerecognize the need for ultimately disposing of nonperforming assets. And only then could a global policy scheme for

addressing the core problem of financial instability be formulated. But until this happens, the US government will most likelycontinue to run a fiscal deficit, further snow-balling its already huge federal debt.

As the US economy continues to stagnate, the Japanese economy will be the hardest hit because its exports will sufferdirectly from the sluggish demand in the world's largest market. Thus, Japan has no choice but to keep on priming the fiscalpump to prop up its economy. Finance Minister Kaoru Yosano promised a 3 trillion fiscal stimulus package at the HorshamG20 meeting, but Japan will still need to take further fiscal steps and act in tandem with the US in the coming months.

Conclusion

So long as people hold onto the expectation that recovery could be brought about by fiscal measures, no national consensuscan be built to proceed with the painful disposition of nonperforming assets. It is necessary to learn by firsthand experiencethat fiscal measures are only makeshift. In this context, the enormous fiscal deficit that will be built up in the US in thecoming months may be the political cost for consensus building, which would be a replay of what Japan went through in the1990s.


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Description of Japaneseeconomy

Statistics GDP: $5.458 trillion (2010 est.) (2010) (nominal)$4.309 trillion (2010 est.) (PPP)

GDP growth: 4.0% (2010)-3.5% (2011 Q1)

GDP per capita: $42,820 (2010 est.) (nominal; )$33,805 (2010 est.) (PPP)

GDP by sector: agriculture: 1.5%, industry: 22.8%, services: 75.7% (2010 est.)

Inflation (CPI) :0.3% (April 2011)

Labour force :65.64 million (2010 est.)

Labour force by occupation :agriculture: 4%, industry: 28%, services: 68% (2009 est.)

Unemployment: 4.7% (April 2011)[

Ease of Doing Business Rank: 18th External

Exports $765.2 billion (2010 est.)

Main export partners :China 18.88%, USA 16.42%, South Korea 8.13%, Taiwan 6.27%, Hong Kong 5.49% (2009)

Imports $636.8 billion (2010 est.)

Main import partners China 22.2%, USA 10.96%, Australia 6.29%, Saudi Arabia 5.29%, UAE 4.12%, South Korea 3.98%, Indonesia 3.95% (2009)

FDI stock :$161.4 billion (31 December 2010 est.)

Gross external debt :$2.246 trillion (30 June 2010)

Public finances Public debt 225.80% of GDP (2010 est.)

Revenues $1.638 trillion (2010 est.) Expenses $2.16 trillion (2010 est.)

Economic aid $9.7 billion ODA (February 2007)

Credit rating

Standard & Poor's:AA- (Domestic)AA- (Foreign)AAA (T&C Assessment)Outlook: StableMoody's:

Aa2Outlook: NegativeFitch:

AA

Outlook: Stable

Foreign reserves US$1.154 trillion (April 2011)


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Japans sovereign downgrading

and its causes

In January, credit ratings agency Standard & Poorsdowngraded Japans sovereign credit rating from AA to AA-.

The agencys decision was based on their evaluation that thenations debt, already nearing 200% of GDP.

Japans economy has been in the doldrums for the past 20

years, and was particularly hard hit by the global economicdownturn in 2008 and 2009, contracting by 1.2% in 2008 and6.3% in 2009. Over the past two decades, the governmentcontinued to pour money into the economy in variousattempts to boost economic growth. However, with consumerspending and private investment stagnating, GDP

growth never seemed to gain significant momentum and thecountry suffered through four economic recessions during theperiod.

As a result, Japans government began running a budgetdeficit that is expected to hit a record high this fiscal year


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Quarterly change in the real GDP (blue) and theunemployment rate (red) of Japan from 2000 to 2010


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Japan's total debt compared todebt at a percent of GDP.


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REASONS CONTRIBUTING TO DEBT CRISIS ANDCONSEQUENT SOVEREIGN DOWNGRADEFundamental Problem #1Declining Savings RateJapanese debt is approaching 200 percent of GDP ,also that debt could shoot up to more than 400percent by 2040.Reason: Japan has historically been a nation of savers. The savings rate in the 80s and early 90shad been steadily over 10 percent, higher than any other developed country. That has allowed theJapanese government to sell nearly all of its bonds to its citizens and institutions to the tune of 94percent of total outstanding public debt.But since the economy in Japan went into stagnation in the 90s and given that interest rates for 15years have hovered around zero, the savings attitudes in Japan have shifted. In fact, the savings

rate is now lower than in the U.S. a nation considered grossly addicted to spending, not saving.


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Fundamental Problem #2

Declining Population

While savings rates have been declining, so has the population in Japan, putting morepressure on the absolute quantity of savings. And its only expected to get worse. The

projection for Japans population shows a big fall over the coming decades due to its ageing

demographic.


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Fundamental Problem #3Non-Competitive Interest Rates

With debt expected to keep growing and revenues and savings expected to decline, Japanwill have to turn to the international markets to find buyers of its debt to keep its economybreathing.But theres a problem with that scenario: Japans interest rates dont remotely match the

risk!

Japans 10-year debt pays just 1.3 percent. Apparently that was enough for loyal Japaneseinvestors. But that wont cut it for attracting international capital. Debt in other competitive

advanced economies, like Europe and the U.S. are in the 3 percent to 4 percent rangeright now.


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conclusion

There are signs of Improvement The economy is showing initial signs of a recovery. Japan has

an export-led economy, and exports surged by almost 25% in2010 in response to a global return to growth. Japancontinues to run a current account surplus with the rest of theworld, and it appears that the countrys persistent deflation is

now beginning to reverse. These positive signs are leadingmany domestic leaders to predict that 2011 will represent aturnaround for the Japanese economy.

The debt crisis in Europe has put a harsh spotlight oncountries with significant amounts of debt. However, onepositive for Japans outlook is that most of their debt is helddomestically, in contrast to Greece, where the significantholdings by foreigners led the debt market to collapse whenfears of default suddenly jumped. However, with the S&Prating downgrade comes more intense scrutiny of Japansfiscal situation.


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Effect on India

The negative effect on India both on export terms from India as wellas our GDP growth would be minimum, or rather would not have hadany effect on Indian GDP. Over a period of time when Japan getsinto a reconstruction mode, there would be a lot of opportunities forIndia to participate in that.


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US Vs JAPANEffect of debt crisis on respective countries


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Investors were unfazed by Moodys Investors Services decision to lowerJapans sovereign rating, unlike in the U.S., where Standard & Poors roiledglobal markets when it cut the U.S. AAA ranking for the first time

Yields on benchmark 10-year Japanese government bonds, known as JGBs,were little changed at 1.02 percent as of 1:32 p.m. in Tokyo, and the yenhovered near yesterdays close against the dollar of 76.66, after Moodys cutJapans grade one step to Aa3. When S&P lowered the U.S. to AA+, the

market value of global stocks tumbled by $761 billion between Aug. 5 andAug. 12, (source:Bloomberg), sparking an investor exodus into Treasuries,with 10-year note yields falling to a record-low 1.97 percent.

The difference with S&P is that Moodys -- which retains an AAA grade for theU.S. -- has incorporated the element of a nations ability to tap investors intoits ratings, something that goes beyond levels of Debt.

Moodys cited weak economic growth prospects, frequent changes of

government that prevent long-term budget planning, and a build-up of debtsince the 2009 global recession as reasons for cutting Japans grade to Aa3.

At the same time, it said the rating outlook is stable, and the nation willbenefit from low funding costs because domestic demand for governmentdebt is stable and Japan is the worlds largest net creditor.


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By contrast, S&P kept the U.S. outlook negative, even as the countryraises cash at historically cheap levels: 10-year Treasury yieldsaveraged 3.16 percent this year, against about 4 percent the pastdecade.

The fiscal situation in the U.S. is deteriorating, but the U.S. hasnt lost its

triple-A capacity to procure money. Similarly, the ability of Japan to tap

domestic investors in selling debt means that while Japans fiscalsituation is deteriorating, its not like the markets headed for a collapse.

While S&P said the U.S. was less creditworthy, investors snapped upTreasuries, driving up prices and sending yields to record lows. Yieldson the bonds fell 21 basis points to 1.174 percent.(source: Bank of

America Merrill Lynchs U.S. Treasury Master index)

The S&P 500 Index of American shares swung by at least 4.6 percent inthe four trading days following the change. Gold rose 5 percent.

Equity investors shrugged off Japan downgrade, with the Nikkei 225Stock Average dipping 0.1 percent as of 1:44 p.m. in Tokyo -- less thanthe 0.3 percent drop in the MSCI Asia Pacific index.


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Contrast in Reaction

Prime Ministers government had no

reaction to the Moodys announcement,with Finance Minister declining specificcomment on the news when asked byreporters in Tokyo today. By contrast, the

Obama administration criticized the S&Pmove, with the Treasury Departmenttelling the company it had overestimatedfuture national debt by $2 trillion.

impact of us and chinese downgrade

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