S&P sent wake up call to Congress

April 19, 2011

, SEOUL, Apr 19 – Asian economies would feel little impact from Standard & Poor\’s downgrade of its US debt outlook but a failure by Congress to reach a budget deal could have more serious repercussions, analysts said.

The ratings agency Monday challenged Washington\’s gold-star "AAA"-rated standard by slapping it with a "negative" outlook, down from "stable", and warned that politicians seemed unable to agree a plan to reduce the shortfall.

Stock markets around the world tumbled on the news, with the Dow slipping 1.14 percent and the main indexes in London, Frankfurt and Paris all losing more than two percent, while Tokyo, Hong Kong, Sydney and Shanghai were also well down.

Rajiv Biswas, Asia-Pacific chief economist at IHS Global Insight, stressed the importance of a US budget deal for Asia, where many governments and central banks hold large amounts of US government debt.

"It is crucial that the US Congress agrees on a roadmap and timetable for medium-term fiscal consolidation to reassure Asian governments about the stability of their existing investments in US government debt as well as to convince them to continue buying new holdings," Biswas said.

"Given the importance of the US as the world\’s largest economy, this is also essential for underpinning the stability of the global financial system."

S&P said the US\’ fiscal profile may become "meaningfully weaker" than that of other triple-A-rated countries unless policymakers can tame the deficit.

S&P said it was unlikely Democrats and Republicans in Washington would reach a deal for President Barack Obama to sign off before next November\’s presidential poll. Without a compromise, it said, things would get worse.

"Because… the path to addressing these (problems) is not clear to us, we have revised our outlook on the long-term rating to negative from stable," S&P said.

If not action is taken, S&P said it could cut the US rating for the first time, a move which would send Washington\’s debt costs sharply higher.

Government debt is now around 10 percent of the country\’s gross domestic product.

But Japan — itself no stranger to the downgrading issue — voiced strong support for US debt. With Treasury bond holdings worth $886 billion as of March, it is the second-largest foreign holder of US bonds after China.

"The US is taking various steps on the fiscal front, and basically we continue to believe that US Treasuries are an attractive product for us," said Finance Minister Yoshihiko Noda.

And Economy Minister Kaoru Yosano said US bonds will still win investor support globally.

Daisuke Uno, chief market strategist of Sumitomo Mitsui Banking Corp, said S&P had warned in February that it might revise its US outlook and so Monday\’s move was not really surprising.

However, Uno said the decision could have negative consequences for Japan as it seeks funds for massive post-tsunami reconstruction.

The move "means that there is now a scar on the once impeccable credibility of US bonds, which is a big thing", Uno said.

"This will inevitably weaken the dollar, and as a result it will lead to the appreciation of the yen."

In Japan, unlike in other countries, when the yen strengthens, share prices go down, Uno added.

The Japanese yen has jumped against the dollar since the announcement and was sitting in the mid-82 yen range on Tuesday in Asia after reaching the high 84 yen level recently.

"Since Japan needs money for rebuilding the disaster-hit areas, the government has considered a variety of ways to create reconstruction funds. But it\’s always better to have more capital coming in to the share markets."

China, which has a large part of its $3 trillion of foreign reserves tied up in US Treasuries, had no immediate official comment but Beijing-based analyst Ren Xianfang, of IHS Global Insight saw no dramatic change long-term.

"The problem (for China) is there are no better options," she said. "The European debt crisis is still progressing and Japan\’s credit conditions are also getting worse.

"Compared with other countries at the moment, the US is still a better choice."

Ren said China could divert more of its reserves into China Investment Corp, a sovereign wealth fund with a diverse foreign portfolio, and to state-owned companies making acquisitions overseas.

Capital Economics analyst John Higgins noted that both the dollar and Treasuries had recovered from initial wobbles since "the idea that the US public finances are on an unsustainable trajectory is hardly new news".

But he cautioned that if Congress cannot agree how to move forward, investors may eventually start to become more nervous.


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