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How badly are China and India affected by the US downgrade?

August 9, 2011

The exact quantum of US debt outstanding is estimated to be around US$ 15 trillion, following the US  downgrade by  Standard & Poor’s (S&P) from AAA to AA+ earlier this week. Foreign countries own nearly US$ 4.5 trillion of this amount and the emerging markets are part of the top 15 countries to which US owes money. Not surprising then that China’s exposure to US debt is the most at a staggering US$ 1.15 trillion amounting to about 26 percent of the total debt, while India ranks 14th at US$ 41 billion.

The downgrade’s impact on China is expected to be the most severe, considering that both economies are tied at the hip. For one, the dollars’ value will depreciate, causing heart burn for China, and reducing exports. While the immediate impact of the downgrade on China is expected to be limited, inflation which is already at a three-year high is expected to escalate. Inflation rose to 6.5 percent on surging food costs, putting the government in a tough position, with worsening global liquidity in sight. China’s Consumer Price Index (CPI), a main gauge of inflation, surged by 6.5 percent in July year-on-year, up from a three-year high of 6.4 percent in June, according to the National Bureau of Statistics (NBS).

China’s yuan strengthened the most in a week, touching a 17-year high last Monday, the People’s Bank also set a new record for the Chinese yuan-dollar central parity exchange rate, dropping it to 6.4305. The currency touched 6.4250, the strongest level since the country unified official and market exchange rates at the end of 1993.

Similarly, while recent developments may have some impact on India, according Pranab Mukherjee, India’s Finance Minister, India’s growth story remains intact. Industry chambers feel India’s growth estimate for 2011-12 will hover around 8 percent, despite the downgrade. Meanwhile there would be some short term impact in terms of slowdown in foreign direct investments into India and weakening global equities could put pressure on the Indian rupee.

Also as borrowing costs go up, the spike in uncertainty in international markets is expected to force Indian companies to put their foreign fund raising plans on the back burner. While the foreign debt had been cheaper than domestic debt, with the US treasury papers themselves now witnessing a higher rate, the borrowing cost will get expensive as international bonds are linked to US treasuries.

However, on the positive side, there would be a decline in commodity and crude oil prices. This may bring a pause to any further interest rate hikes. Lower commodity prices means lower costs for important resources like oil and sugar, and therefore lower import costs for China and India, both battling with high inflation.

The Dagong Global Credit Rating Co recently lowered the US credit rating, but  didn’t have a major impact because of the limited influence of the Chinese agency as compared to that of S&P’s, Moody’s or Fitch.

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