Stinging downgrade

Rarely does the most powerful government in the world get a stinging rebuke like this. Standard and Poor's downgrade of sovereign bonds issued by the US from their top perch of AAA rating last Friday to second rung AA+, will deepen the dismay in the markets that are yet to recover from the US debt crisis. The downgrade suggests that US bonds, cherished as risk-free treasuries for almost a century, are no longer so. It will be no surprise if markets react negatively; the after-effects may linger with the prospect of the other two agencies, Moody's Investor Services and Fitch Ratings, also thumbing down US bonds. So far, they have affirmed the AAA rating after the US President, Mr Barack Obama, steered a deal on the debt ceiling with the Republicans, but they have also affirmed that they could change their views if the economy weakened and the debt reduction measures were not satisfactory. However, even this is no cause for panic.

A detached reflection would discount the slide in markets around the world, including India, as short-term reaction to an undoubtedly momentous and contentious evaluation. The S&P indicts policymaking that has become “less stable, less effective and less predictable than what we believed.” It is not casting doubts on economic or fiscal fundamentals. American debt mounted steeply due to the previous regimes' engagements in Iraq and Afghanistan and the latter still figures prominently without the rating agencies frowning at the escalating costs of war. Then again, compared to European bonds, the demand for US treasuries remains what one analyst calls the “flight to quality asset of choice.” The US has always remained a chronically indebted nation, prospering through perennial deficits because its economic fundamentals based on an open economy and high productivity, have been robust. For both financial and economic reasons, the dollar still rules despite the relatively slow recovery and the supposed prospect of default. No one can deny that the US will have to address both its political gridlock and long-term debt; to reduce the latter and to get the economy moving. Disengaging from futile and costly wars is as critical as raising taxes and not cutting back on social indicators such as health and infrastructure

Given the robustness of US bonds, India need not worry overtly about the downgrade; the September 2008 Wall Street crash was far worse as we know. As it happens, valuations are now attractive for investors. And so long as the Indian economy grows and if policy becomes more assertive, India will remain a destination for both portfolio and direct investments in a world with shrinking options, beating back any ill-winds from S&P-type ratings.

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