US credit downgrade: room for Pakistani rupee to appreciate

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Finally it happened! For the first time in history since 1917, S & P downgraded the world superpower USA, as the promised spending cut was not enough to convince the rating agency. But it is not AA , its AA+ a notch better than market expectation while keeping the outlook negative , which suggest that USA will remain under strict watch for next couple of years.

During this period a slash to AA could be a possibility if spending exceeds rating agencies expectation. Or if fiscal indiscipline further deteriorates America s debt position or if the hike in US interest rates is raised to an unacceptable level.

Impact on Pakistan Market

Apparently, it seems that US downgrading may not have any major effect on Pakistan s financial market, but there are certain pockets, which are going to have some impact. For instance, on Monday, US Dollar is likely to come under severe pressure against majority of the currencies, including currencies of our regional competitors which should also gain.

Stronger currency of our competitors will help Pakistani basket of real effective exchange rate (REER) to strengthen, which means Pak Rupee should also get some space for appreciation.

However, the flip side of the downgrade is that to attract buyers higher interest rates will have to be paid for US bills, bonds and notes that will lead to higher borrowing cost of American consumers, corporations, governments and mortgages as they are pegged to US Govt securities.

Higher US interest rate is certainly not good news for Pakistan as our economy is largely dependent on foreign borrowings. Pakistan already has a foreign debt of roughly $ 60 billion at an average cost of 5. 5 pct that means a jump of one pct would mean USD 500 million to the national exchequer if $ 50 billion debt is in US Dollars, as remaining $ 10 billion debt could be in other currencies. This will not happen overnight, but all future transactions would become costlier affair.

Pakistan already bitten by failing to float USD 500 million exchangeable bonds in international debt market in the 2nd quarter of the calendar year though timing to float bond was a bad decision and may come across more difficult time to raise money. Portugal is one good example that despite its BBB rating its 5-year Credit Default Swap (CDS) spread is 955 basis point, Greece with spread of 2596 basis point and with negative outlook seems extremely notorious. Though Pakistan has stable outlook, but with tough IMF s condition looming and difficulties in attaining fiscal target and high discount rate, threat of downward rating adjustment cannot be out, hence, any outing for to get international bond would spike Pakistan s CDS to between 1200-1500 basis point.

Suddenly with the downgrading, rating of the world s most liquid and safest instrument US Treasury bond dips below Germany, France, Britain, Switzerland and 13 other nations that means 18 sovereign entities are rated above USA. Though in past Japan, Canada, Australia and others have their ratings slashed, but it did not have lasting impact. Pakistan s investment in US securities is USD 2,219 million as of June 2010 as per FED data.

Global Impact:

And therefore, world leaders and their financial managers are in emergency talks to calm the market. We may see various types of intervention, which are yet temporary arrangements.

Meanwhile, I will not be surprised to see short-term chaos. China must be extremely worried, as it will have to take hit on its USD 3. 2 trillion Fx reserves, as the value of its investment in USD will be eroding, because combining two of its investments are in US Treasuries USD 1. 16 Trillion and composition of its foreign exchange in US Dollar is over USD 1 trillion and remaining part in other currencies. Japan has US treasury securities holding of USD 912 billion.

Hence, due to lesser trust in global paper I am expecting that in Asia-Pacific, Monday morning opening session, immediate demand for gold would be seen and expect safe haven buying too for Japanese Yen & Swiss Franc. Both the currencies have the potential to test new all time high.

The biggest test would be for Bank of Japan (BOJ) that was seen intervening last Thursday to defend its currency. Estimates based on latest deposit figures released by BOJ suggest that BOJ intervention amount was 4. 5 trillion Yen or $ 56 billion. Earlier Japan pledged to inject Yen 10 trillion stimulus packages to give boost to its domestic market.

However, US treasury official disputes calculation method of US downgrading and says it s a flawed judgement . It argues that S & P determines rating using a three to five year calculation period, whereas, USD 2 trillion disputed figure was derived by calculating debt over 10-year period.

Asian Market Opening

My initial reaction is that we could witness a very ugly and chaotic Monday market opening with high degree of uncertainty and volatility in Asian market. US Dollar will certainly take the beating. Global leaders are discussing and will try to calm down the market. In 2008 crisis the shift was seen in US Treasuries and US Dollar, now both are party to the crisis.

This does not mean that Europe will have the last laugh. Italy and Spain are in big trouble. Euro gains will be flattered as Italian bond auction will provide more clues. Spain is nervous as it had already cancelled August 18 bond auction. Ideal trading opportunities and safest bet lie in crossers, Swiss Franc and Japanese Yen will dominate against all odds.


EURO - 1. 4279. Initially, Euro is likely to make gains. A break of 1. 4470 could push Euro further higher, but it has a very strong resistance line at 1. 4680, should hold for a fall. On the downside once 1. 4420 surrenders, target 1. 4040. Or else 1. 4850

GBP - 1. 6394. Dollar weakness could push Cable higher towards 1. 6540-80 zones, but does not favour a move beyond, as break below 1. 6280 would risk for1. 6140, as target is 1. 5905. Or else 1. 6870

YEN - 78. 47. BOJ may not intervene immediately, as it could provide opportunity to YEN Bulls, should hold below 79. 20, a break of 76. 50 would encourage for 74. 90. However, last week s high of 80. 20, if seen should be top side of the range and opportunity for those that missed earlier rally.

CHF - 0. 7674. Swissy is the safest bet in the early hours as 0. 7740 should hold for a dip to 0. 7520 probably 0. 7450 or 0. 7220. Or else 0. 7840.

GOLD - $ 1664. 40. Demand for gold should surge and 1685-90 area should be tested, any penetration would encourage buyers to test 1710. Strong support is at 1635, though unlikely to fall below 1648. If seen buying is preferred.



Courtesy: Business Recorder

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