On 6th August, 2011, S&P downgraded US credit rating from AAA to AA+. The fundamentals of US credit were going down for quite some time and it was just a matter of time before US credit rating would have downgraded. The rating agency also slammed US lawmakers for not taking the right action to solve the country's mounting debt burden.
The rating agency has also warned that it can downgrade US credit rating to AA if the country's lawmakers fail to cap the mounting debt, reduce the expenditure significantly over a period, and implement prudent fiscal policies. This is quite a strong statement against a nation whose currency is considered as strong as Gold.
The Impact on Indian stock market
This has created ripples across the world. The stock markets have tumbled and investors have lost huge money. India is not untouched by this. The benchmark index Nifty lost about 140 points in last 2 days. The fluctuation was tremendous. Panic selling in US and European market has impacted Indian market to a very large extent.
India's reserve is about 300 billion USD and has an exposure to $40 billion in US treasury. This is about 13% of the total forex reserve. It is also the 14th largest creditor to the US. Hence the downgrade is sure to impact India. RBI knew that the market will react adversely to the news and hence it issued couple of statements in the weekend itself before the market opened on 8th Aug, 2011. RBI mainly targeted two major focus areas; market sentiments and liquidity.
Resilient Indian Economy
RBI's compared this event with the financial crisis of 2008 and showed India's growth was impressive at 6.8% despite the global financial crisis. The 2008 crisis was one of the worst economic crises in the history and Indian economy did not face a major problem.
Maintain enough rupee and forex liquidity in domestic market
As a consequence of this move by S&P, market may turn more volatile which will impact the forex and rupee liquidity. Essentially, there may be abrupt changes in currency exchange rate. RBI has sought to assure investors that it will create enough liquidity in the domestic market to ensure limited impact on exchange rate.
RBI also did an assessment of amount of forex reserves to meet the forex requirement in case the market sees forex outflows. It has assured the investors that there are enough reserves with the Government to fend off any unwanted forex outflow.
At the same time, RBI assured the investors that they keep an eye on global development and act accordingly to ensure limited impact on Indian economy and investors.
There was talk about RBI reducing the interest rate in such a global scenario. This is logical too as commodity prices are expected to fall down which will ease inflationary pressure on the economy. This may give RBI some breather in its fight to contain inflation. However, RBI has not commented on this.
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