Global Wake-up Call from Standard & Poor

At the outset one must admire the professionalism, courage and conviction of S & P to stand firm on their decision to down grade credit rating of USA notwithstanding a $ 2 trillion error in calculations. The decision was not just reflecting the unbridled accumulation of debts but the ability of the government and Congress to handle the situation and take decisions on such a crucial issue of reduction in budget deficits and reduction in long term piling up of debts. We will swim together or sink together? By knocking one A off the creditworthiness of USA, the rating agency has sent a grim warning to the global community that the time has come for tightening of belts all over the world. This means Europe grappling with economic crisis in Portugal, Italy, Ireland, Greece and Spain must find long term solutions to the issues thrown up by amalgamation of the European Countries into a Union. The economic mismatch of performances of these members has resulted in a drag on other stronger members like Germany and France. Any bailouts for them can be only temporary measures to ward off defaults. But sooner or later this has to impact their social order. And one can be sure that every other year one of these members could be a potential candidate for bailout putting strains on stronger economies. So a viable and sustainable model in Europe is the need of the day keeping experience of close to twenty years as a Union. Unfortunately, some politicians in Europe see the credit rating agencies as their sworn enemies! USA - a Developing Country? On this backdrop comes the scenario of a potential technical default from USA which resulted in a strong measure from S & P knocking off the credit rating from AAA to AA+ which was unchanged since 1941. So in that sense it is history in making. The time has come for remembering old adage Physician, heal thyself. Earlier USA & the European countries dictated developing countries through World Bank and IMF on economic reforms with conditionality attached to the loans. The reforms were generally aimed to get better entry into developing markets and friendly tariff regimes. Reduction in deficit financing was always one of the key parameter to

comply. I remember President Nyerere of Tanzania had the courage to have thrown out IMF team due to such conditionality imposed during late seventies and early eighties. The developing countries always needed and need ability to have access to more finances than what they can save. This is where deficit financing plays a crucial role to bridge the gap, if a country has to develop in spite of lack of resources. But deficit financing has to be capped on the basis of ability to generate resources in medium and long term so that the loans can be serviced without defaults. Very strangely, USA today is in no different situation than a developing country, looking to live on future incomes and wanting no caps to print money! Enforce the Economic Doctrine Now with Europe and USA in financial turmoil, the doctrine has to be rigidly enforced at home by these countries before looking out. Ability of USA to print any amount of money by simply floating bonds, which would be picked up by China and others, has now been questioned as well as curtailed. China has also down graded US bonds with a holding of about 8% of US debts. Today US is in the company of Belgium and New Zealand with AA+ rating. Other rating agencies have not yet reacted but obviously would watch out the way things unfold with policy initiatives and specific measures in the USA. Obama administration has to work really hard to get that rating back before 2012 presidential election bid. Resetting the Global Economic Order S&Ps decision has sent ripples across the world and the stock markets are yet to find their bottoms. Close to a Trillion dollars have been lost in just a few days on the stock markets. US administration should have handled the rating review with S&P more professionally and saved the day for the world. Some of the European countries struggling in the financial crisis like Spain and Italy still enjoy good rating and are on the verge of being downgraded. I hope many more bold decisions will come from the rating agencies to reset the economic order into realistic framework. The agencies should remember that in spite of best of credit ratings Lehman Brothers and others pulled down the world overnight. It will do no good to world economic order to keep high ratings for potentially weak economies. Time has come for rating agencies to do their homework thoroughly and revamp the system. Challenge to Obama

US has become uncompetitive in its pursuit of growth at any cost. There is no propensity to save. USA is living on savings of other countries like China and even India who keep buying their treasury bonds to finance the US deficit. The economic space of USA has shrunk in last 50 years with manufacturing close to vanishing. The avenues for generating national savings have shrunk. Encouraging savings has to be a part of the solution. Even though the credit rating is cut down at sovereign level, it has the associated costs percolating down to common man as well as the corporate levels. If the proportion of debts to present earning capacity does not change at individual, corporate and government levels, the tendency would be to live on future earnings only without intrinsic strengths. The collapse of 2008 had the same message. This is the fundamental issue for survival of USA as a giant economic superpower. Riches of USA coupled with self assigned ability to keep printing money have sustained it as most powerful economy of the world for a century. However, the world is changing fast. The politicians of all shades and hues in Europe and USA should read the writing on the wall. Can Obama break from the past and make the difference to meet challenges to sustain the countrys status? Challenge to Obama administration has assumed huge proportions as under no other Presidency, USA ever lost its credit rating. Obamas personal rating approval among the public is likely to drop to lowest level. Obama has been struggling both on domestic and international fronts with nothing much to write home about. Exception has been Osama Bin Laden. Retreat from Afghanistan is likely to be hastened leaving a strategic vacuum in the region. Foreign policy page is almost blank. So the challenge to Obama is to reassemble his economic team to chalk out a specific plan to address long term and short term issues and assure the world beyond words that US has learnt a lesson to set its house in order and prepare her people to shake off laid back approach to life of living on tomorrow and accept some tough decisions. Hope he is able to convince his fellow Republican Congressmen!

I hope he repeats his famous words Yes, we can. And if he can, may be European leaders can follow. Remember, China is watching closely a USA minus one A! Vijay M. Deshpande Corporate Advisor, Strategic Management Initiative Pune- 411021 August 10, 2011 Visit my blogs on www.strami.com