Policy Alert #11 | July 29, 2011

With the deadline for a U.S. credit default just two weeks away, concern mounts over the consequences of a U.S. government delay or paralysis in resolving the debt ceiling crisis. Overseas, countries holding large sums of U.S. Treasury securities are watching the debate with heightened apprehension and scrutiny. In this Policy Alert, we examine Chinese, Russian, and Indian views on the U.S. debt impasse.

CHINA

As the U.S.’ largest creditor, China has repeatedly called for compromise in the debt talks while encouraging Washington to protect China’s investments in the U.S. debt market. Meanwhile, Chinese ratings agency Dagong placed the U.S. on negative watch for a possible downgrade, highlighting the increasing role of rating agencies as a political tool to influence the global financial system.

• At a regular news briefing in Beijing, China’s Foreign Ministry spokesman Hong Lei expressed hope that “the U.S. government adopts responsible policies and measures to guarantee the interests of investors.”

• “I think there is a risk that the U.S. debt default may happen,” said Li Daokui, advisor to the People’s Bank of China. “The result of U.S. debt default is very serious and Republican lawmakers should stop playing with fire.” Li’s comments also underscored that China is constrained by its vast holdings of Treasuries, and that it is best protected against a U.S. debt default if it stands by the United States. “China can promise that we will not sell our holdings of U.S. debt, but the United States must also promise that you will not hurt our interests by guaranteeing the safety of our investment,” he said.

• Dagong Global Rating Co. Ltd. announced that it is likely to downgrade the U.S.’ sovereign credit rating regardless of whether Congress reaches an agreement on raising its statutory debt limit. Dagong currently rates the U.S. at A+, but has threatened to downgrade its rating even further. The highest possible rating is AAA+. According to Guan Jianzhong, chairman and CEO of Dagong, the downgrading is really just “a matter of time and extent.”

RUSSIA

In Russia, commentary was cynical across the board with allusions to the massive financial disaster that may result in global markets should the U.S. government fail to raise the debt ceiling.

• Harshly critical, Prime Minister Vladimir Putin accused the U.S. of ‘hooliganism’ over the U.S. government’s efforts to ease its financial problems by injecting hundreds of billions of dollars into the economy. He has come out as an “ardent supporter” for the creation of a new ratings agency, the Eurasian Economic Community (EurAsEC). “It’s madness to trust American rating agencies,” Sergei Glazyev, EurAsEC ‘s deputy general secretary argued. “The market is objectively interested in new reference points.”

• “It is clear that the Republicans do not want to come to Obama’s aid…but it is unclear why they insist on keeping the rest of the world in suspense,” remarked political commentator Andrei Fedyashin in the state-run Ria Novosti. “In European eyes, these developments in the White House are a farce rather than a tragedy. It is something akin to taking the world’s financial and economic players hostage and making them the captive audience to an American soap opera that has evoked little but bewilderment and confusion.”

INDIA

India appears divided over the possibility and the implications of a potential debt default, with some expressing confidence that a U.S. default will be averted because the consequences will be too disastrous otherwise, while others encourage India to prepare for the worst.

• “How can the U.S. be allowed to default?” asked an official at India’s central bank. “We don’t think this is a possibility because this could then create huge panic globally.” Indian officials noted that they have little choice but to buy U.S. Treasury debt because it is still among the world’s safest and most liquid investments. According to U.S. Data, it held $42.1 billion in U.S. Treasuries as of April 2011.

• Financial Express commentator K Vaidya Nathan observed that even though the possibility of a substantial number of downgrades of triple-triple assets is low, the world should be better prepared for such shocks. Nathan notes that if the U.S. government loses its AAA credit rating, U.S. entities across the ratings spectrum would go down a grade as well.