IN A SURPRISING turn of events surrounding the debates over the US debt ceiling, House of Representatives speaker John Boehner last night delayed the vote on his party’s proposed budget deficit-cutting plan. That has led to some doubts as to whether Boehner has managed to win enough support within his own Republican party for the plan, which proposes to cut about US$1 trillion ($1.2 trillion) in spending in exchange for an equivalent increase in the debt ceiling. And it increases concern that US politicians will be unable to come to an agreement on how much spending to cut so that they can raise the debt ceiling in time before an Aug 2 deadline.
The Republicans want a temporary plan that will raise the debt ceiling just enough for six months, after which they hope to sit down again and formulate a second plan with larger cuts in spending. The Democrats want to raise the debt ceiling high enough so that they won’t have to relook it till after the coming presidential elections. Market watchers say this brinksmanship makes it very hard to be certain that politicians will manage a compromise before the deadline.
Is Aug 2 a definite deadline? Yesterday, a Reuters report quoted Wall Street analysts as predicting that the US Treasury actually has enough cash to meet its obligations till Aug 15. And even after it runs out of cash, it can choose to halt social security payments or default on other obligations like paying its military before it defaults on its debts.
But Erik Ristuben, chief investment officer for client investment strategies at Russell Investments, says such a scenario would be damaging to the world’s perception of the US currency and US debt as safe havens. “Right now, all participants are treating Aug 2 as the all-important date. Although there is enough cash to fulfil obligations even after that, we don’t know how long this cash will last. It’s the uncertainty that people would have a problem with,” Ristuben says. “Markets aren’t worried about whether or not the US has the ability to pay its debt. What they’re worried about is the country’s willingness to pay that debt.”
All this means that the headwinds for equity, currency and credit markets are strong. “Sovereign debt defaults in major western countries can no longer be ruled out,” says Credit Suisse analyst Robert Prior-Wandesforde in a recent research report. “The same is also true of a US and/or euro zone double-dip.”
At the very least, the US government will be making some budget cuts. Thomas Lam, group chief economist for OSK Group, calculates that both the US Senate and House proposals for fiscal consolidation would lower economic growth by less than 0.5 percentage points a year over the next five years. Weaker growth in the US will have its repercussions on international trade and the global economy.
As confidence in the US dollar continues to wane, its value against international currencies is also expected to fall. And Ristuben of Russell Investments says that borrowing costs for corporates will likely go up should the US be unable to reach a decision by Aug 2. If no agreement is made by then, and political brinksmanship is still at play, he expects the yield on US Treasuries to rise by about 50 basis points. That will have knock-on effects on corporate credit yields.
Singapore’s open economy will likely be hit. Exports to the euro zone make up 12.8% of our GDP, according to Credit Suisse. Another 10.2% of GDP is made up of exports to the US. Credit Suisse’s Prior-Wandesforde ranks Singapore second among Asia ex-Japan countries in vulnerability to a western demand shock. He notes also that these export figures underestimate the importance of US and European demand because many of our exports will initially be headed to other countries for processing before ending up in the west.
Also, he points out that about 15% of our local loans are made by US banks. “Another banking crisis in the western world, whereby commercial banks lose trust in one another and funding becomes extremely hard or expensive to come by, is highly likely, in our view. It is also easy to envisage such an event leading to a credit crunch in non-Japan Asia, both because western banks operating in the region bring money home and domestic banks suffer heavy losses on their own holdings of US/European debt. The confidence of domestic banks to lend, even in their own market, is likely to be significantly shaken as well.”
Analysts expect that companies relying on debt to fund their business are likely to be hit hardest. In particular, traders have singled out commodity supply chain managers Olam International and Noble Group as being potentially at risk. Both also have significant exposure to the US dollar.
Local brokerage Kim Eng has identified several other stocks that derive a significant amount of revenue in US$ or US$-linked currencies. In the technology space, manufacturers like Venture Corp and Armstrong Industrial Corp are the most exposed. Both ST Engineering and SIA Engineering, which provide maintenance, repair and overhaul services for aircraft, also have significant US dollar earnings.
The two ship and rig builders Sembcorp Marine and Keppel Corp will also have some exposure, although Kim Eng expects that hedging policies could limit the downside. Then there are companies like Wilmar International and Singapore Airlines, both of which have significant US dollar earnings but also have large US dollar costs and so have a small natural hedge.
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