The US is rapidly approaching the date when the government will be unable to pay its bills, also known as the “X-date”. Even the approach of breaching the US debt ceiling has in the past led to considerable disruption in the financial markets in the US with global spillover effects.
This time, according to Bloomberg, Republican and White House negotiators are getting closer to an agreement on raising the debt ceiling and capping federal spending for two years, but no agreement has yet been reached.
An actual breach of the US debt ceiling would likely cause severe damage to the US economy and entail global spillovers. However, economists and analysts around the world and in India have so far given a baseline scenario of a resolution close to the American economy nearing the limit.
Even if the deal comes at the last moment, the uncertainty will lead to volatility in stock markets and currencies, said Radhika Pandey, a senior fellow at the National Institute of Public Finance and Policy. The delay in the deal has strengthened the dollar index, putting downward pressure on the rupee. Given the volatility in the markets, investors retreated to safe havens, she explained.
While the likelihood of the US defaulting on its debt obligations is far-fetched, the approaching deadline is making investors cautious, said Jahnvi Prabhakar, an economist at the Bank of Baroda. Should the deal fail, some spillover effects on inland shores could be visible, she said.
The dollar could be significantly affected and this will be reflected around the world as it plays a dominant role in the international trading market. The uncertainty could also lead to volatility in the financial market and put pressure on the rupee. The stock markets are also likely to feel the heat. Any company with exposure to the US market could also be cautious in this scenario.
The risk of default and caution by rating agencies could put pressure on US Treasury yields, the impact of which on domestic yields cannot be entirely ruled out.
According to Gaura Sengupta, an economist at IDFC First Bank, any solution should have no impact on Indian financial markets. Once the debt ceiling is raised, “we may see some rise in US Treasury yields as issuance increases once the debt ceiling is raised.”
In the unlikely event of no resolution, there could be a near-term growth shock to the US due to a sharp contraction in government spending, Sengupta said. However, a US sovereign default is unlikely as debt service will be covered while other spending items are being cut, she added.
In the second scenario, risk aversion would be triggered and could lead to depreciation pressures on emerging market currencies like the rupee, Sengupta said.
A failed deal and a default would obviously have a negative impact on India as outflows from risky assets would shift, but it will also depend on how much and where the US government will be forced to cut spending, Suvodeep Rakshit said , chief economist at Kotak Institutional Equities . If that has the effect of a deep recession, then there would be multiple implications for India’s capital and trade flows, Rakshit said.
However, the situation is still speculative at this point, he said.
A default will have catastrophic consequences, Pandey said. Indian exports could fall further, there could be changes in trade patterns and non-US trade could gain momentum, she said, adding that sectors exposed to the US could suffer a drop in profits.
The yield differential between Indian and US bonds could narrow further, affecting foreign portfolio investment flows, Pandey said.
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