US’ debt ceiling issue resolved: what’s the impact for India?

US’ debt ceiling issue resolved: what’s the impact for India?

- Dr. Kishore Nuthalapati*

The pandemonium of possible economic catastrophe due to US’ debt ceiling is now settled with the solution, but not without leaving anxiety. To touch on, by May 2023 the outstanding US’ debt was nearing close to $31.4 trillion. This was the statutory limit beyond which the US government cannot borrow regardless of the budgets and required expenditure. Unless the ceiling is removed, US could not borrow for honoring its obligations and expenditure which are falling due.

As an operational practice, the US treasury maintains an average cash balance of $500 billion to meet its scheduled and emergency needs. If balance falls below this threshold, the treasury considers the situation as critical and initiates measures. For instance, in the year 2011, the cash balance fell to $54 billion and caused tensity taking the situation close to default. ?Resultantly, for the first time in the US history, US credit rating suffered a down grade which in turn resulted in severe uproar in the financial markets and increase in the borrowing costs for the government.

Recently, by 31st May 2023 the US’ treasury cash balance fell to $22.9 billion which could have caused huge stress on the US’ economy. However, as the markets were confident that the debt ceiling issue will get a solution, the curiosity was limited to note the composition of the solution. Due to this, the equity markets in the US did not have much impact. It is only the bond markets which fluctuated in response to the situation until the debt ceiling issue was resolved. Even within the bond markets, it was the short term treasury securities which had the impact with yields moving marginally higher.

If the recent debt ceiling issue was not resolved and if the US government were to fail in meeting its obligations, the US economy may have suffered significantly. The adverse consequences, as per some reports, could have been steep fall in the US’ equity markets, near-collapse of its debt markets, loss of millions of jobs, steeper rise in the price of gold, etc. For India and other countries, it would have been a fall in value of forex reserves with the fall in US dollar value, etc.

Towards finding a suitable solution to address the looming debt, several permutations and combinations were considered. The debt requirement can be lowered either by increasing the revenue or by reducing the expenditure. To increase the revenue, income tax rates on the rich and on the corporations should be hiked. To reduce the expenditure, social security programs, medical care programs, and military expenditure should be decreased. None of these received concurrence of the approving authority. The unanimity was found only in agreeing to reduce the expenditure on domestic discretionary programs. A near unanimity was also found in allowing the government to spend additional money on any emergencies, helping Ukraine’s fight against Russia, and measures required to deter China suitably. Finally, the expected relief was received on 1st June 2023 with the US suspending its debt ceiling until January 2025.

The present solution is more a postponement of the debt ceiling issue. But it is a relief to the US government, and also to the global economies most of which are coupled with US’ economy by their regular tradelines, forex transactions, investments, and dollar invoicing.

Now, with the suspension of the ceiling, the treasury can resume its borrowings. For reference, it can borrow $726 billion in April-June quarter with a plan to have June end cash balance of $550 billion. Later, it can borrow $733 billion in July – September quarter with a plan to have September end cash balance of $600 billion.

In line with the developments, no sooner the debt ceiling was suspended, within 1 to 2 days, the treasury auctioned and mobilized $144 billion debt comprising of one-day cash management bills, three-months and six-months treasury bills. Further borrowing programs are lined up. With these, the cash balances are expected to be comfortable for meeting the obligations and expenditures.

As the debt ceiling is suspended until January 2025, the exact debt outstanding on the ending date of the suspended period will be fixed as the applicable debt level until further revision. With the suspension of debt ceiling, the US is back into its comfort zone and is continuing its usual course. Due to this, certain aspects are implicitly demonstrated. They include proving that economic issues of the US are issues for the global economy, and the US economy is resilient and would not crumble over short term issues. It also proved that US dollar continues to command substantial global acceptance and would continue to stay as a reserve currency.

The impact for India of the US debt ceiling issue resolution is interesting. The debt funds that may have flown back to the US to get deployed in high-yielding US debt paper stayed back in India. A sell-off by the US foreign institutional investors (FIIs) of their equity holdings in India to meet their domestic redemption requirements is avoided. The solution also avoided the possible steep fall in the equity share prices in the Indian markets. The solution has also avoided the decline in the value of the forex reserves held by India. Thus, the resolution of the US debt ceiling issue left a positive impact for India and so it did for many other global economies.

* Disclaimer: Dr. Kishore Nuthalapati is the CFO of BEKEM Infra Projects Pvt Ltd. Views are personal and do not reflect those of any of the organizations he is or was associated with or of this publication.