6 mins read . 24 May 2023
The big worry in the global markets in the last few weeks has been; whether the US government will default on its debt when it comes up on 01st June 2023? Here is a quick rundown. The US debt ceiling of $34.1 trillion had been hit in January 2023 itself. However, the US government used emergency measures to stretch spending till May. However, the current treasury funds are unlikely to last beyond the end of May, so there must be a deal by 01 June 2023. Either, the Democrats and the Republicans must agree to hike the debt ceiling to allow the US government to borrow more. Alternatively, the US government has to scrap the debt ceiling altogether. Either way, 8 days is a short period of time and there could be a lot of chaos in markets till then.
Firstly, the debt deal itself will take time and there are just 8 days to go. Debt ceiling hike has to be approved by Congress and that takes time since the US Senate is currently out of session. The task of getting enough legislators to vote would be a logistical nightmare since there are just about 5 working days with 29th May being Memorial Day. The reading, vetting and clarifications on the bill take about 3 days, so the draft must be ready by 26th May, latest. Even after that is done, President Biden has to read the fine print and sign the bill.
If the US runs out of money without raising the debt ceiling; the government cannot borrow to pay for federal employees, military, social security, and Medicare. Even, interest on national debt and tax refunds would be held up. Janet Yellen has already dismissed the possibility of partial freeze since any freeze would be tantamount to default. Unlike in 1979, which was a pure technical default, this time around, it will be an intentional default.
At the heart of the differences are the caps on government spending. Republicans want $4 trillion of budget cuts, but Democrats are only willing to accept short-term limits. Secondly, Republicans want to link receipt of food stamps, financial aid, and Medicaid to actively seeking work or enrolling in an education programme. Democrats feel that would be too unfair on people. Lastly, both parties also differ on the utilization of unspent COVID funds. Republicans want these funds back with the government but Republicans do not want to take chances, with the possibility of a relapse still there. It is this handful of differences that are holding up the deal
A US debt default will have some immediate repercussions. Firstly, it is likely to slow the US economy. However, debt market veterans like Mohamed El-Erian, warn that a default could tip the US into recession. Secondly, a default would raise the risk premium for the US debt. Everything from government bonds to private debt to mortgages will have to pay sharply higher rates. Thirdly, this will spill over to other countries. If the US can default, then any other nation can surely default. Lastly, there is the dollar chaos in markets as the dollar could plummet and could make commodity pricing very difficult. Also, countries holding billions of dollars of US bonds could suddenly find their wealth depleted for no fault of theirs.
In fact, the debt ceiling default could hit Indian companies in a number of ways. A weak dollar could lead to most EM currencies weakening sharply, including the Indian rupee. That would make foreign currency borrowings sharply more expensive. Exports and tech spending cuts are likely to hit sectors like textiles, IT, pharma, and chemicals. Above all, it could put the RBI in a policy dilemma, since this is the kind of eventuality that financial markets would be the least prepared for.
Content Source: Bloomberg.com