8 mins read . 30 May 2023
It looks like some good news for the markets as the Democrats and the Republicans have reportedly agreed to a debt ceiling deal. OK, it is not a deal to raise the ceiling from the current $31.4 trillion to a higher level. Instead, the two main US-based parties have agreed to suspend the debt ceiling for a period of 7 quarters. The next discussion on debt ceiling levels will now take place only after January 2025. So, what happens till then?
Effectively, the US can continue to borrow, but its non-defence spending would be capped at the 2023 levels for 2024 also and they will be allowed a 1% enhancement for 2025. This deal is yet to be passed in the US Congress, but that is more a formality. Also, there are areas of spending cuts that both the parties have agreed upon even as some of the more delicate issues have been left out of the discussion. If the deal passes the US Congress, then the US government can continue to borrow, as long as non-defence spending stays capped.
The gist of the deal is that the debt ceiling is not being raised but it is being suspended. That will allow the US government to continue functioning, without risk of default. Here is a gist.
As both the Democrats and Republicans summed it up, it was more of a compromise and less of a solution. But for now, it addresses the core issue of uncertainty.
In the last 20 years, the surge in the American debt ceiling has been driven by the Republican and Democrat governments. It was always going to be hard to point fingers and a compromise was the only solution. Neither wanted to be seen as having precipitated a debt default by the US, just one year ahead of elections. Biden could have suspended the debt ceiling unilaterally, but this makes for better press. The next step is to complete the draft of the deal, give 3 days for members to read it and then push it through the US Congress. To quote Janet Yellen, the Treasury can function till 05th June; perhaps longer if the COVID fund clawback is also factored in. By then, the new deal has to be passed and implemented. Now, it looks more like a formality. Republicans control the House and Democrats the Senate; so there had to only be a compromise.
More than the sub-text of the deal, it is the end of uncertainty that is really material. Global markets were already factoring in the worst-case scenario in which the US would default on debt. That risk is out of the way for now. It is specifically a big relief for emerging markets like India since the uncertainty was already becoming an overhang on the equity, bond and currency markets in India. That uncertainty comes to an end.
For a country like India which runs the largest trade surplus with the US, this deal reduces the risk of recession in the US. That will protect India’s merchandise exports as also the tech spending on which India’s massive services exports heavily rely. The legendary Chinese leader once said, “A cat is a good cat, as long as it catches mice.” For the global financial markets, the debt deal does just that.
Content Source: Bloomberg