What is the US debt ceiling deal really about?

An in-principle debt deal

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.

Seven key points in the debt ceiling deal

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.

1. The debt ceiling stands suspended till the first quarter of 2025, so this will not be an issue till the next US presidential elections are completed. Since the government can continue to borrow during this period, this deal comes with some strings.
    
2. While Republicans were demanding a 10-year cap on spending, that was not practical in the first place. The deal is to cap non-defence spending at 2023 levels for the next 2 years with just a 1% hike permitted in 2025. Defence spending is not part of the deal. 
    
3. On the issue of unspent COVID funds, the deal will allow the clawback of funds. The US government spent $4.5 trillion on anti-COVID measures, of which $30 billion or so is still reportedly available. That should help bridge some cash requirements for the centre. 
    
4. The big shift is in entitlements eligibility. Currently, work requirements for able-bodied adults under the SNAP and TANF program are only up to 50 years of age. Now that stands extended to 54 years. However, war veterans and homeless people are exempted. In addition, Medicaid will continue to be free from work requirement conditions.
    
5. In addition, there is a consensus on IRS-related cuts to ensure that the wealthy do not get away by paying less tax. Also, in the oil and natural resources prospecting debate, the free prospecting license granted by Donald Trump is likely to be circumscribed by strict environment protection measures. In addition, for vulnerable communities, inflation reduction measures will also come with clean energy commitments.
    
6. One of the major proposals by Joe Biden to bridge the budget gap had been to impose heavier taxes on the rich and also plug revenue leakage inflicted by multinationals through offshoring of domicile. This resulted in big tax losses for the US. However, under Republican pressure, this proposal has been struck down.
    
7. Finally, there is a consensus that there would be a status quo in student debt relief. The Republicans were demanding the cancellation of Biden's student debt relief program and actually wanted the entire program rescinded. However, with a longer-term interest in mind, that is not part of the deal and so student debt relief stays for now.

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.

So, what are the next steps?

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.

A deal ends the uncertainty factor in markets

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