Open Forum

New Delhi, 5 August 2011

US Debt Crisis

HOW DOES IT IMPACT INDIA

By Col. (Dr.) P. K. Vasudeva (Retd)

The U.S. averted a debt default on August 2, 2011 when President Barack Obama signed a Bill raising the country’s debt ceiling into law. But that might not be enough to maintain its coveted AAA debt rating, according to Fitch Ratings. The U.S. debt has held AAA rating since 1917. Currently, fewer than 20 countries have AAA ratings, including the United Kingdom, Australia, Germany and Singapore.

The Fitch said the agreement to raise the debt ceiling and make spending cuts was an important first step but “not the end of the process.” Additionally, the rating agency said it wants to see a credible plan to reduce the budget deficit “to a level that would secure the United States’ ‘AAA’ status.”

Fitch expects to conclude its review of the U.S.’s debt rating by the end of this month. Given the terms of the debt deal signed, it is possible the U.S. debt rating could be downgraded at that time, the rating agency stated.

Federated Investors’ chief fixed income strategist Joe Balestrino points out that during the Clinton era the U.S. economy was growing at a much faster pace. Now, the economy is emerging from the deepest recession since the Great Depression and growth is sluggish. The government said that in the first half of the year, the economy grew at its slowest pace since the recession officially ended in June 2009.

The budget released earlier this year showed a staggering $1.65 trillion deficit for the current fiscal year. The US national debt has increased, and touched $14.3 trillion in May. This is forcing the US to use various means to keep the economy going.

It is a universal truth that if you borrow money, you must pay it back on time. This is especially true of inveterate borrowers, be they individuals, groups or countries. Often times, it becomes necessary to borrow afresh to repay old loans. After its banking system collapsed in 2008, the US had to flush the economy with cash to keep its ship afloat. This was done by Washington, when it borrowed several trillion dollars. But even that did not prove enough. So it needed to borrow more. But the Republicans, who are in the Opposition now and whose erratic economic policies caused the problem, decided to show Obama their power. They refused to raise the government's borrowing limit.

A great deal of political haggling over more taxes and less spending ensued. The government tried to frighten everyone by saying the US would default. The markets became nervous and jittery. China, which has the most to lose, showed a false front by saying that the crisis will be over. Other emerging markets quietly exchanged glances.  

But the US is not the PIGS and, in the end, the American politicians, perhaps because the August vacation is sacrosanct, worked out an arrangement at the last minute. No one really understands how the government can reduce the deficit by $2,800 billion over the next decade, in return for which its debt ceiling has been raised by around $3 trillion dollars.

Surprisingly, President Obama got what he wanted in return for a future promise, which some other President will have to keep. The markets stopped biting their lips and got back to their usual betting. The S&P 500 futures went up by 1.2 per cent as did the dollar, by about one per cent against both the yen and the Swiss franc, and gold went down slightly. To be sure, the new arrangement still has to get the approval of the Senate, however, the House of Representatives has already cleared it. No one really had any doubts that the US would default. But the crisis does underline the continuing fragility of the American economy. So severe has been the banking crisis of 2008 that it could take another five years to work itself out.

Interestingly, the main gainer has been gold. As an outcome of all these developments, the demand for gold has increased. The yellow metal is seen as a safe haven, its price has risen to a record high. As the domestic economy is not insulated from the world economy, there will definitely be some tremors in India. Both imports and exports will be impacted. India's exports to the US, particularly IT services, will have an adverse impact.

“Any slowdown in the US will have an impact on India in terms of our ability to export,” said C. Rangarajan, Chairman, Prime Minister’s Economic Advisory Council about the implications of US debt crisis on Indian economy.  He also pointed out that Indian exports had declined sharply in the second half of 2008-09 due to a slowdown in the US economy.

In its economic outlook for 2011-12, the Economic Advisory panel has pegged India's total exports for the current fiscal at $330.2 billion as compared to $250.5 billion in the previous year. At the same time, there may be higher inflows of foreign institutional investor (FII) funds. This will lead to appreciation of the rupee, which in turn will help bring down the current account deficit.

The RBI has said the country has sufficient liquidity to manage a possible US sovereign debt default. The RBI is prepared for any repercussions in the financial markets arising from any such eventuality. With a reasonably strong financial system in place, India is likely to bear the shocks, as in the 2008 turmoil.

Overall, this means that global growth will be slower than what it would otherwise have been. This should come as a relief to India whose growth depends on its domestic market but needs its imports, especially of crude oil and gas, to be cheap. New Delhi should be able to take full advantage of US debt by bringing back the illegal black money stashed in the foreign countries and by taking strict disciplinary action against the flourishing scamsters.

Unfortunately, Prime Minister Manmohan Singh, thanks to his curious leadership style, is not in a position to take advantage of this serendipitous hiatus in the global economic activity. India needs more reforms now, but for the next three years, it is stuck with this paralysed government as it is confronted with the monumental scams. Unfortunately, UPA government has no time to take advantage of this situation by concentrating on the economic reforms in the country to emerge as a strong leader and inch towards AAA debt rating in the world. ---INFA

(Copyright, India News and Feature Alliance)