The USA is edging closer to defaulting on its debt. Unless the debt ceiling is raised by June 5, the country will fall into an economic crisis that may have a far-reaching impact with global spillovers expected, affecting the likes of India, an emerging economy.
The economists are bracing for two scenarios and the effect it might have on the Indian economy. The first one is the base case, meaning, the ceiling will be raised eventually but the volatility in stock markets and currencies would have a sizeable impact.
Even US Treasury Secretary Janet Yellen has warned that waiting till the eleventh hour to raise the ceiling could cause more harm than good.
“Waiting until the last minute to suspend or increase the debt limit can cause serious harm to business and consumer confidence, raise short-term borrowing costs for taxpayers, and negatively impact the credit rating of the United States,” she added.
As markets face danger, the investors park their money in less risky assets such as bonds, gold and dollars. Consequently, the dollar index has strengthened quite a lot in recent months which has put the rupee under pressure.
Of all the foreign exchange reserves held by the world’s central banks, US dollars account for 58 per cent. If the US does indeed default, it will lose its financial prominence and the centre of world trade. Rating agencies will heavily downgrade its creditworthiness and US sovereign bonds where the Indian government parks its money would have their value reduced to incredibly low levels.
Most companies generate funds for their development projects by taking on debt. A US default could prove a hindrance in the development as there will be less liquidity in the market and debt bonds will provide little to no monetary benefit.
Watch | US Treasury Secretary warns country running out of cash
The second scenario is a bit of uncharted territory where the US defaults, albeit briefly. Though unlikely, if it happens, the risk-off sentiment would be triggered and could result in depreciation pressures on emerging market currencies viz. rupee.
A lot of what will happen remains in the grey area for even the Reserve Bank of India has not prepared for such a situation. A default will have catastrophic consequences but given the central position of the US dollar in global trade, especially after World War II, the country and its currency is deemed too big to fail by the pundits.
What is the debt limit?
The debt limit is the amount of money that the US government can borrow to meet its financial obligations such as social security, military salaries and medicare benefits payments.
Congress earlier this year extended the statutory debt limit to $31.4 trillion. However, the weak economic fundamentals and overflowing expenditures mean that the US will be breaching the limit. Consequently, Congress has been engaged in a fierce tussle to raise the limit.
Notably, to raise the limit, any agreement reached will have to pass the scrutiny of the Republican-controlled House and the Democratic-led Senate before Biden could sign it into law – a process that could take more than a week.
(With inputs from agencies)
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