At an investor's level, the impact will be a sum total of economics, finance, and political variables that will play out.
By CA Aditya Sesh
Is it likely that the US will default on its loan obligations? The raising of the debt limit will only mean the postponement of the D-day. Thus while sectors of the economy may grow, overall it will be anemic growth. This will only change when the US economy grows beyond 3% year on year, tax revenues grow, and new avenues to improve government finances arise.
The fact that the US President had to postpone the trip to Asia to find a solution to the debt ceiling crisis in the United States speaks volumes about the issue.
Increasing the debt limit is not going to solve the problem permanently. It may give a temporary relief as it has done before. There is nothing new in raising the debt ceiling. The debt ceiling has been negotiated and raised many times.
2011 had a crisis similar to this. It was resolved at the last minute. Over the last 200 plus years, there is sufficient evidence that governments that borrowed to spend on populist projects have ended up sacrificing growth in the long run.
One has to remember that investors with a conservative approach will always choose a government bond over a private-sector bond, irrespective of the interest rate and end-use of funds. In other words, government borrowings not just affect the balance sheet of the country, but also the capex borrowings for corporates and institutions.
The election is now around the corner and the impact of not raising the debt limit will have political consequences. Politics and Economics are intertwined and therefore one has to take a holistic view.
At an investor’s level, the impact will be a sum total of economics, finance, and political variables that will play out. It is widely expected that there will finally be an agreement on increasing the debt limit which will give temporary relief until the borrowings hit the limit next time.
Assuming that the debt limit is increased the economic situation for the present will be Business as Usual. In the long run, interest payments on the US total debt which has already reached unsustainable levels of 123%+ (90% GD is external debt) of the GDP will eat into the revenues of the government.
At the moment, the US Government has gross revenues of $4.89 Trillion FY 2022. The total spend is $6.27 Trillion and thus fiscal deficit is $1.38 Trillion. The size of the economy is $25 Trillion. The fiscal deficit to GDP, therefore, is 5.52%. Interest payments are in the region of $475bn, accounting for almost 10% of revenues.
It is possible that the US government will have to borrow more from the markets and pay higher interest rates (which is already the case for US Treasury Notes). When the government becomes an aggressive borrower to pay for increasing interest payments, the private sector will be crowded out. This will mean less money for capex and infrastructure.
Since the private sector will be crowded out, the corporates will have to borrow at higher rates. Currently, the inflation in the US is much higher than the comfort level of 2% p.a. These are typical conditions that induce stagflation, meaning inflation and recession exist at the same time. The pressure on the US government to increase social welfare outlays is high given the election year is not far away. This will cause stagnation in the growth of the economy. It has been observed that extended periods of low growth actually result in recession.
(Author is Founder and Managing Director of Basiz Fund Service Private Limited)
