Dr PK Vasudeva: How US debt crisis will hit India

The United States 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.

US debt has held the AAA rating since 1917. Currently, fewer than 20 countries have AAA ratings.

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.

” 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 US’s debt rating by the end of August. Given the terms of the debt deal signed, it is possible the US debt rating could be downgraded at that time, Fitch said.

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 the 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.

Oftentimes, 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 the ship afloat.

The US government did this by borrowing several trillion dollars. But even that did not prove enough. The Republicans, who are in the opposition now and whose erratic economic policies caused the problem, decided to show president Barack Obama their power.

The US is not the PIGs (Portugal, Ireland, and Greece) 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% and the dollar by about 1% against both the yen and the Swiss franc; gold went down slightly.

The main gainer has been gold. As an outcome of all these developments, the demand for gold has increased. As gold is seen as a safe haven, its price has hit a record high.

As the domestic economy is not insulated from the world economy, there will definitely be some tremors here 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 of the 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.

At the same time, there may be higher inflows of foreign institutional investor (FII) funds. This will lead to the 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.

Unfortunately, prime minister Manmohan Singh, thanks to his curious leadership style, is not in a position to take advantage of this serendipitous hiatus in 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.

The UPA government has no time to take advantage of this situation by concentrating on the economic reforms to emerge as a strong leader and inch towards AAA debt rating in the world.