THE US DEBT CRISIS: IMPLICATIONS FOR GLOBAL ECONOMY WITH SPECIAL REFERENCE TO INDIA

PROF(Dr.) SK LAROIYA Click to edit Master subtitle style AMITY BUSINESS SCHOOL AMITY UNIVERSITY UTTAR PRADESH

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What is the US debt crisis? Since 1917, the US congress has stipulated that there has to be statutory limit on US public debt( debt of federal government) This figure has been raised periodically and stands at $ 14.3 trillion (95% of US GDP)
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Aug. 2,2011Compromise deal hammered between the democrats and republicans to resolve the US Debt crisis What is the deal? To raise the debt ceiling from the current $ 14.29 trillion by about $2.4 trillion Spending cuts about $2.4 trillion 4/15/12 Dr. SK Laroiya ABS 33

What is the debt ceiling exactly?

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It's a cap set by Congress on the amount of debt the federal government can legally borrow The cap applies to debt owed to the public (i.e., anyone who buys U.S. bonds) plus debt owed to federal government trust funds such as those for Social Security and Medicare
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The first limit was set in 1917 and set at $11.5 billion Previously, Congress had to sign off every time the federal government issued debt
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How high is the debt limit right now?

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The ceiling is currently set at $14.294 trillion US's accrued debt hit that mark on the morning of May 16

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But by taking various extraordinary measures like suspending investments in federal retirement funds, Geithner, the Treasury Secretary was able to bring total debt down enough to allow the government to continue borrowing until Aug. 2. By the end of trade on May 17, total debt subject to the limit was a mere $25 million shy SK Laroiya ABS of the official cap -- or 4/15/12 Dr. 99

How is the ceiling determined ?

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They don't admit it, but lawmakers tacitly agree to raise the debt ceiling every time they vote for a spending hike or tax cut

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So in reality arguing over the debt ceiling is essentially arguing over whether to pay the bills the US has already incurred And politics, of course, permeates the whole debate Lawmakers who wantABS make hay of 4/15/12 Dr. SK Laroiya to 1212

How many times has the ceiling been raised?

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By the Treasury Department's count, Congress has acted 78 times since 1960 to raise, extend or alter the definition of the debt limit 49 times under Republican presidents, and 29 times under Democratic presidents
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US debt limit since 1940

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Debt Limit as a Percentage of GDP

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Why does Congress even bother to set a debt limit?

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In theory, the limit is supposed to help Congress control spending In reality, it doesn't Every time the debt limit needs to be raised, lawmakers and the US president are forced to take stock of the country's Dr. SK Laroiya ABS fiscal direction, which 4/15/12 1818

What would have happened if Congress had not raised the debt ceiling by Aug. 2?
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Treasury would not have authority to borrow any more money And that can be a problem since the government borrows to make up the difference between what it spends and what it takes in It uses that borrowed money to help fund operations and pay creditors
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If Congress does not raise the debt ceiling, the U.S. Treasury will run out of cash reserves to pay for obligations like Social Security, Medicare and Medicaid, and defence contracts The chart below shows the amount of the nations cash reserves and estimates for when it would have run 4/15/12 Dr. SK Laroiya was out if the debt ceilingABS not 2121 raised

May 16 As the U.S. reached its debt limit, the U.S. Treasury instituted what Secretary Geithner called extraordinary measures to provide $232 billion while a budget deal was negotiated Aug. 3 Obama administration estimate for when it will exhaust its borrowing authority Aug. 10 Estimate by many Wall Street and Washington analysts.

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Geithner's ( The Treasury Secretary) critics say he could have prevented default by simply paying the interest due to bondholders. But since average spending -- minus interest -- outpaces revenue by about $118 billion a month, Geithner wouldn't have been be able to pay all the country's bills.
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Ultimately, had the lawmakers failed to raise the ceiling, they would have been left with two choices, both awful They could either cut spending or 4/15/12 Dr. SK Laroiya ABS 2424 raise taxes by several hundred

The first option would be impossible to execute without serious economic repercussions And the second option could have crippled the economy and send world markets into a tailspin
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A default could hurt U.S. bonds, the dollar and investors' portfolios

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Will reaching the debt ceiling for good cause a government shutdown?

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Not technically A government shutdown occurs if lawmakers fail to appropriate money for federal agencies and programs By contrast, if the debt ceiling is breached, Uncle Sam would still have revenue coming in that could be used to fund the government
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Why is US Facing Debt Crisis?

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In one sense the US is facing a debt crisis The level of government borrowing has risen sharply as a % of GDP (95), and given current spending commitments the forecast for borrowing is to continue to grow
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Nevertheless, despite disputes over raising debt ceiling, the US doesnt currently face a crisis like Greece or other Euro countries. Bond yields on US debt are still low (and have fallen since start of recession in 2008)
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1. Cyclical Factors / Discretionary spending The recession and financial crisis of 2008 led to a fall in tax revenues Falling bonuses led to lower income tax
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2. Unemployment spending US unemployment benefits are relatively low, but, even so, the large rise in unemployment has triggered an increase in social security related payments

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3. Health Care Costs The biggest single factor in explaining the rise in US public sector spending is health care costs In the 1970s, US government spending on health care was 7% of GDP in 2011; Dr. SK Laroiya ABS it is now 15% of 3535 GDP 4/15/12

In the US, the fragmentary system of private provision and government benefits means that the government end up paying for expensive treatment for many people The increase in health costs is being exacerbated by an ageing population who tend to need more treatment
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4. Pensions. The ageing population also puts pressure on government spending on pensions Currently the % of the population over 65 years old is 13 per cent. This is expected to reach about 20 per cent by 2050
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5. Reluctance to Increase Taxes The US has one of the lowest effective rates of corporation tax and income tax in the OECD, but more than anywhere else there is a strong political reluctance to increase taxes
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6. Defence Spending Two wars in the 1990s and 2000s have increased the US spending on military Discretionary spending, which includes defence rose to 9.3% last year. The highest since the late 1980s.
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Arguments Over Debt Ceiling Usually Congress agree to allow debt ceiling to rise. But, currently the Republican party is demanding improvements to budget come from spending cuts rather than tax increases, this political impasse is making markets more nervous over 4/15/12 Dr. SK 4141 buying US bonds Laroiya ABS

Overall The problem is that the US faces demographic factors which put more pressure on government spending. But, there is a reluctance to either increase taxes and / or cut spending in areas which are claiming the biggest increase.
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Likely impact of on global economy

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1. AAA Rating in trouble ? S&P rating for US down to AA What about other countries in Europe? ImplicationsBond market Higher borrowingLaroiya ABS 4/15/12 Dr. SK cost
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With a downgrade, the US government has to pay $2 billion more interest for every $1 trillion debt and investors holding US treasury bills will collectively lose more than $50 billion Morgan Stanley Report

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Moodys and Fitch ratings have affirmed as of now , AAA rating for the US but have warned that downgrades were possible if US fails to enact debt reduction measures and US economy weakens
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Chinese Credit Rating AgencyDAGONG- downgraded US sovereign rating ( Aug. 3)

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RATING OUTLOOK

10-YEARGOVERNMENTBONDYIELD

Switzerland AAA Stable 1.5% HongKong AAA Stable 2.3 Sweden AAA Stable 2.7 Germany AAA Stable 2.7 Canada AAA Stable 2.9 UnitedStates AA WatchNeg. 3.0 BYS&P Denmark AAA Stable 3.0 Britain AAA Stable 3.1 Netherlands AAA Stable 3.1 Finland AAA Stable 3.1 Norway AAA Stable 3.2 Austria AAA Stable 3.3 France AAA Stable 3.3 Australia AAA Stable 4.9 Belgium AA+ Negative 4.3% NewZealand AA+ Negative 5.1 Slovenia AA Negative 4.3% Spain AA Negative 6.0 Japan AA Negative 1.1% China AA Stable 4.1 SlovakRepublic A+ Stable 4.2% Italy A+ Negative 5.6 CzechRepublic A Positive 3.9% SouthKorea A Stable 4.2 Israel A Stable 5.2 Sources:Standard&Poors;Bloomberg Malaysia A Stable 3.9% _________________________________________________________________________________ Poland A Stable 5.8

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TOP FOREIGN HOLDERS OF US TREASURY SECURITIES

The share of US public debt held by foreign governments has risen steadily in the last quarter century up from 13% in 1988 to 25% in 2007 to nearly 50% today As on January 2011, foreigners held roughly $4.45 trillion worth of US debt- which equates to approximately 4/15/12 Dr. SK Laroiya ABS 47% of the $9.5 trillion worth 4949 of

With $ 1.154 trillion worth of US securities, the Central Bank of Mainland China , is the single largest overseas holder of US public Debt followed by Japan India holds $40.6 billion of US public Debt
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RANK
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

COUNTRY
MAIN LAND CHINA JAPAN UK OIL EXPORTERS BRAZIL CARIB. BANKING COUNTRIES TAIWAN RUSSIA HONGKONG SWITZERLAND CANADA LUXEMBURG GERMANY SINGAPORE THAILAND IRELAND INDIA MEXICO TURKEY BELGIUM TOTAL ( ALL HOLDERS)

US DEBT (BILLION US $) AS ON JAN. 2011- DEPTT. OF TRESURY

1154.7 885.9 278.4 215.4 197.6 166.5 157.2 139.3 128.1 107.6 86.6 83.0 61.1 57.8 56.4 44.4 40.6 34.4 32.9 32.1 $ 4453.4

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2. Impact of fiscal correction (as per the deal) in the US

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Low consumption Sluggish investment imports

have serious repercussions on the global economy

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3. US stock market 4.Weak dollar 5. Impact on international monetary system

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Is there any impact on India?

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In the short and medium term, the impact on the India is likely to be marginal Why?

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1. 2. 3. 4. 5.

Exports of IT and IT related services FDI inflows Stock market Exchange rate Oil prices

But we need to be on guard

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Are there few Lesson(s) that we can learn from US debt crisis ?

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