What Is The Noise Around The U.S. Debt Ceiling?
Imagine someone who can no longer pay their bills as they have no money in their bank account. What should they do? They should borrow money from the bank which is a simple process nowadays. However, a simple process becomes cumbersome when it comes to a country and the U.S. is getting a lot of backlash for such borrowing demands in the name of the “debt ceiling”. Let us peek into all the ruckus and make some sense of it.
What Is A U.S. Debt Ceiling?
The U.S. Debt ceiling is a concept of borrowing where the legislative limits the maximum permissible borrowing to protect the economy from excessive debt. To understand it in detail, debt is the amount of money the government is forced to borrow to cover the difference between the expenses (for example development works, government salaries, etc.) and its revenue (for example taxes) in a particular fiscal year.
To cover the deficit, the central government initiates selling marketable assets like T-bonds, sovereign bonds, etc. to the investors. The total debt payable by the government is the sum total of accumulated money along with the proposed interest at maturity. In practice, the government faces recurring deficits, resulting in the compounding of the national debt. At times, it becomes mandatory for the government to seek a raise in the debt ceiling to continue its expenditures.
The History Of The U.S. Debt Ceiling Modification
Raising or suspending a debt ceiling is not a new concept for the U.S. economy. Since 1960, the ceiling has been raised on seventy-eight occasions to date. Suspension of a debt ceiling is a rare event, coming into force in 2013 for the first time. Since then, Congress has exercised its power to suspend the debt limit seven times only.
Historically, a conclusive action on debt ceilings has been a fairly easy procedure for Congress barring 2011 when the debate between President Barack Obama and Republicans ended in a protracted deadlock1. The debt ceiling was eventually raised just two days before the X-date however the damage was done. It was one of the most volatile weeks for the U.S. equity market since the Great Recession of 2008 ending in a rating downgrade by S&P for the maiden and only time in history.
Current Developments
According to the U.S. Treasury, the total debt stands at $31.47 trillion as of May 20232. Now that the Federal Reserves are running low and the President wants to raise the ceiling to increase the borrowings to ensure no major cuts in the country’s spending. However, the Republicans desire to cap the spending at fiscal year 2022 levels.
As the first step to resolving the issue, President Biden and House Speaker Kevin McCarthy signed a deal to suspend the debt ceiling altogether till the first quarter of 2025. With the approval of Congress, the bill moved to the Senate for approval. With the final approval from the Senate coming just in time, the government will noe be able to pay the bills till 2025 and probably the next move will fall on the newly elected President in November 2024.
Effects Of Crossing Over The Debt Ceiling
According to a report published by the Council of Economic Advisers, in the event of the non-raising or suspension of the debt ceiling, the nation is bound to circle back on all the economic growth gained in the last 5 years and fall into the trap of recession3. Experts are of the view that if Congress fails to pass the bill on suspension of the debt ceiling, the U.S. will face the burnt of breach-induced recession impacting both the businesses and the common man.
According to Moody’s, any default on debt could result in a decline in the country’s GDP and a loss of approximately 2 million jobs, all of which will cause a major recession of the likes of 20084. Interest rates will skyrocket hampering the borrowing power of individuals and small businesses5. It is postulated that the equity market will also observe a steep downside on account of staggering sentiments and the pulling out of funds by the majority.
The Powerplay Of Credit Rating Agencies During The Debt Ceiling Dispute
The global debt market looks upon the “big 3”- namely, Moody’s, Fitch, and S&P ratings to determine the creditworthiness of organisations, governments, and even nations. Currently, the U.S. enjoys the highest-rated debt worldwide with a top rating from Fitch (AAA) and Moody’s (Aaa). However, all three agencies plan to downgrade the highest ratings if the U.S. legislature fails to address the issue of raising the debt ceiling6. A downgrade in the U.S.’s ratings would be powerful enough to shake the global economy with the possibility of a recession and erosion in the U.S. dollar value.
Curious to know how credit ratings work in India? Read more.
The Impact Of Hitting Debt Ceiling On The Indian Economy
Historically, any hit on the U.S. markets is bound to cause global spillovers. The delay in a conclusive action has resulted in a fallen dollar index, pressuring the Indian currency considerably7. Although the Indian economy has shown resilience toward global uncertainties in the past few years, volatility amidst the Indian stock market cannot be ruled out if the U.S. surpasses the X-date without any reforms.
A default will also result in declining exports to the plummeting U.S. economy. However, trade relations with other countries may strengthen during this temporary shift bringing new business opportunities for India.
Conclusion
As the debt ceiling approached its exhaustion date, the anxiety amongst the U.S. Congress mounted. The indecisiveness to raise or suspend the 2023 ceiling caused ripples in the economy which were evident from the rising dollar index. Experts feared severe short-term and long-term impacts on the U.S. and global economy if the Senate did not approve the raise. However, the deal between the U.S. President and the House Speaker instilled some hope of relief. Finally, the decision of the Senate to suspend the debt ceiling came just in time to prevent a major global economic catastrophe.
References:
- Council on Foreign Relations <https://www.cfr.org/backgrounder/what-happens-when-us-hits-its-debt-ceiling>
- The Department of the Treasury and the Bureau of the Fiscal Service <https://fiscaldata.treasury.gov/americas-finance-guide/national-debt/>
The White House <https://www.whitehouse.gov/cea/written-materials/2023/05/03/debt-ceiling-scenarios/> - Moody’s analytics <https://www.moodysanalytics.com/-/media/article/2023/going-down-the-debt-limit-rabbit-hole.pdf>
- Brookings <https://www.brookings.edu/articles/how-worried-should-we-be-if-the-debt-ceiling-isnt-lifted/#:~:text=Louise%20Sheiner,-The%20Robert%20S&text=The%20debt%20limit%20caps%20the,limit%20does%20not%20yet%20bind.>
- The New York Times <https://www.nytimes.com/2023/05/24/business/debt-default-credit-ratings.html>
- NDTV Profit <https://www.ndtvprofit.com/business/how-us-debt-crisis-may-impact-india>
Want to stay at the top of your finances? Don’t forget to sign up!
Join the community of 2.5 lakh + investors and learn more about Grip, the latest financial knick-knacks and shenanigans that take place in the world of investing.
Happy Investing!
Disclaimer: This communication does not constitute advice relating to investing or otherwise dealing in securities and is not an offer or solicitation for the purchase or sale of any securities. Grip Invest Technologies Private Limited ("Grip", formerly known as Grip Invest Advisors Private Limited) is not registered with SEBI in any capacity and does not advise, encourage, or discourage its users to invest or not invest in any securities. Grip is solely an execution-only platform and does not guarantee or assure any return on investments made by you in any opportunities sourced by Grip and accepts no liability for consequences of any actions taken based on the information provided. Your investment is solely based on your judgement. Investments in debt securities are subject to risks. Read all the offer related documents carefully.
