The global economy is being held hostage to the US Debt Crisis. But among others, how will it impact the Indian markets?
The stage is set, and all eyes are fixed on the United States. Will the Democrats and Republicans strike a last minute deal and raise the debt ceiling? Or will the US treasury default and put the economy into a recession?
Well, just like everyone else, India is also keenly waiting for the climax because their decision can make or break India’s economic outlook.
Let’s find out how.
In January 2023, the United States reached a critical milestone – it exhausted the cap of its colossal $31.4 trillion debt. This event was crucial globally because if the US treasury defaults, it will push the nation into a recession. The after effects of the default would be seen far beyond American borders, affecting the very economies that have lent money to the US.
According to Economic Times, nearly 30% of the US debt is held by foreign entities, and among them, India stands out with a significant stake of $220 billion in the colossal $31 trillion debt. And after looking at the numbers, the implications seem undeniable.
The 2011 Situation
Now, this is not happening for the very first time because back in August 2011, there was a significant event that shook the global financial landscape. Standard & Poor’s (S&P), a well-known credit rating agency, downgraded the United States’ long-standing AAA rating to AA+, signalling a negative outlook.
S&P’s decision was driven by mounting concerns about the overall financial health of the United States, including its increasing debt burden. During those days too, India had a substantial portion of total forex reserves invested in US Treasury bonds. These investments accounted for approximately 13% of India’s forex reserves, equivalent to around $41 billion.
Now, the Reserve Bank of India (RBI) was responsible for managing these reserves and had to follow an unwritten rule of investing in top-rated (AAA) instruments to prioritize safety and liquidity. But, the downgraded rating was a crucial challenge in front of RBI.
The question remains, will history repeat itself? Well, nobody knows.
How Will The Debt Ceiling Impact India?
If the US defaults, India will also feel the impact. According to Economic Times, the US default could lead to sharp fluctuations in domestic currency markets and put stress on equity markets. Also, the rupee may feel the shivers in the coming times.
The implications of a potential US default will undoubtedly be felt by countries that hold a significant amount of US treasuries. India has holdings of $220 billion. But, it is not alone in this situation. Japan holds over $1 trillion while China holds over $800 billion of US treasuries.
Additionally, numerous wealthy companies, individuals, investment funds, and sovereign wealth funds, based in regions like the Middle East and Norway, also have substantial holdings, according to Kenneth Rogoff, former chief economist at the IMF.
According to CNBC-TV18, there is a prevailing belief on Wall Street that lawmakers will eventually come to an agreement regarding the US debt ceiling. However, the reality at present is that the treasury only has around $95 billion available, a number that needs to rise to $550 billion by the end of June 2023. Achieving this requires an increase in the debt ceiling, but it is not a straightforward process.
To raise the debt ceiling, the treasury will need to issue more bills than usual, which means drawing funds from the private sector. This action can lead to a reduction in liquidity within the US, impacting its economy. As the saying goes, “when the US sneezes, the world catches a cold,” and the world, including the Indian markets will have to face the impact.
That’s it for today. We hope you’ve found this article informative. Remember to spread the word among your friends. Until we meet again, stay curious!
*The companies mentioned in the article are for information only. This is not investment advice.