Indian markets might have ignored the US shutdown despite global equity markets facing relatively volatile moments; but if the US defaults on debts, then it cannot be wished away easily by domestic market participants.
Borrowing afresh to repay old loans has become a frequent phenomenon across the globe. After the US banking system collapsed in 2008, the US had to flush the economy with cash, known as quantitative easing, to keep the ship afloat.
If the Congress and President Obama fail to reach an agreement to raise the debt ceiling of $16.7-trillion before mid-October, the US may technically default on its debt. Such a default, which the world has not witnessed so far, will disrupt the global financial system on a massive scale, particularly emerging markets such as India.
Even, US President Obama had warned that the economic effects of a political gridlock could grow far worse if the Congress fails to raise the debt ceiling by October 17, leaving the country at risk of defaulting on its borrowing. The US had averted debt ceiling crisis on January 1after much dilly-dallying.
“This time it is different,” Obama had warned in an interview and had said that “Wall Street should be concerned.”
As India is completely coupled with the global economy, there will definitely be some tremors felt.
Both imports and exports will be hit. India’s exports to the US, particularly IT services, will have an adverse impact.
However, for India, the primary concern would be of managing the current-account deficit, which has shown some signs of improvement in recent times, thanks to a slew of measures initiated by the Government and the RBI. A default by the US on its debt obligations is likely to push up not only gold prices, but also other commodities such as crude oil which Indian imports in a large quantity.
It may also result in a slowdown or a reversal in foreign institutional investments.
However, there will not be much pressure on Indian banks, as they have only limited exposure to the US treasury markets.
Besides software sector, pharmaceutical will also face some pressure, as the sector’s dependence on the US market is increasing significantly.
Assocham President Rana Kapoor said different wings of the Indian Government should prepare a contingency plan to ring-fence the economy if the US defaults. “The most important factor would be to ensure our foreign exchange reserves do not deplete and we keep foreign institutional investor inflows intact,” Kapoor added.
However, Russ Koesterich, Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist, believes that the current budget battles will ultimately be resolved. “They are likely to cause more near-term angst for investors before a resolution is reached and are likely to be a short-term negative for stocks,” he added.
One hopes the US will find the solution soon to calm the nerves of investors.