Debt & Taxes in US - the Fallout for India!

Of the many prized possessions the U.S.A has had, its long term credit rating was surely a coveted one. It held on to its AAA S&P rating for around seventy long years. The turnaround came in the eventful year of 2007- 2008. After the housing bubble bust led to the ensuing subprime mortgage crisis and brought about the most talked about economic phenomenon of recent times, i.e., the Great Depression, the USA had to pump in trillion of dollars to rescue its Financial institutions of repute. The economists and doomsayers were skeptical alike whether the Sovereign bail out would be enough to bring back the US economy its lost sheen and prestige. But for the time being it seemed the only way out. This rendered some serious fracas on the economic ecosystem of the world’s most envied nation, the effects of which have scaled up over these years. The budget for 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.

Furthermore, the legislators at the helm of the world’s only superpower had no clue on how to cut on the spending and thereby reduce the sovereign debt. The Republicans were hell bent against raising the government’s borrowing limit. What followed was a fractious debate over various moot issues like, raising the nation’s debt ceiling, increasing the tax rates, measures to lessen the spending etc. All this ended in a hasty last minute compromise of raising the debt ceiling (to avert a debt default) by around $3 trillion that would reduce the country’s debt by more than $2 trillion (how this happens still remains a mystery!). This political pandemonium has had its effects on the S&P’s and if concrete measures are not taken, other rating agencies would follow the suit.
If we were to look at all these developments from India’s point of view, the picture does not look all gloomy. Of course, there is no denying the fact that the dollar depreciation would hurt Indian exports by making them less competitive, while cheaper imports will put pressure on domestic manufacturers. The data gathered suggests that Indian exports had declined sharply in the second half of 2008-09 owing to a slowdown in the US economy. The sector that seems to loose the most is the one that is the largest beneficiary of outsourcing (no prizes for guessing that!), i.e., the Great Indian IT sector. Also the Reserve Bank of India has cautioned that in the immediate future its priority will be to ensure that adequate rupee and forex liquidity are maintained to prevent excessive volatility in interest and exchange rates.
But there are also some rosily tinted facets to this turmoil. The slowing down of the world economy will definitely pull down the oil and gas prices which would cut the import bill for India (a great relief indeed!). Moreover, the growth of the country depends to a large extent on the domestic market. This kind of ensures a steady growth rate. Another round of Quantitative easing in the US (third in a row!) is very much on the cards. Every time this happens, some good amount of investments seems to find its way to the emerging markets like India. At the same time, there may be higher inflows of foreign institutional investor (FII) funds. This will lead to appreciation of the rupee, which in turn will help bring down the current account deficit. An obvious course of action for the global investors would be to consider diversifying their assets out of US treasuries. This can very much exert pressure on the dollar. There is also fear that some funds that are not allowed to hold any asset without an AAA rating might be forced to sell treasuries. Also India may not be as vulnerable as compared to China, Japan, Hong Kong or Brazil to loose on its forex portfolio from a spike in US interest rates, as only 13 per cent of its forex reserves are in US treasuries.
But to have all these goodies in our kitty, India needs a whole bunch of economic reforms. It’s high time we take advantage of these happenings and improvise on our BBB- debt rating status in the world. The government should sit up and take stock of it. The reforms should be in the areas of controlling inflation and reducing fiscal deficit; improving economic efficiency; ensuring equitable growth; thrust on education, health and sanitation; an additional three to four per cent investment on infrastructure; addressing issues of land acquisition, rehabilitation and resettlement; deepening policy reforms in the financial sector; addressing gaps in the overall economic regulatory architecture; and last but not the least, to the various environmental issues.