Just when fears of the Federal Reserve ‘tapering’ its extraordinary monetary stimulus measures have receded, the world economy is faced with a new threat emanating from the US – a partial federal government shutdown. The origins of this are political: Wrangling between Republicans and Democrats within the US Congress over the rollout of President Barack Obama’s healthcare reforms has resulted in a deadlock over the budget and seen parts of the federal government close down from the start of the new fiscal year from October 1. Although 700,000 employees face the prospect of unpaid leave, vital government services will continue normally and some with skeletal staff. The impact in the short run may be limited. But if the deadlock continues and the Congress fails to agree on a rise in the US Government’s borrowing limit, now set at $16.7 trillion, it will result in a default of payment obligations.
The spectre of a federal default, leave alone an actual failure to pay, is worrying enough. Fears that the debt ceiling will not be raised may further lead the US Government to slash other spending, denting confidence and derailing the ongoing, albeit slow-paced, economic recovery. The impact of this on Indian exports will be considerable. The second possibility is of default fears stoking a rise in US treasury yields. True, this did not happen in August 2011 when Standard & Poor’s downgraded the credit rating of the US Government. The global investor uncertainty then resulting from the downgrade oddly enough led to US treasury bond prices and the dollar rising . Either way, overall heightened risk aversion and flight to ‘safe’ assets will see investors pulling out money from emerging markets, including India.
On the face of it, renewed concerns about a US economic slowdown, which is likely to push the Fed into a further postponement of its tapering plans, may seem of some benefit to India. But on the other hand, a resolution of the current deadlock may well prompt the Fed to accelerate the scaling down of its bond-buying programme. The lesson is simple: we must keep our own house in order. The global economic environment will continue to be uncertain, irrespective of whether or not there is a Fed tapering or a federal default. The countries most vulnerable to capital outflows in such situations are the ones with macroeconomic imbalances on their external and fiscal fronts. While the Government and the Reserve Bank of India have taken some steps in bringing down the current account deficit to more manageable levels, these clearly aren’t enough. Eliminating under-recoveries in diesel and a clear plan to phase out fertiliser subsidies are important not only to address the ‘twin deficit’ problem, but also from the standpoint of boosting investor confidence. At the end of the day, the best insurance against extraneous monetary or fiscal events lies in what we do at home.